Abstract:
This study presents empirical support for the role of market discipline in
augmenting bank capital ratios in a competitive banking environment. Using a
panel dataset on domestic commercial banks in Pakistan from 2009 to 2014, the
study determines if the market penalized banks for any increase in their risk profile
through a rise in the cost of raising funds. The results point to a significant
relationship between capital adequacy and other risk factors, with the cost of
deposits demonstrating how depositors align the required return to the perceived
risk level of the bank. These findings have important implications for policymakers
as market discipline could complement the role of regulators, which would
eventually lower the cost of supervision. Moreover, the focus of international
reforms as seen through the implementation of Basel III should continue to be on
developing a more competitive and transparent banking system.
