Banking soundness in the European Union : - The impact of the capital requirements regulation

Abstract: Abstract Purpose – The purpose of the report is to investigate the impact of the capital requirements launched by the European Commission in the CRD IV package, using accounting proxies for the CAMELS rating system. By using financial ratios as proxies for the CAMELS variables (capital, assets, management, earnings, liquidity and sensitivity), changes in the financial soundness in Europe can be detected and the impact of the new capital requirements can be understood. Research design – The study is a quantitative research, as the data was collected from the European Union’s 30 largest banks’ annual reports and it is therefore secondary data. The data was used in order to construct financial ratios to act as accounting proxies for the CAMEL variables, which have been used in order to construct a rating of the banks. These ratios were calculated for a five-year period, 2011-2015, in order to detect changes and give an indication of how the banks state and stability have developed during the timeframe. Findings – The findings show that there has been clear changes in the banking sector during the observe time span. The findings indicate a clear increase in capital ratios in the banks, due to the new capital requirements. The findings also show how profitability and liquidity is still too low to indicate a fully sound banking sector, but still may be attributable to the recent recession. Contribution – The authors found indications that while the trend and over all well-being in the banking sector is good there is still room for further improvement in both leverage and liquidity ratios as well as profitability. Value – The sample shows that the have been improvements in the soundness in the banking sector, but the results also indicated that capital requirements by itself is not enough to create stability and increased well-being for the banking sector. Several areas of importance to bank stability are still in need of improvement.