Capital regulatory pressure, charter value and bank risk-taking: empirical evidence for China

Purpose The purpose of this paper is to identify the effect of induced capital regulatory pressure on banks’ charter value and risk-taking, and the influence of bank’s charter value on its risk-taking under such a capital regulatory pressure. Design/methodology/approach The authors use two different estimations to check the robustness of the results. First, they apply a two-stage least squares mode to estimate the impact of capital requirements and bank charter value on bank risk-taking, with the influence of capital regulatory and market-force variables on bank charter value. Second, to reduce the problem of unobserved heterogeneity, the authors use dynamic panel data techniques as a check for robustness. Findings The empirical results show that higher capital requirements pressure brings about a lower charter value for banks, which in turn increases their risk-taking. The issue of banks’ risk-taking is also affected by their size: large banks seem to be more stable than their smaller counterparts. Research limitations/implications The authors’ findings suggest that regulatory pressure has had the desired impact on insolvency risk for Chinese banks due to the expected penalty triggered by a breach of capital requirements. Practical implications It is the first paper that investigates the impact of capital regulatory pressure on risk-taking of the Chinese banking system, which sheds light on concerns about regulatory monitoring of bank risk and capital regulatory framework. Social implications This paper measures the impact of capital regulation on Chinese bank charter value and risk-taking and offers some support for the implementation of Basel III in China. Originality/value The authors have constructed different measures of regulatory pressure to investigate the influence of new capital regulatory regime on banks’ behavior. Most importantly, the exogenous changes of banks’ capital ratio induced by capital regulatory pressure during the past decade that provides a unique opportunity to directly analyze the impact of capital regulatory pressure on bank charter value and risk-taking.