This study examines the moral hazard and capital buffer theories as motivations of Philippine banks in managing their capital and risks following the adoption of Pillar 1 of the Basel III framework on minimum capital requirement. Using the empirical model of Heid et. al (2004) and Malovaná (2017), the results of the study indicate that most banks adjust their regulatory capital ratio by optimizing their portfolio risk through changes in the level of capital. Banks do not have the tendency to immediately adjust their risk-weighted exposures but are more inclined to maintain a reasonable balance between changes in the size of their assets and capital. Moreover, banks that have lower capital ratios relative to their peers have higher tendency to adjust their capital ratio. The capital buffer theory likewise holds true, that is, banks with low capital buffers rebuild an appropriate level of buffer by decreasing their risk exposures while banks with high capital buffer are inclined to simply maintain their capital ratio when these banks increase their risk exposures. Another interesting finding of the study is that the adoption of minimum capital requirement did not result in moral hazard problem rather banks have become more risk-sensitive. In particular, banks try to rebuild an appropriate buffer by raising their level of capital while simultaneously lowering risk. The results are robust against diagnostic tests, different specifications of the model and alternative estimation method.
