DOES BASEL III CAPITAL HELP OR HURT BANK PROFITABILITY? QUANTILE EVIDENCE FROM PAKISTAN

Abstract

Capital is the buffer that protects depositors when a bank makes losses, and Basel III asked banks around the world to hold more of it. Bankers often argue that extra capital lowers their returns, while regulators argue that it makes banks safer and cheaper to fund. The present study tests these claims for Pakistan, where the State Bank of Pakistan phased in Basel III capital rules between 2013 and 2019. It asks whether the Basel regulatory capital ratio raises or lowers bank profitability, and whether its effect is the same for weak and strong banks. Annual data on 29 listed banks (24 private and 5 public) for 2011–2023 were used, giving 377 bank-year observations, and profit was measured by ROA (return on assets) and ROE (return on equity). The effect of capital across the profit distribution was traced with the Method of Moments Quantile Regression (MMQR), and the two-way link between capital and profit was handled with an instrumental variables version of the quantile estimator (IVQR). Regulatory capital raised profitability in all four models and at almost every quantile. In three models its effect grew from the least to the most profitable banks, and for ROE it was not significant among the least profitable banks. The IVQR estimates were very close to the MMQR estimates. These findings imply that the State Bank of Pakistan has no profit-based reason to relax Basel III capital rules, but that capital alone will not restore weak banks, which also need plans to cut bad loans and costs.