This thesis investigates four important interrelated aspects in commercial banking: bank capital requirement policies under financial market competition and government bailouts, the relationship between stock markets and bank capital; systemic risk and capital regulation and the determinants of acquisition premiums paid using foreign capital in the SE Asia banking market before and after the financial crisis;. The thesis is organised into four papers that address the above issues.
The first paper is theoretical and extends Hellmann, Murdock, and Stiglitz's (2000), henceforth HMS, to discuss the influences of external financial market competition on bank bailouts and capital requirement policy. After adding external competition into the HMS model, when external competition is not strong enough, it is found that the government's best supervision policy is still the collocation of the capital requirement and deposit rate ceiling policy. However, if the external competition exceeds a certain level, regardless of whether the deposit rate ceiling exists or not, then capital requirement policy is sufficient to allow banks to choose prudent investments. It is also found that in circumstances where the government hopes that banks will choose prudent investments, the final profits of the bank will decrease under the government's bailout. This implies that the banks do not benefit from the bailout of non-banks.
Using backward induction, the second paper deduces a model to discuss the relationship among bank loan decision, stock price and bank capital requirements. The findings are that (1) the capital adequacy ratio is the capital requirement established by the government in order to ensure deposit safety and the stability of the financial system; but achieving these requirements can lead to greater market volatility; (2) if investors know that there exist a higher probability of breaching capital requirements for banks, this leads to price volatility of an asset (for example, stock A as discussed in this chapter) in the stock market, and this in-turn influences bank's willingness to lend to a company (for example,
company B), therefore producing contagion effects; finally, when the stock market is in a bear phase, owing to the higher probability of breaching bank's capital requirements, correlation between assets is higher than in a bull market due to the outcome of the contagion effect. This also indicates that when the stock market is in a bull market, owing to the small probability of occurrence of the contagion effect, correlation between assets is low and market risk is comparatively small. In a bear market, owing to the higher probability of occurrence of the contagion effect, correlation between assets is higher and market risk is consequently higher.
The third chapter examines a blind-spot in current capital regulations. Capital regulations are supposed to keep banks solvent, but it seems that it has not been effective in the recent financial crisis. Thus, this paper sets out to confirm the reasons for this. To this end, a simple model is used to show that if the regulator does not take the insurance company's counterparty risk into consideration the imposed capital adequacy ratio will be too low. Moreover, the model also demonstrates the importance of measuring systemic risk.
The final paper empirically investigates the determinants of acquisition premiums paid using foreign capital in the SE Asian banking market from 1996 to January 2007. We find that (1) Foreign capital is attracted by the opportunity to expand business into the SE Asia banking market; (2) Acquisition premiums are affected by the profitability of the target; (3) In the non-crisis period, foreign investors are willing to pay higher premiums for listed targets; ( 4) Acquirers are willing to pay a higher premium to acquire the stock rights of the banks based in five countries in South SE Asia (Indonesia, Malaysia, Philippines, Thailand and Vietnam); and finally the average acquisition premium in the financial crisis period is lower than in non-crisis periods.