Sample PhD Conclusion: Effectiveness of Basel III capital and liquidity requirements in reducing banks’ insolvency risk during COVID-19
Chapter 6. Conclusion
This chapter summarises the findings and draws conclusions about the impacts of Basel III regulations on the stability of banks during the COVID-19 pandemic. Section 6.1 provides an overview of the study, while the main findings are discussed in Section 6.2. Section 6.3 considers the implications of the study for both theory and practice. The limitations of the study are discussed in Section 6.4. Section 6.5 suggests recommendations for future research.
6.1 Overview of the study
Since the global financial crisis of 2007–09, regulatory authorities have been developing and implementing the Basel III framework to help improve the stability of the global banking system. Although the recent COVID-19 crisis was not a financial crisis, it served as a stress test for banks’ resilience. This research aimed to evaluate the effectiveness of Basel III requirements in strengthening the stability of European banks during the pandemic. The study examined how banks’ insolvency risk, proxied by the Z-score, was affected by regulatory capital and liquidity ratios, including Common Equity Tier 1 (CET1) Ratio, Tier 1 Capital Ratio, Total Capital Ratio, Liquidity Coverage Ratio (LCR), and Net Stable Funding Ratio (NSFR).
The present study employed a difference-in-differences (DID) design to evaluate the effect of Basel III requirements, with COVID-19 being regarded as an exogenous shock to the banking system. While several recent studies used a similar DID approach for assessing bank resilience during COVID-19 (Berrospide et al., 2021; Cao & Chou, 2022; Anani & Owusu, 2023), they focused on the capital transmission channel and ignored potential non-linearity in the effects of capital ratios on stability. In contrast, this research considered the effects of both capital and liquidity ratios on the insolvency risk, and non-linear relationships were incorporated by estimating a quantile DID regression with interaction effects (Callaway & Li 2019). This allowed the study to complement the evidence from recent research with a more comprehensive description of the relationships between Basel III requirements and bank insolvency risk.
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6.2 Summary of main findings
The results provided strong evidence in support of the effectiveness of Basel III capital ratios. The findings from the DID regression showed that banks with a higher level of regulatory capital ratio before the COVID-19 pandemic were associated with a substantially lower insolvency risk. This indicates that the recent reforms on capital requirements helped build up bank strength, which allowed banks to continue lending to the real economy during the pandemic. Further analysis showed that these effects may be non-linear, with capital ratios having stronger effects for banks closer to the regulatory threshold, as well as for smaller banks.
As for liquidity conditions, mixed evidence was obtained for LCR and NSFR. While the baseline model showed a significant effect of liquidity ratios on Z-score, quantile DID analysis revealed that this effect was largely due to banks that already had relatively poor solvency characteristics before the pandemic. The analysis suggests that the effect of Basel III liquidity on the maturity mismatch is mainly through banks that are close to being liquidity-constrained, with stronger effects being observed for smaller banks and for banks with lower-quality capital.
The results were found to be in agreement with recent literature on the banking sector during COVID-19 (Bitar & Tarazi, 2022). In particular, several studies reported a positive relationship between capital position and resilience (Korzeb & Niedziółka, 2020; Cao & Chou, 2022; Anani & Owusu, 2023; Dursun-de Neef et al., 2023; Alkhazali et al., 2024), as well as between liquidity position and stability (Duncan et al., 2022; Citaku et al., 2023).
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6.3 Theory and policy implications
The research has implications for the understanding of how banks’ lending affects the economy. The findings provide strong evidence that risk-based capital requirements are effective in ensuring that banks have adequate capital to absorb losses. It can be argued that a negative shock associated with high levels of credit risk and liquidity cost would be more easily withstood by banks with a better capital and liquidity position (Berrospide et al., 2021). As a result, the insolvency risk of such banks should not increase as much as for banks with poorer capital and liquidity positions. The present results also support the view that continuous credit supply to distressed clients, enabled by a stronger capital position, would alleviate loan defaults by such clients, in turn reducing banks’ credit risk and therefore insolvency risk (Anani & Owusu, 2023).
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Regarding policy implication, the results indicate that Basel III capital and liquidity requirements have been overall successful in curtailing solvency risk during the COVID-19 pandemic. It is therefore recommended to continue monitoring and improving the framework, in particular when it comes to allowing banks more flexibility. The findings suggest that Basel III requirements more strongly impact banks that are closer to regulatory thresholds, indicating that there may be inefficiencies when it comes to requirements for large, well-capitalised banks (Couppey-Soubeyran et al., 2020). National discretion may also play a role in the comparability of ratios, and it is recommended to incorporate regular revision of regulatory requirements into future developments.
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6.4 Limitations and recommendations for future research
The study is subject to several limitations, including the presence of missing values. While measures were taken to limit potential sampling bias, the results might not be readily generalisable to outside contexts. Private banks were also excluded, as they differ from listed firms in their access to capital markets and risk incentives, but this exclusion limits the generalisability of the results. The study did not distinguish between different types of banks, such as between retail and investment banks, which can be an avenue for future research. Furthermore, it is recommended that future research should consider how the observed effects may differ between countries depending on the degree of concentration of the banking system, presence of foreign banks, and share of Islamic banks, as these characteristics have been linked to differences in resilience (Danisman et al., 2021).
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References
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