Capital Adequacy Ratio and Financing Behavior in Iran’s Banking System

For Iran as an oil exporter country, heavy reliance on the extractive sector to generate fiscal revenues from export earnings, means increased vulnerabilities to oil price shocks. The structure of the economy and the banking system make macroprudential policy a relevant tool for Iran. The capital adequacy is a macroprudential instrument that can be used to maintain the stability of financial system taking into account the conditions of bank’s capital. This paper examines the impact of the capital adequacy on financing behavior of Iran’s banking system. The paper analyzes the reaction of bank financing behavior toward capital adequacy ratio by using the Generalized Method of Moment estimation (GMM) technique and by employing bank-level data for both public and private banks covering the period 2003-2016. The findings indicate that capital adequacy ratio is observed to be effective in curtailing financing behavior of banking system. Furthermore, the results reveal that the impact of capital adequacy in managing credit expansion of private banks is greater than public banks. Moreover, for both private and public banks, larger banks are more responsive to the CAR policy as compared to smaller banks.