Value relevance of risk-weighted capital adequacy ratios before and after the Basel II regulation in European banks
No Thumbnail Available
URL
Journal Title
Journal ISSN
Volume Title
School of Business |
Master's thesis
Ask about the availability of the thesis by sending email to the Aalto University Learning Centre oppimiskeskus@aalto.fi
Authors
Date
2017
Department
Major/Subject
Mcode
Degree programme
Accounting
Language
en
Pages
95
Series
Abstract
Banking is one of the most regulated industries in the world. One major part of the regulation is the capital adequacy regulation which restricts the minimum level of capital banks are required to hold. The best known capital adequacy regulator is the Basel committee on banking supervision which is responsible for the regulation regimes known as Basel I, Basel II and Basel III. Study by Vallascas and Hadendorff (2013) prove that the updated capital ratios in Basel II can explain better the true risk banks face. Due to improved qualities, the ratios should be more useful for investors to be used for market valuation of banks. However, only few researches have been conducted about the market valuation of banks and it is still undiscovered how the changes in capital adequacy ratios affect the valuation. This thesis examines the theoretical and practical value relevance of capital adequacy ratios before and after the Basel II implementation in European banks. By value relevance this thesis means the capability to explain the level of market value, not changes in it. This thesis is unique in multiple ways. European banking sector is not widely covered as most of the studies use U.S. data. Also most of the banking valuation models use unweighted capital ratios instead of risk-weighted regulatory ratios and the studies show mixed results on the effect of capital to banks’ Market-to-Book value. Although the changes in regulation have been studied in multiple ways, the value relevance of improved regulation has not been covered. Data for the research is collected from multiple sources and the final data consist of 448 bank-year observations from 41 banks within years 2002 and 2015. In order to compare the effect of the regulatory changes the data is divided into two subsamples, the prior including observations from 2002 to 2004 and the later from 2010 to 2012. Four different methods are used to evaluate the 5 attributes of value relevant performance measure during both subsample periods. The five attributes evaluated are Persistence, Predictability, Predictability of future cash flow, Substitute for cash flow and Timeliness. The models are adjusted from the methods used by Barton et al. (2010) to suit better the capital adequacy measures. Again, four different methods are used to evaluate the practical value relevance of capital adequacy ratios from which three are modifications from the model created by Calomiris and Nissim (2014). Dependent variable is the three month-forward Adjusted market value of equity divided by Common equity. The results show that three from the five theoretical value relevance attributes have improved after the regulatory changes. The conclusion is that theoretical value relevance of Tier 1 Capital ratio has improved. The practical value relevance however does not show similar improvements. The correlation between Tier 1 Capital ratio and Adjusted Market-to-Book ratio has increased but the explanatory power of capital adequacy ratios shows no improvements. Also the effect of capital adequacy ratios to Adjusted Market-to-Book ratio has become lower – even negative – and statistically insignificant. Thus, the results show clear controversy between the theoretical and practical value relevance of capital adequacy ratios.Description
Thesis advisor
Niemi, LasseKeywords
capital adequacy, bank valuation, value relevance, Basel regulation