Impacts of economic policy uncertainty (EPU) and institutional quality (IQ) on bank risk-taking behavior

Abstract

PurposeThe primary aim of this study is to evaluate the impacts of institutional quality (IQ) and economic policy uncertainty (EPU) on bank risk-taking behavior, especially after the global financial crisis of 2007–2008.Design/methodology/approachAfter considering the outlier effect, missing figure and inconsistent data, the study’s final sample contains 24,364 firm-year observations of 4,367 banks. A total of 27 countries were considered as those data are available on the “EPU index” introduced by Baker et al. (2016) for 2011–2020. To estimate the core results, the dynamic panel generalized method of moments (GMM) has been used to examine the effects of IQ and EPU on bank risk-taking behavior. Later, this study also validates the core results by using two-stage least squares (2SLS).FindingsThe authors found a positive relationship between EPU and banks' risk-taking behavior of banks', but imperatively, a significant and negative relationship exists between IQ and bank risk-taking behavior. This study also has a remarkable and distinct findings from Uddin et al. (2020) one of the vital indicators of IQ quality measurement “voice and accountability” (VACC) impacted negatively on bank risk-taking behavior. It indicates that when VACC is well established, banks tend to take the low risk under the prevailing EPU conditions and vice-versa. Moreover, the lagged dependent variable significantly impacted the bank's risk-taking negatively.Originality/valueTo the best of the authors' knowledge, very few studies endeavored to investigate the dominance or impact level of IQ and EPU on the area, i.e. bank risk-taking behavior which inspired us to contribute to the banking literature to address this issue in a broader aspect – the connection between EPU and bank risk-taking behavior, also a relationship between IQ and bank risk-taking behavior and finally linking them with bank risk-taking behavior.

Economic policy uncertainty and Indian banking stability: the mediating role of regulation and supervision

“…In another study, Tobal and Menna (2020) examined the relationship between monetary policy and financial stability using bank-level data among emerging and advanced economies and concluded that the impact of monetary policy on financial stability is more profound in emerging economies compared to advanced economies because financial conditions in emerging markets economies are more dependent on capital flows. Likewise, Moudud-Ul-Huq and Akter (2022) investigated the impact of policy uncertainty and institutional quality on bank risk using the dynamic panel generalized method of moment (GMM) technique. The empirical outcome concludes that higher uncertainty increases the risk-taking behavior of banks.…”