How Do Capital Ratios Affect Bank Risk-Taking: New Evidence From the United States

Abstract

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 Loss Reserves and the Risk-Weighted Assets for better results.

JEL Classification: G21, G28, G29