Title: The effect of bank capital and liquidity regulations and market discipline on bank risk level in Tanzania

Abstract

The main goal of this study was to examine the effect of bank capital and liquidity regulations and market discipline on bank risk level in Tanzania. Institutional theory and Capital buffer theory were both used. Quarterly data was obtained from 28 commercial banks and two stage least square (2SLS) random effect regression was used for analysis. The behaviour of capital and liquidity of banks showed that large banks maintain low liquidity and high capital. Furthermore, results showed negative significant correlation between liquidity and capital for small banks while positive correlation between capital and liquidity for large banks in the adjustment behaviour. In addition, liquidity regulations significantly reduced credit risk. However, capital regulations significantly improved solvency only in the period before regulatory change. In addition, market discipline was not effective towards solvency risk. However, there was a difference among banks. In case of 2 medium banks, interbank lending was effective in reducing risk but high market power significantly increased solvency risk for medium banks with higher interbank lending and significantly reduced solvency risk for banks with higher interbank lending in the alliance. The implication of the study is that bank regulations remain critical for bank stability despite the heterogeneity among banks. Furthermore, evaluating liquidity of banks using the most liquidity Basel III measures is paramount given the prevailing high liquidity in the banking sector. In addition, market discipline cannot be highly relied upon as it is not effective considering that interbank market is not well developed in Tanzania. However considering heterogeneity among banks is crucial in creating a balance between regulations and market discipline.