The Relationship between Risk, Capital and Efficiency: Evidence from Japanese Cooperative Banks

Abstract: The risk-capital positions of Japanese banks have been under tension throughout the 1990s. However, existing theory on the determinants of bank risk-taking still remains limited and the evidence is conflicting. Most studies concentrate on US and European banks, while empirical evidence has remained scarce for Asian banks. Added to that, to our knowledge, there are almost no papers on this subject for cooperative banks in Japan. Thus, the main contribution of this study is to shed some light on the determinants of bank risk-taking and analyse its relationship with capital and efficiency in Japanese cooperative banking (namely shinkin and credit cooperatives banks). This paper focuses on Japanese cooperative banks as they constitute an important segment of the Japanese banking sector. We employ a simultaneous equation model in which the relationships between, risk, capital and cost inefficiency are modelled. Two stage least squares with fixed effects estimation procedure are applied to a panel data set of 263 Japanese cooperative banks over the period 2003 through 2006. The results confirm the belief that risk, capital and inefficiency are simultaneously determined. The empirical model shows a negative relationship between risk and the level of capital for Japanese cooperative banks. Inefficient Japanese cooperative banks appear to operate with larger capital and take on more risk. These arguments may reflect the moral hazard problem that exists in the banking system through exploitation of the benefits of deposit insurance. We also assess the size effects and find that larger cooperative banks holding less capital take on more risk and are less efficient.