The implementation of prompt corrective action: An assessment

Economic Policy Review, 1998

The Basle Agreement of 1988 is a twelve-nation banking accord that established international bank capital standards. A major implication of this agreement is that capital adequacy became central to regulatory oversight of banking systems around the world. From a policy perspective bank regulators seek to identify those institutions at risk of falling below capital standards in the near future. In this regard, this paper examines the efficacy of early warning systems (EWSs) with respect to the determinants and identification of capital inadequacy among U.S. commercial banks. Based on samples of banks in the late 1980s and early 1990s, EWS models are empirically tested using financial and economic data for individual banks. The empirical results reveal that banks pending capital deficiency are much different from other banks in terms of their financial health. Also, EWS models are able to detect the early onset of financial distress in commercial banks one year in advance with a reasonable degree of accuracy. We conclude that EWS models could be useful to bank regulators as both an off-site surveillance tool and a supplement to on-site examinations by supervisory personnel.

The Basle Agreement of 1988 is a twelve-nation banking accord that established international bank capital standards. A major implication of this agreement is that capital adequacy became central to regulatory oversight of banking systems around the world. From a policy perspective bank regulators seek to identify those institutions at risk of falling below capital standards in the near future. In this regard, this paper examines the efficacy of early warning systems (EWSs) with respect to the determinants and identification of capital inadequacy among U.S. commercial banks. Based on samples of banks in the late 1980s and early 1990s, EWS models are empirically tested using financial and economic data for individual banks. The empirical results reveal that banks pending capital deficiency are much different from other banks in terms of their financial health. Also, EWS models are able to detect the early onset of financial distress in commercial banks one year in advance with a reasonable degree of accuracy. We conclude that EWS models could be useful to bank regulators as both an off-site surveillance tool and a supplement to on-site examinations by supervisory personnel.

SSRN Electronic Journal, 2014

In this study, we test the predictive power of several alternative measures of bank capital adequacy in identifying U.S. bank failures during the recent crisis period. We find that an unconventional ratio-the non-performing asset coverage ratio (NPACR)-significantly outperforms Basel-based ratios including the Tier 1 ratio, the Total Capital Ratio, and the Leverage ratio-throughout the crisis period. It also outperforms in predicting failures among "well-capitalized" banks (as defined by the current Prompt Corrective Action guidelines). Based on our results, we argue that NPACR outperforms other ratios in at least five aspects: (i) it aligns capital and credit risks-the two primary risks of bank failures-in one measure; (ii) it is easier to calculate than the Tier 1 and Total Capital ratios, as it requires calculation of no complex risk weights; (iii) it allows one to account for various time period and crosscountry provisioning rules and regimes, including episodes of regulatory forbearance and crosscountry differences; (iv) it removes the incentives of both banks and regulators to mask capital deficiencies by creating/requiring insufficient loan-loss reserves; and (v) it outperforms all other commonly used capital ratios in predicting bank failures. We believe that all the above features of proposed measure promise its effective use in the prompt corrective actions by bank regulators. We also expect that this single and informative measure of bank risk can be efficiently used in empirical banking studies. The results of this study also shed light on regulatory forbearance during the recent banking crisis.

FRBNY Economic Policy Review, 1998

Journal of Banking & Finance, 1989

The paper extends the option-theoretic framework for the estimation of risk-adjusted deposit premiums to the calculation of risk-based capital adequacy standards. Based on market data for equity and the book value of debt, the model solves for the market value of the capital infusion required to lower the implied deposit premium to acceptable levels of risk. This capital infusion can then be translated into market-value capital adequacy standards and book-value capitalasset ratios, the determination of which is within the current statutory discretion of regulatory agencies. The model is empirically applied to a sample of 43 major U,S. banks. *The authors gratefully acknowledge the helpful suggestions and comments of the participants at finance seminars at

Journal of Finance, 2000

Unless priced and administered appropriately, a governmental safety net enhances risk-shifting opportunities for banks. This paper quantifies regulatory efforts to use capital requirements to control risk-shifting by U.S. banks during 1985 to 1994 and investigates how much risk-based capital requirements and other depositinsurance reforms improved this control. We find that capital discipline did not prevent large banks from shifting risk onto the safety net. Banks with low capital and debt-to-deposits ratios overcame outside discipline better than other banks. Mandates introduced by 1991 legislation have improved but did not establish full regulatory control over bank risk-shifting incentives.

SAGE Open

This study aims to examine the impact of different capital ratios on Non-Performing loans, Loan Loss Reserves, and Risk-Weighted Assets by studying large commercial banks of the United States. The study employed a two-step system generalized method of movement (GMM) approach by collecting the data over the period ranging from 2002 to 2018. The study finds that using Non-Performing loans and Loan Loss Reserves as a proxy for risk, results support moral hazard hypothesis theory, whereas the results support regulatory hypothesis theory when Risk-Weighted Assets is used as a proxy for risk. The results confirm that the influence of high-quality capital on Non-Performing loans, Loan Loss Reserves, and Risk-Weighted Assets is substantial. The distinctive signs of Non-Performing loans, Loan Loss Reserves, and Risk-Weighted Assets have indications for policymakers. The results are intimate for formulating new guidelines regarding risk mitigation to recognize Non-Performing loans and Loan Lo...

Journal of Financial Stability

This paper shows that the revised loan loss provisioning based on the International Financial Reporting Standards (IFRS) and the Generally Accepted Accounting Principles (GAAP) implies a reduction of Tier 1 capital which levies an additional burden on banks. The paper finds in a counterfactual analysis that these changes are more severe (i) during economic downturns, (ii) for credit portfolios of low quality, (iii) for banks that do not tighten capital standards during downturns, and (iv) under a more lenient definition of significant increase in credit risk (SICR) under IFRS. Hence, the provisioning rules further increase the procyclicality of bank capital requirements. Adjustments of the SICR threshold or capital buffers are suggested as ways to mitigate a regulatory pressure that may emerges due to the reduction of regulatory capital.

Journal of Business

The paper provides evidence about Basel II, as international banking regulations failure in recent global financial crisis. It describes old and new banking regulations main aspects on the base of before and during financial crisis periods. Banks’ holding of reasonable capital buffers in excess of minimum requirements could alleviate the procyclicality problem potentially exacerbated by the rating-sensitive capital charges of Basel II. Determining the sufficient buffer size is an important risk management task for banks. Actual bank capital is driven by bank income and default losses, whereas capital requirements within Basel II are driven by rating transitions. New regulatory approach to measuring capital adequacy appears consistent with banks’ own risk evaluations. The purpose of the paper is to show Basel II’s role in financial crisis based on qualitative inductive research. Also paper mentions some political aspects of modern banking regulations and future suggestions and recomm...