An Examination of the Safety and Profitability of Eu and US Banks since Basel III
An Examination of the Safety and Profitability of Eu and US Banks since Basel III

Summary/Abstract: This paper investigates the performance of European and U.S. banks since Basel III. Key findings in the literature as well as multi-year bank performance data are summarized. With a focus on the regulatory requirements on capital adequacy and liquidity and how they affect profitability, we find evidence of improving safety standards across the board. Banking regulation addresses two critical aspects of risk management: capital adequacy and liquidity. Liquidity risk stems from the likelihood that a depository financial institution may not have sufficient funds to meet its recurring payment obligations. To that end, the key reason for bank regulation on liquidity is to address concerns over the safety and stability of banks and the payments system. Capital adequacy deals with the minimum capital capable of absorbing any unforeseen losses from credit, market, and operational risks to which banks are exposed. The goal of capital adequacy is to keep total bank capital sufficiently high so that the chance of bank failure is prevented when financial losses mount. Capital adequacy ratio (CAR) takes into account a bank’s ability to pay its liabilities and respond fully to the risk of any such financial losses. A bank with strong CAR has more than sufficient capital to absorb these losses and therefore less likely to become insolvent. Banks in the EU lead their US counterparts in terms of safety but lag in terms of profitability. There is evidence that the strive toward higher capital and liquidity standards comes with the price of reduced profitability. Notwithstanding, most studies agree that while the new standards impose additional costs, they are necessary for ensuring the stability and sustainability of the financial system.

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