Basel Capital Requirements and Bank Credit Risk Taking In Developing Countries;

Existing literature has focused attention on the impact of Basle I and similar capital requirement regulations on developed countries where such regulations were found to be effective in increasing capital ratios and reducing portfolio credit risk of commercial banks. In the present study, we study the impact of such capital requirement regulations on commercial banks in 11 developing countries around the world within a cross-section framework with the widely popular simultaneous equations model of Shrieves and Dahl (1992). Surprisingly, we find that such regulations did not increase the capital ratios of banks in the developing countries. This implies that particular attention should be given to the business, environmental, legal, cultural realities of such countries while designing and implementing such policies for developing countries. However, we find evidence that such regulations did reduce portfolio risk of banks. We also find that capital ratios and portfolio risk are inversely related in contrast to the predictions of “buffer capital theory”, “managerial risk aversion theory”, and “bankruptcy cost avoidance theory.” Our, evidence also shows that level of financial development and credit risk are inversely related implying that as the financial sector of a country develops it opens up avenues for alternative sources of finance, which results in reduced risk.