Contemporaneous or causal? Evaluating the triumvirate of insolvency risk, capitalization and efficiency in Indian commercial banking
ISSN: 0307-4358
Article publication date: 7 October 2021
Issue publication date: 3 January 2022
Abstract
Purpose
This paper empirically examines the short-term and long-term associations between risk, capital and efficiency (R-C-E) in the Indian banking sector across 2008–2019 to answer the presence of causation or contemporaneousness in the R-C-E nexus.
Design/methodology/approach
The paper focuses on three objectives. First, the authors determine short-term causality in the risk–efficiency relationship by studying the simultaneous influence of a wide array of banking risks on DEA-based technical and cost efficiency in static and dynamic situations. Second, the authors introduce bank capital and contemporaneously determine the interplay between R-C-E using seemingly unrelated regression equation (SURE) and three-staged least squares (3SLS). Last, the authors assess stability in inter-temporal associations using Granger causality in an autoregressive distributed lag (ARDL) generalized method of moments (GMM) framework.
Findings
The authors contend that high capital buffers reduce insolvency risk and increase bank stability. Technically efficient banks carry lesser equity buffers, suggesting a trade-off between capital and efficiency. However, capitalization makes banks more technically efficient but not cost-efficient, implying that over-capitalization creates cost inefficiencies, which, in line with the cost skimping hypothesis, forces banks to undertake risk. Concerning causal relationships, the authors conclude that inefficiency Granger-causes insolvency and increases bank risk. Further, steady increases in capital precede technical and cost efficiency improvements. The converse also holds as more efficient banks depict temporal increases in capitalization levels.
Originality/value
The paper is perhaps the first that acknowledges the influence of the “time” perspective on the R-C-E nexus in an emerging economy and advocates that prudential regulations must focus on short-term and long-term intricacies among the triumvirate to foster a stable banking environment.
Keywords
Acknowledgements
The authors would like to thank the Editor, Prof. Don T. Johnson and an anonymous reviewer for their time and valuable suggestions. Navendu Prakash would also like to acknowledge the financial support (Junior Research Fellowship) of the University Grants Commission, India.
Funding: Navendu Prakash receives Junior Research Fellowship (JRF) from University Grants Commission (UGC), India as part of his Ph.D. program. However, UGC had no involvement in the study design; in the collection, analysis and interpretation of data; in the writing of report and in the decision to submit the article for publication.
Citation
Prakash, N., Singh, S. and Sharma, S. (2022), "Contemporaneous or causal? Evaluating the triumvirate of insolvency risk, capitalization and efficiency in Indian commercial banking", Managerial Finance, Vol. 48 No. 1, pp. 136-157. https://doi.org/10.1108/MF-02-2021-0070
Publisher
:Emerald Publishing Limited
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