Bank Capital across HIMI Economies over Three Decades: When Profitability Meets the Cycle

Abstract

Adequate capital level is essential for banks to balance profitability with protection against future losses. While regulators establish minimum requirements, banks often need to hold additional buffers to maintain resilience, stability, and stakeholder confidence. The global financial crises and subsequent regulatory reforms, such as Basel III, have reinforced the importance of understanding the drivers of bank capital decisions. Therefore, this study investigates the determinants of bank capital level in Islamic and conventional banks across high-income and middle-income (HIMI) economies. Particular attention is given to the interacting role of profitability in the relationship between economy and capital level. The analysis employs unbalanced panel data from 133 banks in ten (10) HIMI countries over the years 1995 to 2024 which equivalent to 30 years. A Random Effects Model (REM) with cluster standard errors is applied to assess the impact of credit risk, liquidity risk, profitability, cost efficiency, bank size, and crisis periods on capital level. The results reveal that credit risk, liquidity risk, profitability, and cost efficiency significantly influence capital level, whereas bank size and crisis periods are insignificant. Profitability positively affects capital level and amplifies the positive impact of economy, consistent with Basel III’s countercyclical buffer framework. Islamic banks are found to hold lower capital level compared to conventional banks. Additionally, banks operated in high-income countries maintain higher buffers of capital compared to middle-income countries. The study recommends to include strengthening risk management, embedding countercyclical capital planning, addressing structural challenges in Islamic banking, enhancing regulatory frameworks in middle-income economies, and promoting cost-efficiency measures.