From Lending To Liquidity: Unraveling The Complexities Of Capital Adequacy In Indian Banks

Abstract

In this paper, we explore the determinants of capital adequacy measures of banks in an emerging market context. We employ panel (fixed effects) regression and Generalized Method of Moments (GMM) method to analyse firm specific data on of major public- and private-sector banks in India, during the period 2011 to 2024. Our study finds profound impact of banks’ lending performance, asset leveraging and NPA provisioning on their capital adequacy. While the effects of deposit generation were found negative, the impact of solvency and liquidity appears to be adverse. Moreover, our research found independence of capital adequacy from bank profitability. More equity capital in banks can contribute to financial stability by reducing the risk of costly banking crises, but lending may become more expensive if banks are required finance their assets with more equity. These insights are vital for investors and policymakers seeking to improve the capital adequacy and financial health of Indian banks.