Net Stable Funding Requirement under Basel III: Loan Portfolio Growth Matters

• Author: Dawood Ashraf,Barbara L'Huillier,Muhammad Suhail Rizwan
• DOI: http://doi.org/10.1111/ajfs.12221
• Published date: 01 August 2018
• Date: 01 August 2018

Net Stable Funding Requirement under

Basel III: Loan Portfolio Growth Matters*

Barbara L’Huillier**

Department of Accounting and Finance, Prince Mohammad Bin Fahd University, Saudi Arabia

Muhammad Suhail Rizwan

Department of Finance and Investment, National University of Sciences and Technology (NUST), Pakistan

Dawood Ashraf

Islamic Economics and Finance Research Division, Islamic Research and Training Institute, Saudi Arabia

Received 16 March 2017; Accepted 1 December 2017

Abstract

This paper evaluates the perceived stability-enhancing role of the net stable funding

ratio (NSFR) requirement under Basel III and its impact on the balance sheets of banks.

Using data from 647 banks located in 47 countries from 2003 to 2013, we find that the

NSFR would have playe d a financial stabili ty-enhancing role i f it had been implemente d

during the sample period . However, the NSFR requi rement would also have had a loa n

portfolio shrinka ge affect and increas es the possibility of su b-optimal loan port folio

selection. Our results suggest that there are costs and benefits to implementing the

NSFR requirement.

Keywords Basel III; Net stable funding ratio; Financial stability; Simultaneous equa-

tion model

JEL Classification: G21, G28, C33

*We wish to thank Dr Adrian Rossignolo and participants at the IFABS 2017 Conference

(Oxford) for their helpful comments. The authors are grateful to the editor (Kwangwoo

Park) and anonymous reviewers for their insightful comments and suggestions to improve

the earlier version of this paper. The views expressed in this paper are those of the author(s)

and do not necessarily reflect the views of the Islamic Research and Training Institute, the

Islamic Development Bank Group, or Prince Mohammad Bin Fahd University. All errors are

the responsibility of the authors. The authors acknowledge and are grateful for support and

encouragement from the Deanship of Graduate Studies and Research at Prince Mohammad

Bin Fahd University.

**Corresponding author: Department of Accounting and Finance, College of Business

Administration, Prince Mohammad Bin Fahd University, Post Code 31952, Al Azeziya Road,

Eastern Province, Kingdom of Saudi Arabia. Tel: +966-13-849-9757, Fax: +966-13-896-4566,

email: blhuillier@pmu.edu.sa

Asia-Pacific Journal of Financial Studies (2018) 47, 477–500 doi:10.1111/ajfs.12221

©2018 Korean Securities Association 477

1. Introduction

In December 2010, the Basel Committee on Banking Supervision (BCBS)

announced a package of new regulations under the Basel III capital accord to

address illiquidity and funding instability issues revealed during the 2007–2009 glo-

bal financial crisis. Two of the new regulatory requirements introduced were a liq-

uidity coverage ratio (LCR) and a net stable funding ratio (NSFR). The LCR is

designed to ensure that banks maintain a sufficient level of liquidity. The NSFR is

designed to avoid a maturity mismatch of assets and liabilities in order to promote

a more stable long-term funding environment. A graduated adoption approach was

suggested for the implementation of the LCR and the NSFR along with other regu-

latory requirements under Basel III to strengthen the global banking system. It is

expected that by 2019 all Basel III requirements will be fully implemented.

There are a number of studies assessing the possible impact of these newly

introduced regulatory measures using historical data. These studies include the rela-

tionship between capital stability, risk-taking behavior, and ownership structure

(Jiraporn et al., 2014; Ashraf et al., 2016); bank liquidity (Distinguin et al., 2013);

bank net interest margins (King, 2013); and a cost–benefit analysis of the Basel III

regulatory requirements (Yan et al., 2012; Dietrich et al., 2014; Wei et al., 2017).

However, we have identified a number of gaps in this growing strand of literature.

First, although the stability-enhancing role of the NSFR is well investigated there is

no study investigating whether this stability enhancement is uniform across banks

and countries. Second, studies like King (2013) and Wei et al. (2017) suggest a pos-

sible negative externality of the NSFR requirement whereby banks may reduce the

size of their balance sheet and/or alter their portfolio composition to meet the

NSFR requirement. However, this has not been investigated empirically. Third,

banks from less developed financial markets usually have less access to income

sources outside traditional intermediation activities, so meeting the NSFR require-

ment may force these banks to adopt less than optimal portfolio reallocations (Ash-

raf et al., 2016). The impact of the NSFR on the financial stability of banks from

less sophisticated banking sectors has yet to be explored.

This study fills these gaps by investigating whether the NSFR requirement affects

the financial stability of banks and, if so, whether it is uniform across banks. It also

investigates its possible impact on the loan portfolios of banks. These questions are

more relevant for banks from less developed countries owing to their limited access

to sophisticated financial risk-management tools such as financial derivatives and

their reliance on traditional risk-management tools for fund-stability management.

We use a sample of 647 banks from 47 countries (excluding banks from North

America and Europe) from 2003 to 2013.

Existing literature on the relationship between regulatory requirements and

banking stability provides evidence of simultaneity as higher capital growth and

capital buffer provide an extra cushion for banks to pursue relatively riskier finan-

cial activities (Wahab et al., 2017). For our empirical analysis, we use a

B. L’Huillier et al.

478 ©2018 Korean Securities Association