A STUDY ON TRANSFORMATION OF EMERGING MARKETS BANKING SYSTEM ON ADOPTION OF BASEL NORMS

Abstract

In recent years, policymakers, researchers, and regulators have collectively emphasized the importance of preserving the stability of financial institutions, particularly in the aftermath of the Global Financial Crisis (GFC). It is widely acknowledged that the existing Basel II framework needed to be revised to handle the challenges posed by the GFC. In response to these shortcomings, the Basel Committee on Banking Supervision (BCBS) introduced Basel III, primarily focusing on implementing capital and liquidity regulations. The overarching goal is to foster an environment conducive to long-term economic stability, strengthen banking practices, and mitigate systemic risks. These measures aim to bolster the overall health of the banking industry and, ultimately, support sustainable economic growth. In addition to the capital adequacy ratio (CAR), BCBS introduced two minimum liquidity norms: the Liquidity Coverage Ratio (LCR), addressing short-term requirements, and the Net Stable Funding Ratio (NSFR), addressing long-term considerations. As per the LCR, banks must maintain a sufficient amount of high-quality liquid assets to cover their needs for liquidity during times of stress that last longer than a month. It is believed that the bank can take necessary corrective action during such times. The goal of the NSFR is to guarantee, over a one-year period, a minimum level of consistent funding for bank assets based on those assets’ liquidity characteristics. However, once banks adhered to the liquidity requirements, their ability to generate liquidity was limited. This is because banks generate liquidity by converting liquid short-term liabilities into long-term non-liquid assets and extending off-balance-sheet loan obligations and guarantees. The study is driven by the motivation to examine various facets of capital and liquidity. First, it examines the influence of increased capital and liquidity regulations on the bank lending of emerging countries banks. Second, it examines the impact of capital and liquidity regulations on the financial stability of merging countries' banks. Third, investigate the effects of implementing capital and liquidity requirements on the bank’s profitability. Fourth, examine the impact of capital and liquidity creation (LC) on the credit risk of banks in emerging countries. Fifth, explore the impact of implementing capital and liquidity requirements on the performance of Indian banks concerning credit supply, non-performing loans (NPLs), and net interest margin (NIM). This investigation is conducted separately for both public and private sector banks to attain a more profound understanding. To achieve these objectives, the study employs data from commercial banks across emerging countries during the period 2013 to 2021. The period of examination starts in 2013, which is Basel III’s real transition phase and is limited to 2021 because of data availability. The findings of the study support that bank lending is positively impacted by the regulatory capital and the short-term liquidity requirement (LCR), but negatively impacted by the NSFR. The bank’s financial stability benefits from achieving the required capital and liquidity requirements. Lending growth and bank stability are nonlinearly impacted by regulations governing bank capital and liquidity. Furthermore, the Generalized Methods of Moments-Quantile Regression (GMM-QR) is used. Finally, results indicate that regulators of developing countries should support adequate capital and liquidity management to lessen adverse economic shocks’ impact on banks’ intermediation capabilities and stability. The findings suggest that there is a positive association between LC and bank profitability. However, this positive relationship doesn’t hold true for small-size banks. The possible reasons for this association may be twofold. Firstly, the Basel III liquidity standards may pose a burden on small banks due to their limited scale of business. Secondly, there is a need for liquidity requirements to limit excessive LC without adversely affecting their profitability. Nevertheless, a significantly positive association between LC and bank profitability holds true for different proxies of LC. Furthermore, the increase in LC leads to an increase in credit risk. This relationship holds true across various sizes of banks and alternative proxies of LC. As a result of the positive correlation between LC and bank profitability, our study's findings indicate that banks have substantial incentives for LC. However, because excessive LC raises the likelihood of a financial crisis due to increased credit risk, regulators may enact measures that restrict banks' excessive LC. Moreover, this positive effect of LC on bank credit risk calls for combined regulation of liquidity and credit risk so that none of the risks is left uncontrolled, as well as their influence on one another Furthermore, the findings of the study indicate that the adoption of Basel III will be advantageous for both private and public sector banks in India. Despite a substantial increase in loan disbursement, there is no reduction in credit supply by banks. The adoption of Basel III is associated with an improvement in net interest margin for banks, with no discernible impact on the levels of non-performing loans (NPLs), irrespective of the type of bank. Both institutional quality indicators and macroeconomic variables exert an influence on credit supply and interest rates for both private and public sector banks. These results carry implications for policymakers and regulators in India, emphasizing the necessity for distinct regulations tailored to the specific characteristics of each type of bank. Furthermore, alongside bank-specific variables, governance quality, and macroeconomic factors also contribute to influencing bank performance. The practical implications of this study extend to both policymakers and financial institutions. Policymakers can leverage the findings to enhance and tailor regulatory frameworks, ensuring that they effectively achieve desired outcomes in terms of bank lending, financial stability, profitability, and credit risk. Financial institutions, armed with these insights, can make informed decisions about the implementation of financial regulations in alignment with Basel III requirements.