Cyclicality of Banks’ Capital Buffer, Credit Risk, and Performance: Evidence from an Emerging Economy

We analyze the impact of the business cycle and earnings diversification on the performance, credit risk, and capital buffer of Indian commercial banks spanning from 2008 to 2021. Employing fixed effects panel estimation, the study reveals a significant negative correlation between the capital buffer and the business cycle, while credit risk and bank performance demonstrate positive and significant associations with the business cycle. Consequently, our research supports the claim that the Basel III accords, specifically those addressing countercyclical capital buffer requirements, play a role in enhancing the stability of financial institutions, particularly during economic downturns. However, our findings do not align with the perceived benefits of diversifying into activities that generate non-interest income.