Effects of Banks’ Free Capital on Performance in Light of the 2008 Financial Crisis: Evidence from the GCC Region

Abstract

how it affected the various performance indicators before and after the crisis should add an important contribution to the existing body of knowledge, especially for this region.In the next section, we review the relevant literature on capital adequacy with the objectives of identifying the proper variables to be investigated and developing the research hypotheses. This should be the proper end of the literature discussion before moving forward to the methodology section where we discuss the scope of the research, the nature of the data selected and methodology. That is followed by a section on the results discussion where we present and discuss the outcomes of our tests and model estimations. The paper ends with the conclusion section where we summarize the study and findings then discuss the possible implications and recommendations. Literature ReviewEver since the introduction of Basel I accord in 1988, consultants and researchers have been busy investigating the validity of CAR as an indicator of bank solvency. Like any business organization, banks exist to maximize the value of their shareholders. This goal is always related to two main elements; profit which is the driver of value maximization and risk which is a driver of solvency when low and a driver of higher returns when high. The main concern of the capital adequacy regulation is to monitor the level of risk which should not exceed a certain limit. This regulation suggests that banks face credit solvency risk when they fail to satisfy the capital adequacy ratio. Given the risk Keywords: Capital adequacy; Basel accords; Financial solvency; Financial crisis; GCC banks IntroductionInternational and national regulators consider bank capital as the first defensive shelter against insolvency in case of financial downturns. Since the Basel I accord in 1988, capital adequacy ratio (CAR), defined, as the percentage of capital to risky assets, has been a subject of utmost concern to practitioners and researchers. Ever since that time, regulators were concerned that CAR may not be enough to provide the proper protection against credit risk, hence, the propositions of Basel II accord in 2004 and Basel III accord introduced in 2013-2105. Major financial downturns (i.e., the Asia financial crisis in 1997 and the latest global financial crisis in 2008) have proved the seriousness of that concern.Acknowledging the importance of capital, researchers have strived to investigate the validity of CAR as a measure to guard against bank insolvency. Different causal models were proposed. Some, used CAR as a dependent variable affected by various explanatory variables. Others, albeit more, have used it as the explanatory variable explaining the variability in some independent variables representing riskiness, profitability, etc. Some research attempts questioned the validity of the ratio to serve its purpose. The research outcome has been inconclusive. Fitch Ratings [1] argued that although banks may meet the minimum required CAR, they may well be undercapitalized due to man...