The purpose of this paper is to assess whether the level of capital requirements based on risk weighted assets, the Basel Index, is able to predict bankruptcy of financial institutions. Additionally, we compare the performance of such indicator in that task to the performance of the simple index of total capital requirements, computed taking no account of asset risks. One of the challenges for conducting such analysis in Brazil is that the Basel Index ratio reported for each institution is publicly available only since 2009, while most of the bank failures in the country occurred in the period between 1995 and 2005. Therefore, we first complete the task of building a Synthetic Basel Index (IBS) for each of the institutions analyzed, for the period of December 1995 up to December 2014, using information from balance sheets and income statements of 313 Brazilian financial institutions, and from the resolutions of the National Monetary Council and Brazilian Central Bank on banking regulation in Brazil. Using this IBS, we were able to assess whether (and to what extent) a higher level of capital relative to risk assets reduces the probability of failure of a financial institution. Using logit models, we estimate that an increase of one percentage point in IBS increases the chances of a financial institution not failing by 1.04 times. A survival analysis shows that an increase of one percentage point in IBS delays the failure of a financial institution in 1.08 times. These results corroborate the hypothesis of an inverse relationship between the level of capital and the probability of bank failure.
