When Basel-inspired capital regulations are insufficient : Evidence from Zambia’s use of absolute minimum bank capital requirements

Can absolute minimum capital rules be used by lower-income countries when Basel-inspired capital rules are insufficient for their high equity, high-risk contexts? We discuss the limitations of standard capital rules for reducing bank risk in less developed financial systems and quantitatively evaluate Zambia’s alternative policy, a large increase in minimum absolute capital requirements announced in 2012. We use detailed bank-level panel data and the arguable exogeneity of the recapitalisations to evaluate whether the policy was successful at achieving the Bank of Zambia’s goals of strengthening the financial system and increasing lending. We find the following: (i) broadly speaking, banks were able to raise capital to meet the rule; (ii) banks improved their capitalisation rates, and such improvements persisted (at least in the short term); (iii) banks that recapitalised increased their total assets, but typically by buying treasury assets, rather than making additional loans; and (iv) banks responded heterogeneously, with larger banks expanding more post recapitalisation, potentially putting pressure on smaller banks’ market share