Basel III Capital Requirement Ratios: An Analysis of Regulatory Capital Ratios as Effective Predictors of Bank Failure

Abstract

This paper investigates the effectiveness of Basel III capital requirement ratios in predicting bank failure. Using Statistics on Depository Institutions data compiled by the FDIC from 2007 to 2011, we examine the Basel III capital ratio requirements in the context of wide-scale commercial bank failures following the 2007 financial crisis. This paper presents three main results. First, the Basel III capital requirement ratios are significant predictors of bank failure. And in comparison with CAMEL regulatory ratios that measure asset, earning performance and liquidity risk, Basel III capital requirement ratios have higher impact in predicting bank failure than most CAMEL ratios. Second, among the Basel III capital requirement ratios, our results show that leverage ratio and CET1 ratio are stronger predictors of bank failure compared to the total risk-based capital ratio. Third, results show that the current minimum requirement of CET1 ratio is insufficient in regulating high predicted probability of bank failure at its current level.