Capital Adequacy Diagnosis of Financial Intermediaries using Implied Forbearance Threshold
Bong Jun Kim
Young Jin Kim
Ronn and Verma(1986) assumed capital forbearance threshold as exogeneous and constant. This assumption does not coincide with reality and thus measurement error of exogeneous variable may amplify estimation error of deposit insurance premium. We found that relative deposit insurance premium of Ronn and Verma(1986) was very dependent on the assumption of capital forbearance threshold. To overcome this weakness We derived implied capital forbearance threshold to justify actual deposit insurance premium and substituted it for risk-adjusted deposit insurance premium as the criteria to categorize financial intermediaries according to their business risk. As the result of panel regression, implied capital forbearance threshold showed statistically significant and economically valid relations with management index like BIS capital ratio, fixed loan rate, interest spread. This implies that implied capital forbearance threshold reflect well market information about capital adequacy of individual financial intermediary. Thus We conclude that implied capital forbearance threshold is more valid as the indicator to monitor capital adequacy of financial intermediary.
Ronn and Verma,implied capital forbearance threshold,risk-adjusted insurance premium,moral hazard,fixed insurance premium,Ronn and Verma
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