Proponents of stringent regulation argue in favour of higher capital requirements as it is said to promote financial stability. Opponents of higher capital requirements argue that capital adequacy rules might not enhance stability but might in fact increase a bank’s riskiness. The paper tests this hypothesis with a dynamic panel data model for eight Malawian commercial banks. Results reveal that there is high persistency in risk-taking behaviour of Malawian banks. Further, the study finds that high capital ratios reduce bank risk-taking behaviour of Malawian banks through reduction in Non-Performing Loans (NPLs) ratio and investment in high risky assets. Based on these results, imposition of stringent penalties on banks that fail to meet minimum capital requirements and strict enforcement of regulation is key to ensuring that all banks sustain sufficient capital buffers and hence safeguard stability of the banking system.
