Effectiveness Analysis of Capital Adequacy Regulation in China

by Changchun Hua

East-West Center Working Papers, International Graduate Student Conference Series, No. 24

Publisher: Honolulu: East-West Center
Publication Date: 2006
Binding: paper
Pages: 15
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This paper is to estimate the effectiveness of capital adequacy regulation (CAR) in improving capital ratios and restraining risk-taking behavior of Chinese banks in a simultaneous equation framework with an unbalanced panel data of 37 China's commercial banks (1999-2003). As shown in the data, most domestic banks in China have not yet met the 8 percent capital requirement. The empirical analysis does not find a statistically significant relationship between changes in capital, risk levels and the regulatory pressure, implying that the imposition of capital adequacy regulation may not effectively increase capital level and discourage risk-taking behavior of banks in China. To improve capital adequacy of Chinese banks, therefore, recapitalization for state-owned banks should be implemented. Furthermore, the regulatory authority should be handed over the independence, which may help it fairly exercise its regulatory and supervisory authority. More importantly, ownership reform should be launched so that the government can focus on its role as a regulatory and supervisory agency instead of a bank owner, which is necessary for promoting an equal footing for all banks in the financial regulatory framework. Moreover, this also helps cultivate proper internal control mechanisms in banks.