Institutional quality and risk in the banking system

Abstract

Purpose This paper aims to offer an empirical study of the impact of institutional quality on the banking system risk and credit risk. Design/methodology/approach Applying cross-sectional dependent tests and stationary tests to check the property of our sample, the panel corrected standard errors model is recruited as the main estimator, while feasible generalized least squares, pool ordinary least squares (OLS), robust pool OLS and other estimators are used as a robustness check for an unbalanced panel data for 56 economies divided into three subsamples between 2002 and 2015. Findings The empirical results show several significant contributions. First, an improvement in institutional quality is an important factor to reduce the banking system risk. This effect of the institutions is less important in well-capitalized, highly profitable and in high-economic growth countries. This effect is also stronger in highly liquid banking systems. Notably, a better institutional quality helps to reduce the banking system risk in the highly concentrated banking system. Second, institutional quality has a significant negative relationship with the banking credit risk, especially in highly concentrated banking systems and in high-growth countries. This influence is weaker in highly liquid and well-capitalized banking systems. Finally, better institutions reduce the positive effect of trade openness, but it induces a higher credit risk for the banking system from the trade openness. Notably, a better institutional quality enhances the negative effect of foreign direct investment (FDI) inflow on both banking system risk and credit risk. These findings are documented for a global sample and three subsamples: low and lower-middle-income economies, upper-middle-income economies and high-income economies. Originality/value This study provides some recommendations, for policymakers, on the roles of institutions in the banking system and financial stability.

Reassessing the feasibility of adopting dollarization in Latin America

“…This last point is essential to avoid financial crises. An improvement in institutional quality is an important factor to reduce the banking system risk, even more in highly liquid and concentrated banking systems (Canh et al, 2021). However, despite the stabilization capacity of dollarization, after the adoption of the dollar in Ecuador and El Salvador, no other LA country adopted this regime and the focus on this monetary agreement has gone fading through the years.…”

“…This last point is essential to avoid financial crises. An improvement in institutional quality is an important factor to reduce the banking system risk, even more in highly liquid and concentrated banking systems (Canh et al. , 2021).…”

Credit rating announcement and bond liquidity: the case of emerging bond markets

“…A large literature has shown that the ratings issued by credit rating agencies have an impact on different segments of the financial system (Canh et al, 2021). Indeed, previous studies have found very significant relationships between the bad news provided by the agencies and stock market returns, currency, bond spreads, CDS spreads and volatility in asset prices, while the good news has an insignificant or limited impact (e.g.…”

“…A large literature has shown that the ratings issued by credit rating agencies have an impact on different segments of the financial system (Canh et al. , 2021).…”

Artificial intelligence and loan default: The case of commercial banks in India

“…The structure of the banking system affects the systemic risk, where the structure of the banking system refers to its level of capitalization, the degree to which banks are connected, the size of interbank exposures and the degree of concentration of the system (Nier et al, 2007). Canh et al (2021) examined the impact of institutional quality on system risk and credit risk in the banking system using ordinary least squares for unbalanced panel data for 56 economies from 2002 and 2015. The study indicated that the banking credit risk negatively affects institutional quality, especially in highly concentrated banking systems and high‐growth countries.…”