Abstract:
The literature does not take housing price volatility and residential mortgage risks into capital adequacy models, albeit the subprime crisis verifies that they affect bank safety. Hence, this paper combines housing price volatility and residential mortgage into optimal capital adequacy models. Employing the bank-level databases of China’s 189 commercial banks and their germane city-level databases of housing price indices over 2005Q1-2015Q4, this paper finds that the trend terms of housing price positively affect capital adequacy ratio, but the volatility terms of housing price have negative effects on capital adequacy ratio. As a consequence, China’s commercial banks have a salient pro-cycle nature in capital adequacy since 2005. Second, the volatility terms of housing price have an asymmetric effect on capital adequacy ratio. The effects of upward housing price volatility on capital adequacy ratio are greater than that of downward housing price volatility. Thus, to improve counter-cycle management, the commercial banks should have more capital at the presence of upward housing price movement while less capital at the presence of downward housing price movement. Lastly, the mortgage ratio negatively affects the capital adequacy ratio, which testifies that the residential mortgages are the relatively higher-quality assets in the commercial bank asset pool and could be increased by a proper ratio.
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