Fair value and financial instability: Comparative study between
Islamic and conventional banks
Gharbi Leila, Ph.D Student
Department of Accounting
Faculty of Economics Sciences and Management
Sfax, TUNISIA
Leila.gharbi29@yahoo.fr
Halioui Khamoussi, Associate Professor
Department of Business Management
College of Economics, Management and Information Systems
Nizwa, OMAN
khamoussi.halioui@gmail.com
Abstract
In Gulf Cooperation Council countries, Islamic banks operate side-by-side with conventional
banks. Both their operations are based on their own principles and frameworks although some
regulations might overlap with each other. This study aims to explore the impact of fair value
accounting on financial instability for both types of banks during the period 2003 to 2011. The
paper discusses whether fair value affects capital adequacy ratio and risk-taking behavior of
Islamic and conventional banks in the same way. The findings prove that regulatory capital of
Islamic banks is less affected by fair value changes than conventional ones. However, they
behave similarly with regard to the risk associated with fair value measurement. Only three-stage
least squares estimation showed positive and significant impact of fair value changes on risktaking behavior for all banks and Islamic banks, but not for conventional banks.
Keywords: Fair value accounting, Unrealized Gain and Loss, Capital adequacy ratio, riskweighted asset.
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I.
Introduction
The resilience of Islamic banking sector to the latest global financial crisis has gained particular
attention as the rest of the world’s economies have floundered. The search for alternatives to
western style banks has given added impetus to Islamic principles.
The principles guiding Islamic banks are significantly different from those for conventional
banks. Islamic banks operate upon principles of Islamic law which requires risk sharing and
prohibits the payment or receipt of interest. In contrast, conventional banks are guided mainly by
the profit maximization principle. Islamic and conventional banks may be distinguishable from
one another on the basis of accounting and financial information obtained from company balance
sheets and income statements (Olson and Zoubi, 2008).
Conventional banks in the GCC counties have adopted the financial accounting rules established
by the International Accounting Standards Board (IFRS), while a number of reporting
frameworks are used across Islamic banks. Although many use IFRS, some use partly converged
IFRS based standards, some use IFRS with additional requirements for Islamic banks, and others
use standards exclusively for Islamic banks issued by the Accounting and Auditing Organization
for Islamic Financial Institutions (AAOIFI) (ACCA and KPMG, 2010).
Both IFRS and AAOFI rely on the concept of fair value. Under IAS 39, fair value is defined as
“the amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm’s length transaction”.
AAOIFI FAS 1 defines fair value as “the value representing estimate of the amount of cash or
cash equivalent that would be received for an asset sold or amount of cash or cash equivalent paid
for a liability extinguished or transferred in an orderly transaction between a willing buyer and a
willing seller at the measurement date”.
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From a theoretical point of view, fair value is believed to be more relevant than historical cost
approach, since fair values should reflect investors’risk-adjusted expected cash flows more
precisely than other approaches do (Hitz, 2007; Allen and Carletti, 2008). However, discussions
surrounding fair value accounting remain controversial.
The controversy has been intensified since the onset of the financial crisis of 2008, primarily due
to some practical problems. In fact, there is a popular belief that the interaction between bank
capital rules and fair value accounting helped trigger the recent financial crisis. The claim is that
valuations of investments based on prices obtained from illiquid markets created a pro-cyclical
effect whereby mark to market adjustments reduced regulatory capital forcing banks to sell off
investments which further depressed prices. These ultimately led to bank instability and increase
the overall risk in the financial system (Cifuentes and al, 2005; Plantin, Shin and Sapra, 2008).
The purpose of this paper is to explore the relationship between fair value accounting and
financial instability in general, and particularly the effects of urealized gains and loss on capital
adequacy ratio and risk-taking behavior for both Islamic and conventional banks.
In this study, we attempt to answer the following questions:
To what extent may fair value accounting affect bank regulatory capital levels? Have fair value
measurements had an effect on bank’s risk-taking behavior?
-
If so, did fair value affect Islamic and conventional banks in the same way? Given the
specificities of Islamic banks (concept of conservatism and prudence, concept of justice), are
they more or less affected than conventional banks?
-
If no, are there other contingency factors that exceed the accounting issues and that should be
considered in the explanation of the financial instability?
The remaining sections of this paper are organized as follows: Section 2 provides thetheorical
background and hypothesis development. Section 3 describes the methodological framework.
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Section 4 presents our empirical tests and findings. Section 5 summarizes and concludes the
study.
II.
Theoretical background and hypotheses development
1. Implication of fair value accounting for regulatory capital requirements
Capital adequacy ratio is defined as”the ratio which regulators in the banking system use in order
to monitor the bank's health, specifically the bank’s capital towards its risk. A Bank’s capital is
considered as a cushion for potential losses, which protect the bank’s depositors or lenders,
thereby maintaining confidence and financial stability in the banking system” (Essvale
corporation, 2011).
The concept of fair value accounting has been partly adopted in the capital adequacy
requirements. The unrealized gain and loss of investment securities can be included in the
numerator of the capital-to-assets ratio used to assess capital adequacy.
Unrealized gain and loss refers to the write-down or write-up of an investment portfolio of
trading or available-for-sale securities resulting from applying the market value method on an
aggregate basis. On a trading securities portfolio, the unrealized loss or gain is shown on the
income statement whereas on available-for-sale securities portfolio, the total unrealized loss or
gain is presented as a separate item under “Accumulated Other Comprehensive Income” in the
stockholders’ equity section of the balance sheet.
The financial crisis of 2008 led to severe attacks against the recognition of fair value. Critics
assert that the inclusion of unrealized gains and losses in regulatory capital is a procyclical capital
policy that could exacerbate capital needs during periods of market stress.
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Khan (2009) and Laux and Leuz (2009) provided a review of the literature on the topic.
Besanko and Kanatas (1996) studied the effect of capital standards on bank safety in the presence
of fair value accounting rules. They assumed that a bank satisfies the capital requirement by
selling equities to outside investors and show that a more stringent capital requirement may raise
the probability of bank failure.
Barth and al. (2005) found that Banks violate regulatory capital requirements more frequently
under fair value than historical cost accounting. Fair value accounting for investment securities
reduces the margin by which the mean sample bank exceeds capital requirements by 19 percent
and results in 151 additional firm-year regulatory capital violations with an increase of 43.6
percent. Although violations under fair value accounting help predict future regulatory capital
violations, the potential increase in regulatory risk associated with fair value accounting is not
reflected in bank share prices. Only historical cost violations are market information events.
Cfuentes and al. (2005) examined the consequences of marking-to-market of financial
institutions’ balance sheets when there are externally imposed regulatory solvency requirements.
They argued that a shock that depresses the market value of assets carried on the balance sheets
of financial institutions can lead to forced disposal of assets to avoid violation of solvency ratios.
Under a mark-to-market accounting regime when assets are marked down to the newlower prices,
a firm can be forced to dispose of more assets to avoid violating externally imposed prudential
solvency constraints. Additional disposal of assets can further depress prices and can create a
vicious circle of falling prices and additional asset disposals. Cifuentes and al. (2005) concluded
that the combination of mark-to-market accounting and externally imposed solvency constraints
can lead to a downward spiral in asset prices and become an important source of systemic risk in
the financial system.
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Using data from Flow of Funds Accounts of the United States, Adrian and Shin (2007) found that
commercial banks seem to target a fixed leverage ratio. This implies that when assets of banks
are marked to market, a shock that reduces the market price of assets can lead to the sale of assets
by a bank adjust the leverage back to the target ratio.
More recently, Heaton and al. (2010) showed that the interaction between fair value accounting
rules and a fixed regulatory capital requirement can lead to an economic inefficiency that is
absent under historical cost accounting rules (Carlos and al., 2011).
In order to investigate the relationship between fair value accounting and capital adequacy ratio,
our study specifies the following hypothesis.
H1: Fair value changes affect negatively bank regulatory capital levels.
The concept of fairness and justice are among the most important values that must be adhered to
in valuation and measurement from the Islamic perspective. As mentioned in the Quran:
“Give measure and weight with (full) justice; … whenever you speak, speak justly” (6:152)
“And O mankind! Give just measure and weight, not withhold from the people the things that are
their due…” (11:85)
Muslim scholars, including Al-Ghazali, Ibn Taymiyyah, Ibn al-Qayyim, Al-Shatibi had the idea
of price of the equivalent (qimat-al-mithl) or just price (qimat-al-adl). But their concept of just
price was not borrowed from the Greek literature. It originate in Islamic tradition itself as the
term was used by the prophet (peace be upon him) as well as by his two Caliphs, Umar and
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free play of market forces, demand and supply (Islahi, 1988).
In its statement of accounting concepts, the AAOIFI (1996) recognized the current value concept
of assets, liabilities and restricted investments. However, due to practical difficulties in the
implementation, AAOIFI accepted the historical cost concept. The use of the current value
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financial statement is only regarded as supplementary information if the enterprise considers its
importance for the potential investor and other users. Therefore, in practice, it is the historical
cost which is applied by Islamic banks (Shihadeh, 1994; Ibrahim, 2005).
The AAOIFI realized the problem of using historical cost but argued that there is not much
information available to support the use of current value over historical cost. In fact, the
acceptance of the cost concept was not endorsed by all members. As quoted by Naim (2010), the
majority of them were of the opinion that “it is not evident that adequate means are currently
available to apply this (current value equivalent) concept in a manner that is likely to produce
reliable information” (AAOIFI SFAS 2, para 135).
Karim (1996) mentioned that most Islamic financial institutions tend to adhere to historical
costing in the valuation of their assets. According to him, some banks, (for exemple Kuwait
Finance House) use the “lower of cost or market value” for valuation of inventories whilst the
others (for exemple Bank Islam Malaysia Berhad) use only the historical cost.
Most of Islamic accounting literature takes Zakat as a cornerstone of determining measurement
tools.
According to Sulaiman (2003), there were some arguments among scholars on the accurate
method of valuing the assets for Zakat. On one hand, some scholars suggested the assets to be
revalued should be based on the current value of the assets during the payment of zakat. They
believed that by using the current value, the true wealth of the individuals could be determined.
On the other hand, some jurists preferred that the amount of Zakat should be determined based on
the historical cost of the assets to avoid uncertainties.
Nevertheless, this issue was resolved during the Seventh Seminar on Contemporary Issues of
Zakat in 1997 in Kuwait (AAOIFI, 2008). The seminar ruled out that the assets should be valued
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based on the market selling price for the purpose of Zakat. The decision was based on the Hadith
of Jabir bin Zayd:
“Evaluate them on the day when zakat is due on the and then pay their due Zakat”
Pertaining to this issue, Nadzri (2009) examined the actual disclosures of Zakat and financial
instruments as compared to the disclosure requirements by AAOIFI FAS 9 on Zakat as well as
FAS 2 on Murabahah, FAS 3 on Mudarabah and FAS 4 on Musharakah. The study revealed that
the extents of disclosure by the Islamic financial institutions are much lower than the AAOIFI
requirements. In both 2006 and 2007, only 5 out of 25 Islamic financial institutions managed to
disclose at least 50% of the disclosure requirements in FAS 9 on Zakat. Surprisingly, there were
7 Islamic financial institutions that scored 0% disclosure of Zakat. The study also found that
leverage and origin factors might contribute to the level disclosures of Zakat and financial
products. In addition, the test performed also revealed that the adopters of AAOIFI provide more
disclosure as compared to the non-adopters.
Alkhtani (2012) suggested that current Saudi accounting practices do not comply fully with
Shariah requirements. An interview with the chief financial officers of an Islamic bank confirmed
that “Zakat standards in Saudi Arabia Accounting Standards use historical cost, whereas for
Zakat purposes and according to Shariah, fair value should be used”.
Moreover, IFRSs allow the use of fair value measurement in investment property. However,
under Saudi Arabia Accounting Standards, investment property should be measured at historical
cost.
The Department of Zakat and Income Tax believed that with the use of fair value the Department
of Zakat and Income Tax’s revenue may increase, and also that the use of fair value is more
accurate and preferable than historical cost from the point of view of Shariah.
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According to Fiechter (2010), the prudence concept associated with Islamic banking implies the
use of historical costs instead of fair values in their statutory accounts (Solé, 2007). Islamic banks
are expected to be less likely to apply the fair value option although they would be allowed to do
so in their consolidated financial statements in accordance with IFRS.
To reinforce this expectation, it would be appropriate to note that unlike conventional banks,
Islamic banks are not permitted to have any direct exposure to financial derivatives or
conventional financial institutions’ securities which were hit most during the global crisis.
Hasan and Dridi (2010) pointed out that the Gulf Bank, a Kuwaiti conventional bank, incurred
$1.4 billion losses due mainly to derivatives activities, with the bank’s shareholders and the
Kuwait Investment Authority injecting an equivalent amount of capital. The National
Commercial Bank, the largest Saudi conventional bank, lost more than one billion riyal on
changes in fair value for financial instruments in 2008.
Based on the previous literature, we can conclude that conventional banks are more fair value
oriented than Islamic banks.
Given that regulatory capital ratios based on fair value accounting are more volatile than those
based on historical cost (Yonetani and Katsu, 1995; Barth and al. 2005; Cfuentes and al., 2005;
Heaton and al., 2010), we draw the following hypothesis:
H2: Regulatory capital of Islamic banks is less affected by fair value changes than
conventional banks.
2. Implication of fair value accounting for risk-taking behavior
A number of recent studies have examined the implication of accounting measurement for risktaking behavior.
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Plantin and al. (2008) analyzed the impact of a historical cost accounting regime versus a fair
value accounting regime on the bank manager’s decision to hold the loan portfolio in the balance
sheet. They showed that there are tradeoffs in moving from a historical cost accounting regime to
one that is based on fair values. Under a historical cost accounting regime, a short-sighted bank
manager seeking to maximize reported earnings finds it optimal to sell assets that have
appreciated in value to book the gain on sale. The opposite happens when assets have declined in
value. A short-sighted bank manager is likely to hold assets that have recently declined in value
to avoid recognizing the loss on sales hoping that fortunes would reverse and the recognition of
the loss on sale can be avoided. Thus, historical cost accounting is insensitive to recent price
changes and can lead to countercyclical trades which reduce the volatility in prices.
Plantin and al. (2008) concluded that fair value accounting overcomes the insensitivity of
historical cost based accounting to recent price changes by marking assets to market prices.
However, fair value accounting can induce additional price volatility that offsets the advantage of
fair value accounting being more timely and sensitive to recent price changes.
Li (2009) compared banks’ risk-taking behaviors under three different accounting regimes,
historical cost accounting, lower-of-cost-or-market accounting and fair value accounting. He
found that fair value accounting may be less effective in controlling banks’ risk level when
compared to other regimes.
Burkhart and Strausz (2009) argued that more accounting transparency may exacerbate the asset
substitution effect of debt and in turn lead to more excessive risk-taking behaviors (Carlos and al.
2011).
Regarding bank’s risk-taking behavior, the third hypothesis may be formulated as follow:
H3: Fair value evaluation is positively associated with bank’s risk-taking behavior
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Instead of interest-rate risk, which is considered to be a fair value exposure on fixed instruments,
Islamic banks face rate of return risk which is a cash flow exposure. Rate of return risk is mainly
related to sale based instruments such as Murabahah, Salam, and Istisna as well as Ijarah
instruments. Although, the risks are considered to be small for short term Murabahah contracts,
the risk increases for transactions with a longer maturity. One of the risk mitigation techniques in
use is to link Ijarah rentals to a benchmark such as LIBOR or an inflation index and periodically
adjust the rental amounts (Schoon, 2010).
In practice, Islamic banks have shown a strong preference for fixed return modes of financing
which are less risky. The most commonly used modes are Mutharabah and Ijarah. According to
Dusuki (2007), mark-up instruments represent 86 percent of financing in Islamic banks in the
Middle East and North Africa, 70 percent in East Asia, 92 percent in South Asia and 56 percent
in Sub-Saharan Africa.
In a Mutharabah transaction, the bank finances the purchase of assets by buying it on behalf of its
client on a cost plus basis. Under Ijarah the bank would buy the equipment or machinery and
lease it out to their clients who may opt to monthly payment will consist of two components
rental of the use of equipement and instalement towards the purchase price (Akgunduz, 2009).
Hence, the fourth hypothesis to be tested is:
H4: Fair value accounting may induce less Islamic bank’s risk-taking.
III.
Methodological framework
This study investigates the impact of fair value accounting on the regulatory capital adequacy
ratio and the risk-taking behavior for Islamic and conventional banks in the GCC region.
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Using tow panel data models, we carried out the empirical analysis for each sample. The twostage least squares (2SLS) and three-stage least squares (3SLS) procedures are also used to
recognize the endongeneity of both bank capital ratios and risk levels in a simultaneous equations
framework.
1. Data sources and accounting rules
The analysis focuses on Islamic and conventional banks in the GCC region. Conventional banks
in the GCC region have adopted the financial accounting rules established by the International
Accounting Standards Board, while a number of reporting frameworks are used across Islamic
banks. Although many use IFRS, some use partly converged IFRS based standards, some use
IFRS with additional requirements for Islamic banks, and others use standards exclusively for
Islamic banks issued by the AAOIFI (ACCA and KPMG 2010).
There are some differences between AAOIFI standards and IAS standards. However, all banks in
the GCC region must comply with the accounting rules and regulations of the country of their
incorporation. Since the central banks in each GCC country have required all banks to follow IAS
in preparing financial statements, it should be possible to make meaningful comparisons between
the accounting rules of conventional and Islamic banks. Also, comparing data across these
countries should not cause any particular problems (Olson and Zoubi, 2008).
This study covers 20 Islamic banks and 40 conventional banks during 9 years from 2003 to 2011.
Accounting and financial data were collected from Worldscope database. Data on risk-weighted
assets and regulatory capital ratio were obtained from individual bank annual reports for end-ofyear reporting.
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2. Models specification and variables measurement
2.1.
Models specification
Shrieves and Dahl (1992) developed the simultaneous equations model to analyze adjustments in
bank capital and risk levels, which is widely accepted and applied by following empirical studies.
They argue that in order to test the theories about the bank behavior, it is reasonable to analyze
the relationship between changes in risk and changes in capital, rather than the relationship
between capital and risk levels.
The previous section suggests that a relationship exists between fair value accounting and capital
adequacy ratio and risk-taking behavior. To examine this issue, the simultaneous equations model
developed by Shrieves and Dahl (1992) was modified to incorporate Unrealized Securities Gains
and Losses (URSGL) arising from fair value changes.
The equations can be established as:
∆CARi,t = a0 + a1 ∆RISKi,t + a2 SIZEi,t+ a3 ROAi,t-1 + a4 CARLOWi,t+ a5 CARHIGHi,t + a6
CARi,t -1+ a7 URSGL i,t + uj,t
(Equation1)
∆RISKj,t = b0 + b1 ∆CARj,t + b2 SIZEj,t+ b3 LLPLj,t−1+ b4 CARLOWj,t+ b5 CARHIGHj,t + b6
RISKj,t-1+ a7 URSGL j,t + vj,t
2.2.
-
(Equation2)
Variables description
Change in capital adequacy ratio (∆CAR)
Following Shrieves and Dahl (1992), Jacques and Nigro (1997) and Zhang (2008), the capital
ratio is defined as total capital to total risk-weighted assets. Change in capital adequacy ratio is
defined as the first-order difference of the capital adequacy ratio.
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-
Change in risk-weighted assets to total assets ratio (∆RISK)
Major determinants of the risk of a bank’s asset portfolio include the allocation of assets across
risk categories and the quality of its loans and other assets in the loans component of the portfolio
(Shrieves and Dahl, 1992; Jacques and Nigro, 1997; Zhang, 2008). Therefore, the ratio of riskweighted assets to total assets is used to measure RISK in this paper. ∆RISK is defined as the
first-order difference of the bank risk-weighted assets to total assets ratio.
The endogenous variables ∆CAR and ∆RISK have been included to recognize the possible
simultaneous relationship between changes in capital and changes in risk. Shrieves and Dahl
(1992) noted that a positive correlation between capital and risk may result from regulatory costs,
the unintended impact of minimum capital requirements, bankruptcy cost avoidance, or risk
aversion by bank managers, while a negative correlation may result from the mispricing of
deposit insurance.
-
Bank size (SIZE)
Size may have an impact on bank’s investment opportunity, reputation and portfolio
diversification, and on the bank’s access to equity capital (Zhang, 2008). The natural log of total
assets is included to capture size effects.
-
Lagged return on asset (ROAt−1 )
According to Zhang (2008), operational income is an important source for renewing capital and
good earning levels help banks to keep adequate capital. Banks may increase their capital ratio by
internal funding, and earning level may have positive effects on the bank’s objective capital level.
In the capital equation, the lagged return on asset is included as explanatory variable.
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-
Regulatory pressure (CARLOW / CARHIGH)
Jacques and Nigro (2007) specify the regulatory pressure variable as the difference between the
bank’s capital adequacy ratio and the minimun capital standard. Banks with capital adequacy
ratios above and below the minimum requirement may react to the regulation differently.
Following Jacques and Nigro (2007) and Zhang (2008), we adopt CARLOW and CARHIGH
variables to represent the degree of regulatory pressure brought about by the capital regulation.
CARLOW equals 1/CAR - 1/8% for banks with a capital adequacy ratio less than 8% and 0 for
banks with a capital adequacy ratio above the minimum standard. These banks are under pressure
to increase the capital adequacy ratios or decrease portfolio risks, since they did not meet the
minimum standard. CARLOW should have a positive effect on capital adequacy ratio changes
and a negative effect on risk-weighted asset to total asset ratio changes.
CARHIGH equals 1/8% - 1/CAR for banks with a capital adequacy ratio greater than or equal to
8% and 0 otherwise. Banks may reduce their capital adequacy ratios or increase their level of
portfolio risk because they hold capital in excess of the regulatory minimum.
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Lagged capital adequacy ratio (CARt-1)
Banks may adjust their capital adequacy ratio according to their capital adequacy ratio level in
the last period. Because banks with lower capital adequacy ratio level may increase their capital
adequacy ratio, the coefficient of CARi,t-1 is expected to be negative (Shrieves and Dahl, 1992 ;
Jacques and Nigro, 1997; Zhang, 2008).
-
Lagged risk-weighted asset to total asset ratio (RISKt−1)
Banks may adjust their portfolio risk according to their risk-weighted asset to total asset ratio
level in the last period. For banks with high risks may reduce their portfolio risk, the coefficient
of RISKi,t−1 is expected to be negative (Shrieves and Dahl 1992 ; Jacques and Nigro 1997; Zhang
2008).
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-
Unrealized gains and losses (URSGL)
Following Barth and al (2005), we use unrealized securities gains and losses per share (URSGL)
to approximate fair value changes. Regulators might consider banks with substantial unrealized
securities losses to be in violation of regulatory capital requirements.
-
Lagged ratio of loans loss provision to total loans (LLPLt−1)
As quoted by Zhang (2008), the asset quality is one of the most important supervisory indexes.
The asset quality may relate to the public reputation and the regulatory measures by the
supervisory authority. Therefore, asset quality is not only the consequence of risk behavior but
also the influencing factor on bank risk-taking. The lagged ratio of loans loss provision to total
loans is included as explanatory variable in the risk equation. A positive coefficient of LLPLt−1
indicates that an increase in loans loss provision leads to an increase in assets risk. Therefore,
loans loss provision should be controlled to bring down asset risks of banks.
IV.
Emperical results
1. Descriptive Statistics
Table 1 provides descriptive statistics on the variables used in this study.
The results of descriptive statistics show that the average of capital adequancy ratio (CAR) for
Islamic banks (26%) is higher than for conventional banks (19%) over a nine year period.
As shown in Table 1, CARLOW mean equals zero for all banks. It implies that capital adequacy
ratio is greater than the minimum standard for both Islamic and conventional banks in the Gulf
Corporation Council region. The RISK for conventional commercial banks and Islamic banks are
8.6% and 8.1%, respectively. The mean of unrealized gain and loss (URSGL) for conventional
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banks is huge at 50% compared to Islamic banks. This provides support for the hypothesis that
conventional banks are more fair value oriented accounting regime than Islamic banks.
2. Results of panel models
Table 2 summarizes CAR regression results of the estimates for all banks, conventional banks
and Islamic banks samples respectively.
Results in Table 2 indicate that the first hypothesis was confirmed. Fair value changes affect
negatively and significantly at 5% the capital adequacy ratio of all banks in the GCC region.
More empirical evidence suggests that URSGL for conventional banks is negatively and
significantly related to capital changes but it is insignificantly related to Islamic banks. This
provides support for the hypothesis 2 that capital adequacy ratio of Islamic banks is less affected
by fair value changes than conventional ones. Hence, Islamic banks are more likely to be stable
but less fair value oriented.
However, as argued by Gambling and Karim (1991), Sulaiman (1998) and Alkhtani (2012), fair
value based regime would satisfy Islam’s concept of justice more adequately than would
historical costs. The adherence to the concept of conservatism as applied in accounting principles
would lead to an understatement of the wealth subjected to Zakat.
Further, fair value provides investors with more transparent, timely and accurate information
thereby enhancing confidence in the capital markets. Whereas historical cost accounting masks
problems by allowing it only to show up gradually through negative annual net interest income
fair value approach would arguably highlight the problem much earlier, and allows the resolution
(Plantin and al., 2008).
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Results also show a positive and significant relationship at 1% between CARHIGH and CAR for
Islamic and conventional banks. These results indicate that banks with capital adequacy ratio
above the minimum requirement expand the capital cushion for precautionary authority and
investors.
CAR
t-1
is negatively associated with the change in capital adequacy ratio at 1% level for both
types of banks. The negative coefficient of CAR
t-1
indicates that banks with lower capital
adequacy ratios in last period will increase their capital adequacy ratios in the current period.
Changes in risk-weighted asset to total asset ratio for conventional banks are negatively and
significantly related to changes in capital adequacy ratio, but it is positively and not significantly
related to Islamic banks. Under compulsory constraint of the capital regulation, conventional
banks increase capital adequacy ratios to meet the standard and take measures to reduce assets
risk instead of investing in more high risk assets.
ROA t-1 variable has insignificant impact on capital changes for both types of banks which means
that there is no notable relationship between earnings and changes in capital adequacy ratio.
There is also an inverse and significant relationship between SIZE and capital adequacy ratio
changes for conventional banks but it is insignificant for Islamic banks.
Table 3 summarizes risk-taking behavior regression results of the estimates for all banks,
conventional banks and Islamic banks samples respectively.
The regression results show that there is no significant impact of unrealized loss changes on risktaking behavior for both conventional and Islamic banks. This reveals that banks, particularly
conventional banks seem to underestimate fair value risk measurement which may threaten
financial stability and accentuate global losses.
In this respect, IASB issued IFRS9 on October 2010 incorporating new requirement for
classifying and measuring financial assets that must be applied starting on Jaunary 1st 2013. The
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IASB also issued IFRS 13 “fair value measurement” in May 2011 requiring more extensive
disclosures to be provided particularly when fair value measurement relies on unobservable
inputs.
Results also show a negative and significant relationship between changes in risk-taking behavior
and CARHIGH at 1% for Islamic and conventional banks suggesting that capital requirement has
an impact on risk-taking behavior of tow types of banks.
Changes in risk-taking behavior for conventional banks are negatively and significantly related to
the lagged ratio of risk-weighted asset to total asset, but it is not significantly related for Islamic
banks. The result reveals that conventional banks with higher risks may reduce their asset risks
approaching the reasonable level of risk.
3. Results of simultaneous equations systems
To recognise the endongeneity of both capital adequacy ratio and risk takaking behavior in
simultaneous equations, we used two-stage least squares (2SLS) and three-stage least squares
(3SLS) techniques over the period 2003- 2011.
3.1.
Two-Stage Least Squares estimates Results
Tables4, 5 and 6 present results of two-stage least squares estimation of capital and risk
equations. Two-Stage Least Squares estimation confirms most ordinary least squares (OLS)
regression estimates.
In the capital equation, fair value changes negatively and significantly affect the capital adequacy
ratio of all banks in GCC region at 10%. Furthermore, the URSGL for conventional banks is
negatively and significantly related to capital adequacy ratio changes but it is insignificantly
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related to capital adequacy ratio changes of Islamic banks. Results also show a positive and
significant relationship at 1% between CARHIGH and CAR for all, Islamic and conventional
banks.
In risk equation, there is no significant impact of URSGL on risk-taking behavior for both
conventional and Islamic banks. Results also indicate positive and significative relationship at 1%
between CARHIGH and change in risk for Islamic and conventional banks. The lagged riskweighted asset to total asset ratio negatively and significantly affects risk-weighted asset to total
asset ratio changes for two types of banks.
3.2.
Three-Stage Least Squares (3SLS)
The 3SLS technique also recognizes the simultaneity of change in capital adequacy ratio and
risk-taking behavior. The advantage of 3SLS over 2SLS is a gain in asymptotic efficiency.
Tables7, 8 and 9 present results of three-stage least squares estimation of capital and risk
equations.
Three-stage least squares estimation confirms most two-stage least squares capital equation
results with one exception in significance level. Using three-stage least squares, we find that fair
value changes negatively and significantly affect capital adequacy ratio changes of all banks in
the GCC region at 5%. However, for risk equation, three-stage least squares produce different
results from two-stage least squares estimates. Results show that there is positive and significant
impact at 10% of unrealized loss changes on risk-taking behavior for all banks and Islamic banks
samples.
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V.
Conclusion
This study investigated the impact of fair value changes on capital adequacy ratio and risk-taking
behavior. It consisted of data for Islamic and conventional banks in GCC over 9-year period. Our
findings proved that regulatory capital of Islamic banks is less affected by fair value changes than
conventional ones. We conclude that Islamic banks are more stable but less fair value oriented. It
is demonstrated that fair value based regime would satisfy Islam’s concept of justice more
adequately than would historical cost. The adherence to the concept of prudence would lead to an
understatement of the wealth subjected to Zakat and a decrease in transparency to financial
reporting.
On the other hand, only three-stage least squares estimation showed positive and significant
impact of fair value changes on risk-taking behavior for all banks and Islamic banks samples, but
not for conventional banks. This reveals that conventional banks seem to underestimate fair value
risk measurement which may threaten financial stability and accentuate global losses. Requiring
more extensive disclosures particularly when fair value measurement relies on unobservable
inputs is absolutely necessary to adequate and effective risk management.
The tradeoff between transparency and stability remains an important issue, since transparency
must often be reduced in order to maintain financial system stability. More researches need to be
conducted to resolve this issue. All relevant parties should try to reconcile their ideas in order to
find the appropriate method for valuation and measurement for all purposes and times.
21
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25
Table1: Descriptive statistics
Variables
∆ CAR
CAR t-1
CARLOW
CARHIGH
∆ RISK
RISK t-1
ROA t-1
LLPL t-1
SIZE
URSGL
Type of bank
All
CB
IB
All
CB
IB
All
CB
IB
All
CB
IB
All
CB
IB
All
CB
IB
All
CB
IB
All
CB
IB
All
CB
IB
All
CB
IB
Mean
-.0151814
-.0055767
-.0375535
.2168965
.1966337
.2600119
0
0
0
7.149255
6.931362
7.711045
.0019502
.0012245
.0032992
.0851277
.0864381
.0813352
.0229312
.0222239
.0251125
.0069273
.0064666
.0061881
22.53314
22.64587
22.28253
.0480136
.0583709
.0239942
Std. Dev.
.0714881
.0533414
.0864948
.1174839
.0744898
.1439892
0
0
0
1.661838
1.502772
1.739439
.0179231
.0181497
.014338
.0433893
.0470849
.0264303
.0328772
.0306405
.0243528
.0116492
.0121938
.0075151
1.401843
1.484259
1.121744
.201153
.2504183
.050057
Min
-.385
-.2663
-.31
.107
.109
.1219
0
0
0
3.26639
3.523339
4.441982
-.0654348
-.0772175
-.0252182
.0112929
.0094755
.0492114
-.142646
-.1424278
-.0142661
-.0095273
-.037657
0
18.94192
18.4256
20.3314
-.4729475
-.5896819
-.0518716
Max
.1122
.1122
.0631
.86
.578
.6951
0
0
0
11.27451
10.50797
10.64815
.0826502
.0876606
.0367285
.3466637
.3498885
.1673647
.1360965
.127369
.0837535
.0726377
.0726377
.0257656
25.06262
25.06562
24.3642
1.131943
1.267178
.1586519
Notes to Table1:
All : Total sample ; CB: Conventional banks sample and IB: Islamic banks sample
Variable definitions:
∆CAR
−The first-order difference of total capital to total risk-weighted assets ratio
CARt-1
−The lagged ratio of total capital to total risk-weighted assets
CARLOW −Equals 1/CAR - 1/8% for banks with a capital adequacy ratio less than 8% and 0
for banks with a capital adequacy ratio above the minimum standard
CARHIGH −Equals 1/8% - 1/CAR for banks with a capital adequacy ratio greater than or equal
to 8% and 0 otherwise.
∆RISK
−The first-order difference of risk-weighted asset to total asset ratio
RISKt−1
−The lagged ratio of risk-weighted asset to total asset
ROAt−1
−The lagged ratio of return on asset
LLPLt−1
−The lagged ratio of loans loss provision to total loans
SIZE
−The natural log of total assets
URSGL
−Unrealized securities gains and losses per shar
26
Table 2: Test of H1 and H2 - Fair value accounting and capital ratio changes
∆CARi,t = a0 + a1 ∆RISKi,t + a2 SIZEi,t+ a3 ROAi,t-1 + a4 CARLOWi,t+ a5 CARHIGHi,t + a6
CARi,t-1+ a7 URSGL i,t + uj,t
Independent
Variables
Pred.
Sign
∆RISK i,t
SIZE i,t
+
ROA i,t-1
+
CARLOW i,t
+
CARHIGH i,t
+
CAR i,t-1
URSGL i,t
Number of obs
Number of groups
R-square
All banks
Estimate
P- Value
Conventional banks
Estimate
P- Value
Islamic banks
Estimate
P- Value
-.1959676 <0.01 ***
-.0029758 <0.01 ***
-.0417552
0.274
dropped
dropped
.0302806 <0.01 ***
-.820438 <0.01 ***
-.0075302
0.039**
308
60
0.9666
-.1048625
-.0034176
.0332784
dropped
.0311017
-.9526538
-.0047209
.0144433
-.0017367
-.0564339
dropped
.0329209
-.849852
-.0007404
0.036**
<0.01 ***
0.402
dropped
<0.01 ***
<0.01 ***
0.082 *
223
40
0.9063
0.892
0.212
0.336
dropped
<0.01 ***
<0.01 ***
0.975
85
20
0.9638
Note to table2:
***, **, and * represent respectively statistical significance at 0.01, 0.05, and 0.1 level.
Variable definitions:
∆CAR
−The first-order difference of total capital to total risk-weighted assets ratio
∆RISK
−The first-order difference of risk-weighted asset to total asset ratio
SIZE
−The natural log of total assets
ROAt−1
−The lagged ratio of return on asset
CARLOW −Equals 1/CAR - 1/8% for banks with a capital adequacy ratio less than 8% and 0
for banks with a capital adequacy ratio above the minimum standard
CARHIGH −Equals 1/8% - 1/CAR for banks with a capital adequacy ratio greater than or equal
to 8% and 0 otherwise
CARt-1
−The lagged ratio of total capital to total risk-weighted assets
URSGL
−Unrealized securities gains and losses per share
27
Table 3: Test of H3 and H4 - Fair value changes and risk-taking behavior
∆RISKj,t = b0 + b1 ∆CARj,t + b2 SIZEj,t+ b3 LLPLj,t−1+ b4 CARLOWj,t+ b5 CARHIGHj,t + b6
RISKj,t-1+ a7 URSGL j,t + vj,t
Independent
Variables
Pred.
Sign
∆CAR i,t
+
SIZE i,t
+
LLPLi,t−1
+
CARLOW i,t
+
CARHIGH i,t
RISK i,t−1
URSGL i,t
Number of obs
Number of groups
R-square
All banks
Estimate
P- Value
Conventional banks
Estimate
P- Value
Islamic banks
Estimate
P- Value
-.0698119 <0.01***
-.0006593
0.131
.035136
0.377
dropped
dropped
-.0012829 <0.01***
-.0705572 <0.01***
.0024114
0.349
308
60
0.3201
-.1092754 <0.01***
-.000369
0.492
.0810368
0.144
dropped
dropped
-.0009387
0.043**
-.0725125
0.017**
.0013018
0.608
223
40
0.4491
-.0157927
-.0027404
-.3344937
dropped
-.0021826
-.0459815
.0351075
0.294
0.030**
0.021**
dropped
<0.01***
0.437
0.209
85
20
0.3123
Note to table3:
***, **, and * represent respectively statistical significance at 0.01, 0.05, and 0.1 level.
Variable definitions:
∆RISK
−The first-order difference of risk-weighted asset to total asset ratio
∆CAR
−The first-order difference of total capital to total risk-weighted assets ratio
SIZE
−The natural log of total assets
LLPLt−1
−The lagged ratio of loans loss provision to total loans
CARLOW −Equals 1/CAR - 1/8% for banks with a capital adequacy ratio less than 8% and 0
for banks with a capital adequacy ratio above the minimum standard
CARHIGH −Equals 1/8% - 1/CAR for banks with a capital adequacy ratio greater than or equal
to 8% and 0 otherwise
RISKt−1
−The lagged ratio of risk-weighted asset to total asset
URSGL
−Unrealized securities gains and losses per share
28
Table 4: Two-Stage Least Squares estimates for all banks sample
∆CARi,t = a0 + a1 ∆RISKi,t + a2 SIZEi,t+ a3 ROAi,t-1 + a4 CARLOWi,t+ a5 CARHIGHi,t + a6 CARi,t1+ a7 URSGL i,t + uj,t
∆RISKj,t = b0 + b1 ∆CARj,t + b2 SIZEj,t+ b3 LLPLj,t−1+ b4 CARLOWj,t+ b5 CARHIGHj,t + b6
RISKj,t-1+ a7 URSGL j,t + vj,t
Independent
Variables
Pred.
Sign
∆CAR i,t
∆RISK i,t
SIZE i,t
ROA i,t-1
LLPLi,t−1
CARLOW i,t
CARHIGH i,t
CAR i,t-1
RISK i,t−1
URSGL i,t
Number of obs
Number of groups
R-square
+
+
+
+
+
-
∆CAR
Estimate
P- Value
∆RISK
Estimate
P- Value
.1181923
-.0017416
-.0837372
dropped
.0318286
-.8008395
-.0114677
-.0343448
-.0042004
.0898175
dropped
-.0024851
-.4623836
.0034292
0.698
0.135
0.060*
dropped
0.000***
0.000***
0.051*
303
60
0.9734
0.032**
0.102
0.258
dropped
0.001**
0.000***
0.473
303
60
0.3169
Note to table4:
***, **, and * represent respectively statistical significance at 0.01, 0.05, and 0.1 level.
Variable definitions:
∆RISK
−The first-order difference of risk-weighted asset to total asset ratio
∆CAR
−The first-order difference of total capital to total risk-weighted assets ratio
SIZE
−The natural log of total assets
ROAt−1
−The lagged ratio of return on asset
LLPLt−1
−The lagged ratio of loans loss provision to total loans
CARLOW −Equals 1/CAR - 1/8% for banks with a capital adequacy ratio less than 8% and 0
for banks with a capital adequacy ratio above the minimum standard
CARHIGH −Equals 1/8% - 1/CAR for banks with a capital adequacy ratio greater than or
equal to 8% and 0 otherwise
CARt-1
−The lagged ratio of total capital to total risk-weighted assets
RISKt−1
−The lagged ratio of risk-weighted asset to total asset
URSGL
−Unrealized securities gains and losses per share
29
Table 5: Two-Stage Least Squares estimates for conventional banks sample
∆CARi,t = a0 + a1 ∆RISKi,t + a2 SIZEi,t+ a3 ROAi,t-1 + a4 CARLOWi,t+ a5 CARHIGHi,t + a6 CARi,t1+ a7 URSGL i,t + uj,t
∆RISKj,t = b0 + b1 ∆CARj,t + b2 SIZEj,t+ b3 LLPLj,t−1+ b4 CARLOWj,t+ b5 CARHIGHj,t + b6
RISKj,t-1+ a7 URSGL j,t + vj,t
Independent
Variables
Pred.
Sign
∆CAR i,t
∆RISK i,t
+
SIZE i,t
+
ROA i,t-1
+
LLPLi,t−1
+
CARLOW i,t
+
CARHIGH i,t
CAR i,t-1
RISK i,t−1
URSGL i,t
Number of obs
Number of groups
R-square
∆CAR
Estimate
P- Value
.4838291
-.0032882
-.0519016
dropped
.0350362
-.9686063
-.0101036
0.185
0.011 **
0.437
dropped
0.000 ***
0.000***
0.092 *
188
38
0.8316
∆RISK
Estimate
P- Value
-.1050878
0.000 ***
-.0026234
0.513
.0474274
0.633
dropped
dropped
-.001984
0.068***
-.5215763
0.000***
.0022222
0.651
192
39
0.4605
Note to table5:
***, **, and * represent respectively statistical significance at 0.01, 0.05, and 0.1 level.
Variable definitions:
∆RISK
−The first-order difference of risk-weighted asset to total asset ratio
∆CAR
−The first-order difference of total capital to total risk-weighted assets ratio
SIZE
−The natural log of total assets
ROAt−1
−The lagged ratio of return on asset
LLPLt−1
−The lagged ratio of loans loss provision to total loans
CARLOW −Equals 1/CAR - 1/8% for banks with a capital adequacy ratio less than 8% and 0
for banks with a capital adequacy ratio above the minimum standard
CARHIGH −Equals 1/8% - 1/CAR for banks with a capital adequacy ratio greater than or equal
to 8% and 0 otherwise
CARt-1
−The lagged ratio of total capital to total risk-weighted assets
RISKt−1
−The lagged ratio of risk-weighted asset to total asset
URSGL
−Unrealized securities gains and losses per share
30
Table 6: Two-Stage Least Squares estimates for Islamic banks sample
∆CARi,t = a0 + a1 ∆RISKi,t + a2 SIZEi,t+ a3 ROAi,t-1 + a4 CARLOWi,t+ a5 CARHIGHi,t + a6 CARi,t1+ a7 URSGL i,t + uj,t
∆RISKj,t = b0 + b1 ∆CARj,t + b2 SIZEj,t+ b3 LLPLj,t−1+ b4 CARLOWj,t+ b5 CARHIGHj,t + b6
RISKj,t-1+ a7 URSGL j,t + vj,t
Independent
Variables
Pred.
Sign
∆CAR i,t
∆RISK i,t
+
SIZE i,t
+
ROA i,t-1
+
LLPLi,t−1
+
CARLOW i,t
+
CARHIGH i,t
CAR i,t-1
RISK i,t−1
URSGL i,t
Number of obs
Number of groups
R-square
∆CAR
Estimate
P- Value
∆RISK
Estimate
P- Value
-.1150038
.0319714
-.0147034
-.2413131
dropped
-.0026521
-.2590867
-.0061591
-.0120719
.0190815
dropped
.0361193
-.8924087
.0021308
0.790
0.137
0.857
dropped
0.000 ***
<0.000 ***
0.966
82
20
0.9556
0.106
0.000***
0.270
dropped
0.034 **
0.003**
0.862
82
20
0.3119
Note to table6:
***, **, and * represent respectively statistical significance at 0.01, 0.05, and 0.1 level.
Variable definitions:
∆RISK
−The first-order difference of risk-weighted asset to total asset ratio
∆CAR
−The first-order difference of total capital to total risk-weighted assets ratio
SIZE
−The natural log of total assets
ROAt−1
−The lagged ratio of return on asset
LLPLt−1
−The lagged ratio of loans loss provision to total loans
CARLOW −Equals 1/CAR - 1/8% for banks with a capital adequacy adequacy ratio less than
8% and 0 for banks with a capital adequacy ratio above the minimum standard.
CARHIGH −Equals 1/8% - 1/CAR for banks with a capital adequacy ratio greater than or equal
to 8% and 0 otherwise.
CARt-1
−The lagged ratio of total capital to total risk-weighted assets
RISKt−1
−The lagged ratio of risk-weighted asset to total asset
URSGL
−Unrealized securities gains and losses per share
31
Table 7: Three-Stage Least Squares estimates for all banks sample
∆CARi,t = a0 + a1 ∆RISKi,t + a2 SIZEi,t+ a3 ROAi,t-1 + a4 CARLOWi,t+ a5 CARHIGHi,t + a6 CARi,t1+ a7 URSGL i,t + uj,t
∆RISKj,t = b0 + b1 ∆CARj,t + b2 SIZEj,t+ b3 LLPLj,t−1+ b4 CARLOWj,t+ b5 CARHIGHj,t + b6
RISKj,t-1+ a7 URSGL j,t + vj,t
Independent
Variables
∆CAR i,t
∆RISK i,t
SIZE i,t
ROA i,t-1
LLPLi,t−1
CARLOW i,t
CARHIGH i,t
CAR i,t-1
RISK i,t−1
URSGL i,t
Number of obs
R-square
Pred.
Sign
+
+
+
+
+
-
∆CAR
Estimate
P- Value
0.456
0.091*
0.111
dropped
0.000***
0.000***
0.044**
303
0.9251
.2734191
-.0016402
-.0693833
dropped
.0320332
-.8025799
-.0116616
∆RISK
Estimate
P- Value
-.0629782
-.0016098
.0782254
dropped
-.0013109
-.0378605
.0073132
0.000***
0.039**
0.256
Dropped
0.027**
0.080*
0.057*
303
0.1478
Note to table7:
***, **, and * represent respectively statistical significance at 0.01, 0.05, and 0.1 level.
Variable definitions:
∆RISK
−The first-order difference of risk-weighted asset to total asset ratio
∆CAR
−The first-order difference of total capital to total risk-weighted assets ratio
SIZE
−The natural log of total assets
ROAt−1
−The lagged ratio of return on asset
LLPLt−1
−The lagged ratio of loans loss provision to total loans
CARLOW −Equals 1/CAR - 1/8% for banks with a capital adequacy ratio less than 8% and 0
for banks with a capital adequacy ratio above the minimum standard.
CARHIGH −Equals 1/8% - 1/CAR for banks with a capital adequacy ratio greater than or
equal to 8% and 0 otherwise.
CARt-1
−The lagged ratio of total capital to total risk-weighted assets
RISKt−1
−The lagged ratio of risk-weighted asset to total asset
LLPLt−1
−The lagged ratio of loans loss provision to total loans
URSGL
−Unrealized securities gains and losses per share
32
Table 8: Three-Stage Least Squares estimates for conventional banks sample
∆CARi,t = a0 + a1 ∆RISKi,t + a2 SIZEi,t+ a3 ROAi,t-1 + a4 CARLOWi,t+ a5 CARHIGHi,t + a6 CARi,t1+ a7 URSGL i,t + uj,t
∆RISKj,t = b0 + b1 ∆CARj,t + b2 SIZEj,t+ b3 LLPLj,t−1+ b4 CARLOWj,t+ b5 CARHIGHj,t + b6
RISKj,t-1+ a7 URSGL j,t + vj,t
Independent
Variables
∆CAR i,t
∆RISK i,t
SIZE i,t
ROA i,t-1
LLPLi,t−1
CARLOW i,t
CARHIGH i,t
CAR i,t-1
RISK i,t−1
URSGL i,t
Number of obs
R-square
Note to table8:
Pred.
Sign
+
+
+
+
+
-
∆CAR
Estimate
P- Value
.7794187
-.0035138
-.0284509
dropped
.0366458
-1.021259
-.0091284
0.050**
0.001**
0.673
dropped
0.000***
0.000***
0.091*
221
0.8221
∆RISK
Estimate
P- Value
-.1408426
0.000***
-.000673
0.432
.091617
0.215
dropped
dropped
-.0000553
0.938
-.0436398
0.051*
.0036189
0.309
221
0.2594
***, **, and * represent respectively statistical significance at 0.01, 0.05, and 0.1 level.
Variable definitions:
∆RISK
−The first-order difference of risk-weighted asset to total asset ratio
∆CAR
−The first-order difference of total capital to total risk-weighted assets ratio
SIZE
−The natural log of total assets
ROAt−1
−The lagged ratio of return on asset
LLPLt−1
−The lagged ratio of loans loss provision to total loans
CARLOW −Equals 1/CAR - 1/8% for banks with a capital adequacy ratio less than 8% and 0
for banks with a capital adequacy ratio above the minimum standard.
CARHIGH −Equals 1/8% - 1/CAR for banks with a capital adequacy ratio greater than or equal
to 8% and 0 otherwise.
CARt-1
−The lagged ratio of total capital to total risk-weighted assets
RISKt−1
−The lagged ratio of risk-weighted asset to total asset
URSGL
−Unrealized securities gains and losses per share
33
Table9: Three-Stage Least Squares estimates for Islamic banks sample
∆CARi,t = a0 + a1 ∆RISKi,t + a2 SIZEi,t+ a3 ROAi,t-1 + a4 CARLOWi,t+ a5 CARHIGHi,t + a6 CARi,t1+ a7 URSGL i,t + uj,t
∆RISKj,t = b0 + b1 ∆CARj,t + b2 SIZEj,t+ b3 LLPLj,t−1+ b4 CARLOWj,t+ b5 CARHIGHj,t + b6
RISKj,t-1+ a7 URSGL j,t + vj,t
Independent
Variables
∆CAR i,t
∆RISK i,t
SIZE i,t
ROA i,t-1
LLPLi,t−1
CARLOW i,t
CARHIGH i,t
CAR i,t-1
RISK i,t−1
URSGL i,t
Number of obs
R-square
Pred.
Sign
+
+
+
+
+
-
∆CAR
Estimate
P- Value
3.07645
.0040656
.0222972
dropped
.0451227
-.9701478
-.2012961
0.400
0.656
0.896
dropped
0.000***
0.000***
0.354
82
0.8325
∆RISK
Estimate
P- Value
-.0386165
-.0024904
-.0034953
dropped
-.0018014
0.025**
0.075*
0.983
dropped
0.071*
.0184766
0.690
.053479
0.053*
82
0.1661
Note to table9:
***, **, and * represent respectively statistical significance at 0.01, 0.05, and 0.1 level.
Variable definitions:
∆RISK
−The first-order difference of risk-weighted asset to total asset ratio
∆CAR
−The first-order difference of total capital to total risk-weighted assets ratio
SIZE
−The natural log of total assets
ROAt−1
−The lagged ratio of return on asset
LLPLt−1
−The lagged ratio of loans loss provision to total loans
CARLOW −Equals 1/CAR - 1/8% for banks with a capital adequacy ratio less than 8% and 0
for banks with a capital adequacy ratio above the minimum standard.
CARHIGH −Equals 1/8% - 1/CAR for banks with a capital adequacy ratio greater than or equal
to 8% and 0 otherwise.
CARt-1
−The lagged ratio of total capital to total risk-weighted assets
RISKt−1
−The lagged ratio of risk-weighted asset to total asset
URSGL
−Unrealized securities gains and losses per share
34