Regulatory Capital Regime, Competition and Stability: The Case Study of Banking Sector of Pakistan

Abstract

Regulatory capital requirements serve an important objective of ensuring financial stability. However higher capital requirements may increase risk of financial instability and even lead to accumulation of market power by banks thus affecting competition in the process through concentration of pricing power.

Using data of 30 banks over the period 2011Q1 till 2018Q2 for Pakistan, we find that higher capital requirements are associated with, improved financial stability of overall banking sector. Results vary depending on type (private or public sector banks) and size (big, medium or smaller banks). The findings for Big6 and Small9 banks indicate that imposing higher capital requirements might increase instability.

The study also finds that higher capital requirements mildly increase pricing power of the banks with bigger banks accumulating more power compared to medium and smaller-sized banks in Pakistan.

Keywords: Bank Regulation, Capital Requirements, Supervision

JEL Classification: G280