Interrelationship Between Basel Accords Regulations, Efficiency and Risk. An Empirical Analysis of Pakistani Banking Industry
This study examines the effectiveness of Basel Accord regulations on the banking sector of Pakistan. Pakistani banking sector has undergone a lot of changes and it has witnessed a remarkable growth from 1998 to 2015. Incidentally this is the time period when Pakistan started implementing Basel regulations. Since one objective of these Basel regulations was to reduce risk of the banks and enhance the efficiency of banks so the purpose of this study is to find the impact of Basel capital regulations on the risk taking and efficiency of Pakistani banks. The fact that banks are obligated to implement Basel also raises questions on how regulation affects efficiency and risk taking behavior of the banks, and how this effect has changed over time. By taking various proxies and using secondary data collected from balance sheet and income statements of banks listed in Pakistan Stock Exchange during 1998 to 2015 the present study empirically investigates the impact of bank capital regulation on bank risk and bank efficiency from beginning of Basel regulation in 1998 to 2015 in Pakistan. Moreover this study also quantifies the effect of different Basel accords on the banking sector of Pakistan. By employing the Generalized Method of Moments (GMM), results of this study highlights that Basel capital regulations have reduced the bank risks taking, however the effect of capital regulation of Basel I and II on bank risk taken is not same. Though capital adequacy ratio for Basel I and II is same, however Basel II is more successful than Basel I in curbing the risk taking behavior of banks, thus highlighting the effectiveness of Basel II in reducing risks than Basel I. As far as the impact of capital regulation on the bank efficiency is concerned, it reduces the bank efficiency. However banks have seen their efficiency reduced more in Basel II, while Basel I impact on the cost efficiency of banks is negligible. Furthermore this study also analyzes the effect of other regulatory, firm specific and macroeconomic factors on the relationship between capital, risk and efficiency in the commercial banks of Pakistan. The findings of this study are beneficial for policy maker like State Bank of Pakistan (SBP) and management of banks to assess the consequences of implementation of Basel regulations in terms of risk reduction and efficiency enhancement. The results of this study are significant as they facilitate (SBP) to assess whether banks in Pakistan are following Basel regulation in its true Letter and Spirit. The findings of this study are helpful to SBP in formulating and enforcing suitable policies and strategies regarding risk management and improvement of the efficiency of Pakistani banks for the betterment of the banking industry in particular and stability of financial system in general.