The Journal of Applied Business Research – January/February 2015 Volume 31, Number 1 Copyright by author(s); CC-BY 231 The Clute Institute Bank Capital Adequacy Requirements And Risk-Taking Behavior In Tunisia: A Simultaneous Equations Framework Faten Ben Bouheni, Ph.D., Professor at ISC Paris Business School & Researcher at LITEM Research Laboratory, France Houssem Rachdi, Ph.D., University Of Jendouba & University Of Tunis El Manar, Tunisia ABSTRACT We extend exiting literature on the efficiency of capital adequacy requirements in reducing risk- taking behaviour of Tunisian commercial banks using a new risk measure: the weighted-assets to total assets. Thus, using a simultaneous equations framework, we reach four main results. First, interaction between capitalization and risk level is negative, which means that an increase in capital is followed by a decrease in banking risk-taking. Second, Tunisian banks dispose of a weak institutional and regulatory level. Third, largest banks are the best managers of their risk, since they have more experience in managing risk levels through diversification. Finally, we found a negative relationship between size and bank capitalization, indicating that more bank is large, more its risk level is low. Keywords: Tunisia; Risk-Taking; Bank Capital Adequacy Requirements; Simultaneous Equations INTRODUCTION n response to the recent global financial crisis, regulators have increased their focus on capital adequacy of banking institutions in order to enhance stability of the financial market. Therefore, how do bank capital adequacy requirements affect risk? The Basel Committee on Banking Supervision (BCBS) was set forth to update the guidelines for capital and banking regulations. Basel III proposes many new capital, leverage, and liquidity standards to strengthen regulation, supervision, and risk management in the banking industry. Capital standards and new capital buffers will require banks to hold more capital and a higher quality of capital than what was required by the current Basel II rules (Lee and Hsieh, 2013). The recent credit crisis revealed the need to further understand bank risk determinants in an environment of lower bank capital (Festic et al., 2011). For instance, in 2008 the Federal Reserve Board of the U.S. proposed a rule for public comment that would institute certain less-complex approaches for calculating risk-based capital requirements. The proposal, known as the standardized framework, would be available for banks (Lee and Hsieh, 2013). However, the European Union has already implemented the Basel II accord via the EU Capital Requirements Directives, and many European banks have already reported their capital adequacy ratios according to the new system. All credit institutions in the EU adopted Basel II at the beginning of 2008. Although banking regulation and supervision are being rewritten and restructured in response to the global financial crisis, their implementation requires complex steps depending on each country’s national policies which could have different effects on bank risk-taking depending on the financial and institutional environment in which the banks operate (Ben Bouheni, 2013). It is thus not surprising that the relationship between bank regulation and risk has recently become a hot topic. However, empirical studies on this topic are inconclusive and mixed. For example, Barth et al. (2008) find that some Asian countries, like the Philippines, Singapore, and Indonesia, are strengthening capital requirements, while some others are easing their capital requirements in the aftermath of their crises, like South Korea and Japan. This differs from Argentina, which made the same move, but in advance of the I brought to you by CORE View metadata, citation and similar papers at core.ac.uk provided by Clute Institute: Journals