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The IUP Journal of Bank Management
Regulatory Capital and Its Impact
on Credit Risk: The Case
of Indian Commercial Banks
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This paper investigates the association between Capital Adequacy Ratio (CAR) (as set by the Reserve Bank of India in line with Basel Committee on Banking Supervision [BCBS]) and the credit risk of Indian commercial banks. The data for the study is a set of balanced panel of 43 (25 public sector and 18 private sector) banks for the period 1996-2016 which are triangulated from various secondary sources. The dependent variable credit risk is proxied by two measures, viz., Credit-Deposit Ratio (CDR) and Net Non-Performing Assets to Total Advances (NPA_TA). The independent variable is measured by the CAR as prescribed by the Basel norms. Apart from CAR, some bank-specific and macroeconomic variables are also used as predictor variables, namely, profitability, bank size, revenue diversification, liquidity, managerial efficiency, economic growth and inflation. With the help of panel data regression, the study reveals that when CDR is taken as a measure for credit risk, a positive association between CAR and credit risk exists, as against the model when NPA_TA is taken as a measure of credit risk where a negative association is observed. This implies that the regulatory capital positively impacts the quantum of lending operation of the banks as well as the quality of such lending. It is therefore inferred that banks have been undertaking risk set off measures in order to comply with the regulations and sustain a balance between profitability and stability. Moreover, it is observed that the different risk measures used to represent credit risk also have a bearing on the results.

 
 
 

Risk is inherent and an inescapable phenomenon in any business organization. So far as the banking sector is concerned, it is considered as the most risk-prone business due to its highly leveraged activities. Moreover, its role as a financier, trustee, protector, stabilizer and a lever to the economy crafts it as the most significant industry at national as well as at international levels. Due to its vital role and the dire consequences of its instability on the economy, regulators pour stern regulations over it. Banks, during their functioning, come through various types of risks. The initiation of financial reforms in 1991, deregulation of interest rates, rise in foreign participation, etc. induced increase in severity of competition which necessitated a high level of innovation in their products and services to survive in the market. Although such changes have brought a wide gamut of opportunities, they also increased the risks manifold. As pointed out by Raghavan (2005), the banks have graduated from being a financial intermediary in the past to a risk intermediary in the present. In many cases the banks increased their risk profile without simultaneously increasing their capital to sop up the losses incurred due to the unexpected events. This was evident from the degrading performance of the banks in terms of reduced profits, efficiency, increasing level of Non-Performing Assets (NPAs) and failure of many banks in different parts of the world. Although there were risk management practices prevalent in different parts of the world, those proved insufficient in a changing banking scenario. Of late, risk management in the banking sector has become a much discussed and debated issue. The introduction of the 1988 Basel Accord on international bank capital standards reignited interest in the effectiveness of bank capital regulations in reducing risk and increasing efficiency (Nguyen and Nghiem, 2015). But since being published and practiced, it has been consistently in dispute (Ma et al., 2011). As a single regulation, it is being imposed disregarding various
country-specific, and bank-specific factors. Further there have been questions regarding its effectiveness, fitness and efficiency..

 
 
 
Bank Management Journal, Capital Adequacy Ratio (CAR), Basel Committee on Banking Supervision [BCBS]) , Credit-Deposit Ratio (CDR), Net Non-Performing Assets to Total Advances (NPA_TA).