Jordan Journal of Business Administration, Volume 4, No. 1, 2008 - 89 - Capital Adequacy, Risk Profiles and Bank Behaviour: Empirical Evidence from Jordan Khaled Al-Zubi, Mohammad Al-Abadi and Hanadi Afaneh ABSTRACT Given the high rates of growth and the overall dramatic regulatory changes toward banks, this study explores how bank behave against changes in capital requirements imposed by the regulatory bodies in Jordan. Yet, the relationship between change in risk levels and adjustments in capital is tested by employing multivariate panel regressions/simultaneous equations model, in which the Generalized Least Square (GLS), the Fixed Effect Model (FEM), and the Random Effect Model (REM) are used. The study concludes strong positive effects of the regulatory framework and banks capital stipulated levels that need to be reconstructed to meet their risk profiles. The study revealed that while Jordanian banks become close to the minimum level of capital requirements they tend to increase their capital base, given their different risk's levels. JEL Classification: G21, D21 Keywords: Capital Adequacy, Bank Behaviour, Panel Data. 1. INTRODUCTION Within the Jordanian context, several dramatic regulatory changes has emerged over the last few years, inducing more rivalry toward banks, high rates of growth, new electronic trading innovations as well as local and global expansionism. Yet, given banks crucial role as financial intermediaries, the expansion creates the need for continuous reforms and supervision, in which capital constraints is of the most. The motive is to lower the probability of failure, as these constraints are built. Controversial results are revealed regarding the impact of capital constraints. For example, the imposition of a higher capital-to-assets ratio to be followed by banks would provide adverse impact on banks performance. In this regard, as stressed by Koehn and Santomero (1980), regulating bank capitals through ratio constraints appear to be an inadequate tool to control the riskness of banks, reflecting the need to look after other control techniques to control the probability of banks failure, asset restrictions for example. This view is supported by Dietrich et al. (1983) who investigated the effectiveness of capital regulation, in which they concluded that regulation on banks is inefficient. Marcus (1983) also revealed the same conclusion about the effect of capital regulation on bank holding companies. Several other related studies illustrated additional disadvantages of regulation. Kim and Santomero (1988), and Rochet (1992), revealed that if capital is relatively expensive, the forced reduction in leverage diminishes the banks expected return. On the contrary, by using 103 largest U.S banks as a sample, Keeley (1988) suggested that the capital regulations are effective. Worldwide, in the last few years, significant decline in banks capital ratios are observed. Under which regulators issued explicit capital requirements that required banks to hold a fixed proportion of their total Received on 16/11/2006 and Accepted for Publication on 24/10/2007. © 2008 DAR Publishers/University of Jordan. All Rights Reserved.