Capital adequacy requirements and the risk-return profile of Korean banks.

Bank supervision in general, and capital adequacy requirements in particular, are concerned fundamentally with bank safety, the stability of the financial system and depositor protection. Bank safety and the stability of the banking and financial system are crucially influenced by the public confidence that depositors and other creditors have in the banks and banking system. Bank capital adequacy is a critical element in generating public confidence in a bank's ability to handle uncertainty and as the ultimate defence against such losses. In this context, capital adequacy regulations by the supervisory authorities have become an increasingly important policy tool to help curb the amount of risk exposure that a bank can assume, thereby helping to preserve public confidence in a bank and the banking system as a whole. Capital adequacy regulations essentially operate on a bank's risk and return profile. This role of capital adequacy requirements is particularly important in Korea. To examine the impact of the new capital adequacy requirements on bank's risk-return profile, an event study methodology was developed. The empirical results using the OLS and SURE estimation indicated strongly that the new capital standards in Korea did not have an impact on bank shareholders' wealth, whereas they had an apparent partial effect on banks' risk, at least perceived by investors in Korea. In addition, no intra-industry effects were found. Our conclusions reveal some policy implications. Firstly, supervisory authorities should reexamine and reassess the present supervisory monitoring system and reestablish it to be appropriate for the new, more vulnerable and competitive (deregulating) financial environment. Secondly, to improve the supervisory monitoring process, the supervisory authorities should enhance the role of the market. Finally, under a environment where the free market is being emphasised in resource allocation, bank supervisors should always consider the simultaneous impact of structural deregulation and supervisory re-regulation within their policy-making process