The Effect of Bank Capital on Profitability and Risk in Turkish Banking

Abstract

The purpose of the study is to shed some crucial light on the determinants of bank risk-taking and analyze its relationship with capital and profitability. For the explanatory variables we use a range of bank-specific and country-specific variables that are believed to be important in explaining the performance and risk-taking propensity of banks.This paper applies the Two-Step System Generalized Method of Moments technique developed by Arellano and Bover (1995) and Blundell and Bond (1998)for dynamic panels using bank-level data for 23 Turkish commercial banks over the period 2003 to 2011 to investigate the impacts of bank capital on profitability and risk. We find evidence that the effect of increasing bank capital on risk is significantly positive and negative, supporting the regulatory hypotheses and moral hazard hypothesis, respectively. The results also suggest thatthere is a positive and negative relation between the capital and profitability. Thus, the sample supports also structure-conduct-performance hypothesis. Important policy implications emerge from our empirical results. First, different profitability (risk) variables present different patterns with capital. Hence, the authorities should realize that using a single profitability (risk) variable may result in a totally wrong policy. Second, Turkish banking supervisor or regulators should improve their banking system by mending the financial efficiency of commercial banks to implement the suggestions proposed by Basel III.

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