Content Analysis is a research technique for conducting qualitative and quantitative analyses [124]. The content analysis is a helpful technique that provides the required information in classifying the articles depending on their nature (empirical or conceptual) [76]. By adopting the content analysis method [53, 102], the selected articles are examined to determine their content. The classification of available content from the selected set of sample articles that are categorized under different subheads. The themes identified in the relationship between banking regulation, risk, and profitability are as follows.
Regulation and profitability of banks
The performance indicators of the banking industry have always been a topic of interest to researchers and practitioners. This area of research has assumed a special interest after the 2008 WFC [25, 51, 86, 114, 127, 132]. According to research, the causes of poor performance and risk management are lousy banking practices, ineffective monitoring, inadequate supervision, and weak regulatory mechanisms [94]. Increased competition, deregulation, and complex financial instruments have made banks, including Indian banks, more vulnerable to risks [18, 93, 119, 123]. Hence, it is essential to investigate the present regulatory machinery for the performance of banks.
There are two schools of thought on regulation and its possible impact on profitability. The first asserts that regulation does not affect profitability. The second asserts that regulation adds significant value to banks’ profitability and other performance indicators. This supports the concept that Delis et al. [41] advocated that the capital adequacy requirement and supervisory power do not affect productivity or profitability unless there is a financial crisis. Laeven and Majnoni [81] insisted that provision for loan loss should be part of capital requirements. This will significantly improve active risk management practices and ensure banks’ profitability.
Lee and Hsieh [83] proposed ambiguous findings that do not support either school of thought. According to Nguyen and Nghiem [95], while regulation is beneficial, it has a negative impact on bank profitability. As a result, when proposing regulations, it is critical to consider bank performance and risk management. According to Erfani and Vasigh [46], Islamic banks maintained their efficiency between 2006 and 2013, while most commercial banks lost, furthermore claimed that the financial crisis had no significant impact on Islamic bank profitability.
Regulation and NPA (risk-taking of banks)
The regulatory mechanism of banks in any country must address the following issues: capital adequacy ratio, prudent provisioning, concentration banking, the ownership structure of banks, market discipline, regulatory devices, presence of foreign capital, bank competition, official supervisory power, independence of supervisory bodies, private monitoring, and NPAs [25].
Kanoujiya et al. [64] revealed through empirical evidence that Indian bank regulations lack a proper understanding of what banks require and propose reforming and transforming regulation in Indian banks so that responsive governance and regulation can occur to make banks safer, supported by Rastogi et al. [105]. The positive impact of regulation on NPAs is widely discussed in the literature. [94] argue that regulation has multiple effects on banks, including reducing NPAs. The influence is more powerful if the country’s banking system is fragile. Regulation, particularly capital regulation, is extremely effective in reducing risk-taking in banks [103].
Rastogi and Kanoujiya [106] discovered evidence that disclosure regulations do not affect the profitability of Indian banks, supported by Karyani et al. [65] for the banks located in Asia. Furthermore, Rastogi and Kanoujiya [106] explain that disclosure is a difficult task as a regulatory requirement. It is less sustainable due to the nature of the imposed regulations in banks and may thus be perceived as a burden and may be overcome by realizing the benefits associated with disclosure regulation [31, 54, 101]. Zheng et al. [138] empirically discovered that regulation has no impact on the banks’ profitability in Bangladesh.
Governments enforce banking regulations to achieve a stable and efficient financial system [20, 94]. The existing literature is inconclusive on the effects of regulatory compliance on banks’ risks or the reduction of NPAs [10, 11]. Boudriga et al. [25] concluded that the regulatory mechanism plays an insignificant role in reducing NPAs. This is especially true in weak institutions, which are susceptible to corruption. Gonzalez [52] reported that firm regulations have a positive relationship with banks’ risk-taking, increasing the probability of NPAs. However, Boudriga et al. [25], Samitas and Polyzos [113], and Allen et al. [3] strongly oppose the use of regulation as a tool to reduce banks’ risk-taking.
Kwan and Laderman [79] proposed three levels in regulating banks, which are lax, liberal, and strict. The liberal regulatory framework leads to more diversification in banks. By contrast, the strict regulatory framework forces the banks to take inappropriate risks to compensate for the loss of business; this is a global problem [73].
Capital regulation reduces banks’ risk-taking [103, 110]. Capital regulation leads to cost escalation, but the benefits outweigh the cost [103]. The trade-off is worth striking. Altman Z score is used to predict banks’ bankruptcy, and it found that the regulation increased the Altman’s Z-score [4, 46, 63, 68, 72, 120]. Jin et al. [62] report a negative relationship between regulation and banks’ risk-taking. Capital requirements empowered regulators, and competition significantly reduced banks’ risk-taking [1, 122]. Capital regulation has a limited impact on banks’ risk-taking [90, 103].
Maji and De [90] suggested that human capital is more effective in managing banks’ credit risks. Besanko and Kanatas [21] highlighted that regulation on capital requirements might not mitigate risks in all scenarios, especially when recapitalization has been enforced. Klomp and De Haan [72] proposed that capital requirements and supervision substantially reduce banks’ risks.
A third-party audit may impart more legitimacy to the banking system [23]. The absence of third-party intervention is conspicuous, and this may raise a doubt about the reliability and effectiveness of the impact of regulation on bank’s risk-taking.
NPA (risk-taking) in banks and profitability
Profitability affects NPAs, and NPAs, in turn, affect profitability. According to the bad management hypothesis [17], higher profits would negatively affect NPAs. By contrast, higher profits may lead management to resort to a liberal credit policy (high earnings), which may eventually lead to higher NPAs [104].
Balasubramaniam [8] demonstrated that NPA has double negative effects on banks. NPAs increase stressed assets, reducing banks’ productive assets [92, 117, 136]. This phenomenon is relatively underexplored and therefore renders itself for future research.
Triad and the performance of banks
Regulation and triad
Regulations and their impact on banks have been a matter of debate for a long time. Barth et al. [12] demonstrated that countries with a central bank as the sole regulatory body are prone to high NPAs. Although countries with multiple regulatory bodies have high liquidity risks, they have low capital requirements [40]. Barth et al. [12] supported the following steps to rationalize the existing regulatory mechanism on banks: (1) mandatory information [22], (2) empowered management of banks, and (3) increased incentive for private agents to exert corporate control. They show that profitability has an inverse relationship with banks’ risk-taking [114]. Therefore, standard regulatory practices, such as capital requirements, are not beneficial. However, small domestic banks benefit from capital restrictions.
DeYoung and Jang [43] showed that Basel III-based policies of liquidity convergence ratio (LCR) and net stable funding ratio (NSFR) are not fully executed across the globe, including the US. Dahir et al. [39] found that a decrease in liquidity and funding increases banks’ risk-taking, making banks vulnerable and reducing stability. Therefore, any regulation on liquidity risk is more likely to create problems for banks.
Concentration banking and triad
Kiran and Jones [71] asserted that large banks are marginally affected by NPAs, whereas small banks are significantly affected by high NPAs. They added a new dimension to NPAs and their impact on profitability: concentration banking or banks’ market power. Market power leads to less cost and more profitability, which can easily counter the adverse impact of NPAs on profitability [6, 15].
The connection between the huge volume of research on the performance of banks and competition is the underlying concept of market power. Competition reduces market power, whereas concentration banking increases market power [25]. Concentration banking reduces competition, increases market power, rationalizes the banks’ risk-taking, and ensures profitability.
Tabak et al. [125] advocated that market power incentivizes banks to become risk-averse, leading to lower costs and high profits. They explained that an increase in market power reduces the risk-taking requirement of banks. Reducing banks’ risks due to market power significantly increases when capital regulation is executed objectively. Ariss [6] suggested that increased market power decreases competition, and thus, NPAs reduce, leading to increased banks’ stability.
Competition, the performance of banks, and triad
Boyd and De Nicolo [27] supported that competition and concentration banking are inversely related, whereas competition increases risk, and concentration banking decreases risk. A mere shift toward concentration banking can lead to risk rationalization. This finding has significant policy implications. Risk reduction can also be achieved through stringent regulations. Bolt and Tieman [24] explained that stringent regulation coupled with intense competition does more harm than good, especially concerning banks’ risk-taking.
Market deregulation, as well as intensifying competition, would reduce the market power of large banks. Thus, the entire banking system might take inappropriate and irrational risks [112]. Maji and Hazarika [91] added more confusion to the existing policy by proposing that, often, there is no relationship between capital regulation and banks’ risk-taking. However, some cases have reported a positive relationship. This implies that banks’ risk-taking is neutral to regulation or leads to increased risk. Furthermore, Maji and Hazarika [91] revealed that competition reduces banks’ risk-taking, contrary to popular belief.
Claessens and Laeven [36] posited that concentration banking influences competition. However, this competition exists only within the restricted circle of banks, which are part of concentration banking. Kasman and Kasman [66] found that low concentration banking increases banks’ stability. However, they were silent on the impact of low concentration banking on banks’ risk-taking. Baselga-Pascual et al. [14] endorsed the earlier findings that concentration banking reduces banks’ risk-taking.
Concentration banking and competition are inversely related because of the inherent design of concentration banking. Market power increases when only a few large banks are operating; thus, reduced competition is an obvious outcome. Barra and Zotti [9] supported the idea that market power, coupled with competition between the given players, injects financial stability into banks. Market power and concentration banking affect each other. Therefore, concentration banking with a moderate level of regulation, instead of indiscriminate regulation, would serve the purpose better. Baselga-Pascual et al. [14] also showed that concentration banking addresses banks’ risk-taking.
Schaeck et al. [115], in a landmark study, presented that concentration banking and competition reduce banks’ risk-taking. However, they did not address the relationship between concentration banking and competition, which are usually inversely related. This could be a subject for future research. Research on the relationship between concentration banking and competition is scant, identified as a research gap (“Research Implications of the study” section).
Transparency, corporate governance, and triad
One of the big problems with NPAs is the lack of transparency in both the regulatory bodies and banks [25]. Boudriga et al. [25] preferred to view NPAs as a governance issue and thus, recommended viewing it from a governance perspective. Ahmad and Ariff [2] concluded that regulatory capital and top-management quality determine banks’ credit risk. Furthermore, they asserted that credit risk in emerging economies is higher than that of developed economies.
Bad management practices and moral vulnerabilities are the key determinants of insolvency risks of Indian banks [95]. Banks are an integral part of the economy and engines of social growth. Therefore, banks enjoy liberal insolvency protection in India, especially public sector banks, which is a critical issue. Such a benevolent insolvency cover encourages a bank to be indifferent to its capital requirements. This indifference takes its toll on insolvency risk and profit efficiency. Insolvency protection makes the bank operationally inefficient and complacent.
Foreign equity and corporate governance practices help manage the adverse impact of banks’ risk-taking to ensure the profitability and stability of banks [33, 34]. Eastburn and Sharland [45] advocated that sound management and a risk management system that can anticipate any impending risk are essential. A pragmatic risk mechanism should replace the existing conceptual risk management system.
Lo [87] found and advocated that the existing legislation and regulations are outdated. He insisted on a new perspective and asserted that giving equal importance to behavioral aspects and the rational expectations of customers of banks is vital. Buston [29] critiqued the balance sheet risk management practices prevailing globally. He proposed active risk management practices that provided risk protection measures to contain banks’ liquidity and solvency risks.
Klomp and De Haan [72] championed the cause of giving more autonomy to central banks of countries to provide stability in the banking system. Louzis et al. [88] showed that macroeconomic variables and the quality of bank management determine banks’ level of NPAs. Regulatory authorities are striving hard to make regulatory frameworks more structured and stringent. However, the recent increase in loan defaults (NPAs), scams, frauds, and cyber-attacks raise concerns about the effectiveness [19] of the existing banking regulations in India as well as globally.
