The IUP Journal of Bank Management
Does Cost Efficiency Influence Bank Capital Formation and Cost of Bank Credit? Evidence from China and India

Article Details
Pub. Date : Nov, 2020
Product Name : The IUP Journal of Bank Management
Product Type : Article
Product Code : IJIT21120
Author Name :Mohammed Mizanur Rahman and Mohammad Mizanour Rahman
Availability : YES
Subject/Domain : Finance
Download Format : PDF Format
No. of Pages : 34



In response to the Global Financial Crisis (GFC) of 2007-2009, stringent capital requirements in the form of Basel III Accord have been implemented for the banking sector across the globe. Critics argue that banks may face difficulty in raising costly equity and may either decrease loans or charge higher cost on bank credit. We argue that cost efficiency can help banks to accumulate capital through profits, while at the same time, enable them to charge lower cost on bank credit. Analyzing a panel dataset of 224 banks from China and India over the period 2007-2015, we find robust evidence that cost efficiency has a positive impact on bank capital formation and a negative effect on the cost of bank credit. We further observe that the recent GFC has a substantial positive impact on banks’ capital ratios and the cost of bank credit. Chinese banks are more cost-efficient and highly concentrated compared to Indian banks. We draw important implications for bank regulators and banks.


Given the recent financial crisis, regulatory authorities in many countries have adopted stringent capital requirements in the form of Basel III for banks to ensure future financial stability. On the other hand, strict capital requirements have been criticized on the ground that holding higher capital is ‘too expensive’ and would jeopardize the banks’ ability to lend, increase the bank lending rates, and, consequently, would adversely affect the economic output (Wong et al., 2010; IIF, 2011; and Slovik and Cournède, 2011). Contrarily, Admati and Hellwig (2013) argue that equity is ‘not expensive’ and suggests even higher equity ratios (i.e., 20 to 30%). They argue that equity appears expensive because debt is subsidized by taxpayer-backed deposit insurance and bailout schemes and suggests that marinating higher equity ratios would not increase credit cost. Majumder and Li (2018) argue that efficient banks are holding higher capital that would assist in performing better. In this paper, we examine how the cost efficiency helps the Chinese and Indian banks to accumulate equity through profits and, at the same time, to charge lower interest rates on loans.


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