Using a sample of 1,992 banks from 39 OECD countries during the 1999-2013 period, we examine whether the imposition of higher capital ratios is effective in reducing risk and improving the efficiency and profitability of banking institutions. We demonstrate that while risk-and non-risk based capital ratios improve bank efficiency and profitability, risk-based capital ratios fail to decrease bank risk. Our results cast doubts on the validity of the weighting methodologies used for calculating risk-based capital ratios and on the efficacy of regulatory monitoring. The ineffectiveness of riskbased capital ratios with regard to bank risk is likely to be exacerbated by the adoption of the new Basel III capital guidelines. While Basel III requires banks to hold higher liquidity ratios along with higher capital ratios, our findings suggest that imposing higher capital ratios may have a negative effect on the efficiency and profitability of highly liquid banks. Our results hold across different subsamples, alternative risk, efficiency, and profitability measures and a battery of estimation techniques.

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This paper benefits from various risk-and non-risk-based regulatory capital ratios and examines their impact on bank risk and performance in the Middle East and North Africa (MENA) region. Our findings suggest that compliance with Basel capital requirements enhances bank protection against risk, and improves efficiency and profitability. The impact of capital requirements on bank performance is more pronounced for too-big-to-fail banks, banks in periods of crises and banks in countries with good governance. The results are also robust when controlling for the Arab Spring transition period. Finally, endogeneity checks, alternative risk and performance measures, a principal component analysis and other estimation techniques confirm findings.

We investigate whether and how political systems affect the financial soundness of conventional and Islamic banks. Using factors extracted from principal component analysis, we find that Islamic banks underperform their conventional counterparts in more democratic political systems but outperform them in hybrid and Sharia'a-based legal systems. The findings reflect the challenges Islamic banks face in Western countries in terms of perception, financial infrastructure, and regulatory constraints while mirroring the recognition of their specificities and their cultural and religious compliance with Sharia'a law in Muslim countries. The findings are robust to a battery of alternative estimation techniques and methods of correcting standard errors.

We report new evidence on the bank and institutional determinants of Islamic bank capital ratios in 28 countries between 1999 and 2013. Overall, we find that smaller, more profitable, and highly liquid Islamic banks are more highly capitalized. Additionally, improvements in the economic and financial environments and market discipline within a country correspond with higher Islamic bank capitalization. The results shed light on the impact that Sharia'a law restrictions have on Islamic banking capitalization. Our findings are most robust to banks that choose to hold capital well in excess of that required by regulators, consistent with traditional capital structure theory. Our results highlight the role that stable economic and political systems play in improving bank capitalization and reducing financial sector risk. By reducing political instability and corruption, improving legal systems, and encouraging access to capital markets, policymakers may incentivize managers to make financing decisions that increase the capitalization of the Islamic banking industry in developing countries.