Relationship between market discipline and capital buffers in Brazilian banks

Abstract

The aim of this study was to investigate the relationship between the market discipline and the capital buffers of Brazilian banks, identifying the channels through which this phenomenon materializes. The literature on market discipline and capital buffers has focused on developed countries. In Brazil, the topic is in its infancy, despite the characteristics of the market representing a relevant opportunity for broadening the related studies. Even with the specificities of an emerging market, the Brazilian banking industry provides a vast field for studying market discipline and capital buffers, given that the banks have leverage with investors, who are sensitive agents to alterations in the risk appetite of those entities. This study contributes to understanding the dynamics of the market discipline in the banking industry and to fostering discussions about the role of that private supervision in promoting the transparency and solidity of the financial system, providing support and guidelines for banking regulation. Using data from 193 Brazilian banks, from 2001 to 2017, the empirical tests included the estimation of panel data models, with the use of two-stage least squares (TSLS), following Ayuso et al. (2004), Flannery and Rangan (2004), and Nier and Baumann (2006). As the discipline exercised by the monitoring and influence of the market is not directly verifiable by external agents, six proxies were developed based on the cost of fundraising, on unsecured deposits, on subordinated debt, and on disclosure. The capital buffer was represented by the difference between the capital calculated by the institution and the minimum regulatory requirement. The results of the empirical tests revealed a positive association between the capital buffer and market discipline, providing evidence of the presence of that private supervision in the Brazilian banking industry.