Abstract:
There are controversies in literature on how impositions of capital adequacy
ratio (CAR) affect the bank behavior. In this context, present study analyzed
the impact of CAR on the bank behavior in terms of risk taking, lending and
profitability in the banking sector of Pakistan. For this purpose, present study
used sample of 26 banks due to the availability of data on CAR for the period of
2005-2015. The study contributes in literature by extending Shrieves and Dhal
(1992) model in Pakistani banking sector by using 2SLS and 3SLS techniques.
The study also used Chami & Cosimano (2005) model and trade-off theory, by
employing GMM technique to analyze the impact of CAR on the lending and
profitability behavior of Pakistani banks. Results of the study confirm that CAR
is effective in limiting risk-taking behavior of Pakistani banks which restrict
their lending capacity for private sector in Pakistan. However, higher CAR leads to
reduced cost of bankruptcy which improves the profitability position of Pakistani
banks. Furthermore, the study also aims to identify the implementation challenges
of advance approach of Basel Accord by using survey questionnaire. Results of
the survey show key challenges such as lack of resources, credit and operational
risk and supervisory review process however, proactive risk management
culture positively contributes to the implementation process. The study has
policy implications for the banks and regulators by providing them insights on
the tradeoff of higher CAR and recommendations to overcome implementation
issue of advance approaches of Basel Accord.
