The effect of the Basel Accord on bank portfolios in Japan

This study investigates the hypothesis that stricter capital adequacy requirements introduced under the Basel Accord caused Japanese banks to alter their portfolios away from heavily weighted risk assets such as loans and corporate bonds and into unweighted assets such as government bonds. Using a panel of Japanese bank balance sheets for fiscal years 1982-1999, this study finds that neither. international nor domestic bank asset portfolios are strongly affected by the total regulatory capital ratio. However, there is clear evidence that international bank asset portfolios are highly sensitive to the core tier I capital requirement. International banks with relatively low core capital ratios tend to reduce heavily risk weighted assets such as loans and substitute into unweighted low-risk assets such as government bonds. International banks with relatively low core capital ratios also tend to issue more subordinated debt, which counts toward tier II capital. This sensitivity of international bank portfolios to capitalization is only observed in the post-Basel period since 1988, indicating that the regulatory changes implemented under the Accord significantly affected the behavior of international banks. There is no evidence that the portfolios of domestic banks were affected by the Accord. (C) 2004 Elsevier Inc. All rights reserved.