South African Reserve Bank working paper links stricter capital requirements to higher problem loans except for banks with moderate market power

The South African Reserve Bank has published a Working Paper examining how capital requirements regulation affects problem loans in South Africa around the adoption of Basel II and the implementation of Basel III. Using bank-level evidence, the study finds that tighter capital requirements are associated with higher problem loans overall, but that this relationship turns negative for banks with moderate market power. The paper analyses annual data for seven South African banks over 2000–2022 and proxies problem loans using non-performing loans as a share of total loans. Capital requirements are captured through a constructed capital regulation index (0–10), the Tier 1 capital ratio, and Basel II (2008–2012) and Basel III (2013–2019) dummy variables. Across dynamic panel specifications estimated with difference and system generalised method of moments, the capital regulation index is positive and significant, the Basel II dummy is positive and significant, and the Basel III dummy is not significant, while the Tier 1 capital ratio is also positive and significant; interaction results indicate capital requirements reduce problem loans when combined with moderate market power. Macroeconomic and bank-specific drivers are also identified, including lower problem loans with higher real GDP growth, higher problem loans with higher real lending interest rates, and generally lower problem loans with higher return on assets, alongside evidence of persistence in problem loans via a significant lagged dependent variable.