The behaviour of the risk based capital adequacy ratio in Iran’s banking system

ABSTRACT

This study was carried out to identify the determinants of the behaviour of public and private banks in determining their risk and capital over 2001–2016 period by considering the banks’ risk and capital simultaneously. The model was estimated using 2SLS-RE and GMM methods. According to the results, the endogeneity of two variables of risk and capital in equations cannot be rejected. It should be noted that this study does not reject a significant relationship between the risk and thecapital to risk (weighted) assets ratio (CRAR) over the study period.

KEYWORDS:

• Iran’s banks
• capital adequacy
• risk
• endogeneity
• 2SLS-RE
• GMM

JEL CLASSIFICATION:

• G2
• C33
• G21
• G32

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. Capital adequacy ratios (CARs) are a measure of the amount of a bank’s core capital expressed as a percentage of its risk-weighted asset.Capital adequacy ratio is defined as:

$CAR=\frac{Basic\mathrm{C}\mathrm{a}\mathrm{p}\mathrm{i}\mathrm{t}\mathrm{a}\mathrm{l}}{(\mathrm{R}\mathrm{i}\mathrm{s}\mathrm{k}\mathrm{C}\mathrm{o}\mathrm{f}\mathrm{f}.\ast \mathrm{T}\mathrm{r}\mathrm{a}\mathrm{n}\mathrm{s}\mathrm{C}\mathrm{o}\mathrm{f}\mathrm{f}.\ast \mathrm{o}\mathrm{f}\mathrm{f}\mathrm{b}\mathrm{a}\mathrm{l}\mathrm{a}\mathrm{n}\mathrm{c}\mathrm{e}\mathrm{i}\mathrm{t}\mathrm{e}\mathrm{m}\mathrm{s})+(\mathrm{R}\mathrm{i}\mathrm{s}\mathrm{k}\mathrm{C}\mathrm{o}\mathrm{f}\mathrm{f}.+\mathrm{B}\mathrm{a}\mathrm{l}\mathrm{a}\mathrm{n}\mathrm{c}\mathrm{e}\mathrm{s}\mathrm{h}\mathrm{e}\mathrm{e}\mathrm{t}\mathrm{i}\mathrm{t}\mathrm{e}\mathrm{m}\mathrm{s})}$

Where, CAR indicates the capital adequacy risk, Basic Capital represents the base capital, the risk coff indicates risk coefficient, the Trans Coff, transformation coefficient, off balance items, off balance sheet items and items above the balance sheet.

2. https://www.cbi.ir/simplelist/1463.aspx

3. https://www.cbi.ir/datedlist/5254.aspx

4. After 1979 Iran’s revolution, banking system has experienced several stages. At the first stage, immediately after revolution, the ownership of banks transferred from private sector to public sector and entirely under control of government. As a second phase, and five years later in 1984, the new regulation called ‘banking law without interest rate’ has been approved and executed. The third stage of Iran’s banking has started from 2000, the year which funding private banks has been authorized. In spite of implementing new regulation based on Islamic finance since 1984, in practice the principles of old regulation of ‘ Iran’s monetary and banking law’ (approved in 1960 and corrected in 1972) have been using. These two parallel laws beside a large volume of diversified regulations were not able to improve standards of regulations in Iran’s banking system. Now, it is necessary for monetary authority to follow international standards in regulating banking activities. This sentence doesn’t exclude implementing of Islamic banking, due to some ambiguities in performance of banking system and its inconsistence with some principles of Islamic finance.

5. It is worth mentioning that we didn’t set our equations based on formal Islamic theory of bank. Instead, we used a set of informal econometric equations which only consistent with theoretical relations between risk and capital holding, regardless of Islamic or conventional theory of bank. It can be the subject of other independent study.

6. This variable was fixed after converting it into a ratio and its definition is as the ratio of bad credits to the total credits (LL).

7. During that period, banks ordered by government to pay some short- term loans to micro and small firms to incentivize their employments or production lines surge.

Additional information

Notes on contributors

Ebrahim Rezaei

Ebrahim Rezaei is an associate professor at the economics department of the institute for research and development in the humanities (SAMT), Tehran, Iran. Over his working experience for more than a decade, he has published several papers on banking and taxation subjects with emphasizing on Iran's economy and other emerging markets.