The Effectiveness of Bank Measures of Capital: A Canadian Study
Posted: 29 Sep 1999
Date Written: April 1999
Abstract
Since worldwide bank crises and major bank failures can cause systemic financial collapse, the Basle Committee on Banking Supervision has agreed upon a common system for the measurement of capital adequacy and for setting minimal capital standards. The proposed Basle capital requirements take into account banks? exposure to credit risk and off-balance sheet activities. Using a sample of Canadian banks, the first objective of this study is to compare the effectiveness of a measure of capital based on generally accepted accounting principles (GAAP) and the Basle measure of capital to proxy for banks? owner-contributed capital (the market value of equity adjusted for the deposit insurance subsidy). The second objective is to examine the extent to which the Basle ratio adequately captures banks? exposure to credit risk as well as the importance of other risk factors. The results indicate that a simple measure of capital based on GAAP performs as well as the Basle measure of capital. The results also indicate that the Basle ratio does capture some, but not all the credit risk. Given that other accounting measures of risk are also found to be significant, regulatory capital must account explicitly for other types of risk. These findings are consistent with the amendment being implemented in 1998, by the Bank of International Settlements Capital Adequacy Accord, to incorporate risk other than credit risk in capital adequacy ratios.
JEL Classification: M41, G21, G28
Suggested Citation: Suggested Citation