Evaluating the Effectiveness of Basel III Implementation on Bank Default Risk: Empirical Evidence from Pakistan

Abstract

This study assesses the retrospective impact of Basel III regulatory standards on the financial stability and default probability of Pakistani banks. Specifically, the analysis focuses on three major indicators introduced by Basel III: the Capital-to-Asset Ratio (CAR), Liquidity Coverage Ratio (LCR), and Net Stable Funding Ratio (NSFR). Using annual data from a panel of Pakistani banks spanning 2005 to 2018, the study applies both Ordinary Least Squares (OLS) and Generalized Method of Moments (GMM) estimations to analyze the relationship between these indicators and bank performance proxies, including Return on Assets (ROA) and Z-score. The results from OLS models suggest that Basel III reforms, especially improvements in CAR and LCR, are associated with enhanced financial resilience and lower probability of default. However, GMM estimations do not yield statistically significant results, likely due to the small sample size and annual nature of the data. This research contributes to the broader discourse on banking regulation in emerging economies, offering policy implications for regulators and banking institutions in Pakistan and similar contexts.