Political institutions and bank risk-taking behavior

This paper examines the impact of political institutions on bank risk-taking behavior. Using an international sample of banks from 98 countries over the period 1998–2007, I document that sound political institutions stimulate higher bank risk-taking. This is consistent with the hypotheses that better political institutions increase banks’ risk by boosting the credit market competition from alternative sources of finance and generating the moral hazard problems due to the expectation of government bailouts in worst economic conditions. While it is contrary to the hypotheses that better political institutions decrease banks’ risk by lowering the government expropriation risk and the information asymmetries between banks and borrowers. The results are robust to a number of sensitivity tests, including alternative proxies of bank risk-taking and political institutions, cross-sectional bank- and country-level regressions, endogeneity concerns of political institutions, country income levels, explicit deposit insurance schemes and sample extension from 1998 to 2014. I also examine the interdependence between political and legal institutions and find that political and legal institutions complement each other to influence bank risk-taking behavior

Do trade and financial openness matter for financial development? Bank-level evidence from emerging market economies

Openness theory of financial development argues that opening up a country to both international trade and financial flows can promote financial development. In this study, I test the openness theory at micro-level by examining the impact of recent rapid trade and financial openness of emerging economies on their banks’ development. I use three sets of indicators of bank development to distinguish the cost, volume and risk of bank credit. Using a panel dataset of 287 key banks from 37 emerging countries over the period 2000–2012, I find robust evidence that higher trade openness promotes bank development by increasing the volume and decreasing the cost and risk of bank credit. I identify that these results are driven, respectively, by the higher demand for finance, the domestic financial sector liberalization reforms and the lending diversification opportunities caused by the higher trade-openness. Contrary, I find that the role of financial openness for bank development is limited because though the intense credit market competition caused by the capital inflows in financially open countries urges the banks to cut the cost of credit, however it also forces them to increase risk-taking despite the lower volume of credit extended. In such a scenario, the costs associated with higher bank risk-taking might outweigh the benefits associated with the lower cost of bank credit

Is Economic Uncertainty a Risk Factor in Bank Loan Pricing Decisions? International Evidence

Uncertainty in economic environment leads economic agents to act cautiously. In this paper, we postulate that such uncertainty leads banks to charge higher interest rate on loans. Measuring aggregate country-level economic uncertainty with the World Uncertainty Index (WUI) and using a bank-level dataset from 88 countries over the period 1998–2017, we find that heightened economic uncertainty increases bank loan interest rates. Specifically, bank loan interest rates rise by 20.67 basis points with a one standard deviation increase in WUI. Our results are robust when we use alternative proxy of uncertainty, include additional controls in the model, and extend the sample size. We also observe that WUI index is better at measuring local economic uncertainty as compared to the Economic Policy Uncertainty (EPU) index. Overall, this study provides evidence that bank price in economic uncertainty is an important risk while setting interest rates on bank loans

Economic impact of government interventions during the COVID-19 pandemic: International evidence from financial markets

The outbreak of COVID-19 pandemic came as a rare, unprecedented event and governments around the globe scrambled with emergency actions including social distancing measures, public awareness programs, testing and quarantining policies, and income support packages. In this paper, we examine the expected economic impact of government actions by analyzing the effect of such actions on stock market returns. Using daily data from January 22 to April 17, 2020 from 77 countries, we find announcements of government social distancing measures have a direct negative effect on stock market returns due to their adverse effect on economic activity, while an indirect positive effect through the reduction in COVID-19 confirmed cases. Government announcements regarding public awareness programs, testing and quarantining policies, and income support packages largely result in positive market returns. Our findings have important policy implications, primarily by showing that government social distancing measures have both positive and negative economic impact

Foreign bank subsidiaries’ risk-taking behavior: Impact of home and host country national culture

This paper examines whether the risk-taking behavior of foreign affiliates of multinational banks is more influenced by the national culture of their parent banks’ home country or the national culture of foreign affiliates’ host country. The study uses a dataset of 292 foreign affiliates (i.e., subsidiaries or branch operations) operating in 66 countries having parent banks in 26 countries for empirical analysis. National culture of both home and host countries is measured with four dimensions—uncertainty avoidance, individualism, masculinity and power distance—of Hofstede's framework of national culture. Findings suggest that the national culture of parent banks’ home country has higher impact on the risk-taking behavior of foreign affiliates of multinational banks than the national culture of their host country. Specifically, foreign affiliates’ risk-taking is higher if parent banks’ home country has low uncertainty avoidance, high individualism and low power distance cultural values. This study extends our understanding that how informal institutions, such as the national culture, influence the financial decisions in multinational banks

The performance of Islamic versus conventional stocks during the COVID-19 shock: Evidence from firm-level data

In this study, we extend the recently heated debate that compares the performance of Shariah compliant equities with their non-Shariah compliant counterparts especially during the Covid-19 shock. Unlike the existing literature, which uses stock market index level data to reach controversial conclusions, we use firm-level stock returns data to find robust evidence that Shariah compliant stocks outperformed their conventional counterparts during the Covid-19 market meltdown. More specifically, we find that the prices of Shariah compliant stocks reacted to the increase in Coronavirus confirmed cases and government social distancing measures with lower negative returns than the prices of non-Shariah compliant stocks. Overall, our findings imply that Shariah compliant stocks fared better during the Covid-19 crisis episode

The Impact of Board Internationalization on Real Earnings Management: Evidence From China

In this article, we examine the impact of board internationalization on real earnings management. Using the annual data of 2,899 Chinese listed non-financial firms with 16,638 firm-year observations over the period from 2008 to 2017 for empirical analysis, we find robust evidence that higher proportion of foreign directors on corporate boards reduces real earnings management. Results support the hypothesis that foreign directors increase boards’ effectiveness in monitoring the management and, consequently, lead to less earnings management by corporate executives. Our results are robust to alternative measures of board internationalization, instrumental variable analysis, and adding additional control variables. We further observe that foreign directors are more effective in reducing earnings management in firms with local directors with foreign experience and in Chinese provinces with developed institutional environment. Moreover, Chinese firms complement accrual and real activities–based earnings management, and board internationalization is effective in reducing both types of earnings management. Overall, our findings imply board internationalization improves the quality of reported earnings to outside shareholders

How to regulate bank dividends? Is capital regulation an answer?

This paper is a contribution to the debate on “how to regulate banks' dividend payout behaviour”, a question that has attracted special attention of academicians as well as policy makers since the onset of 2007–08 financial crisis. In this paper, we examine whether common equity based capital regulation and more stringent risk based capital requirements force banks to restrict dividend payments. Common equity based capital regulation is likely to restrict bank dividends by limiting the sources of new capital for banks. Similarly more stringent risk based capital requirements are likely to force banks to retain profits to meet regulatory capital requirements. We use an international sample of 8689 banks from 58 countries over the pre-crisis period 1998–2007 for empirical analysis. Results show that banks paid lower dividends, were less likely to pay dividends and were less likely to pay excessive dividends in countries where regulators imposed common equity based capital regulation and more stringent risk based capital requirements for the banking industry during the pre-crisis period. We also extend our sample period from 1998 to 2012 and observe that regulatory capital requirements are less effective in restricting bank dividend payments during crisis period. From a policy perspective, we suggest that regulators can limit banks' options to raise new capital from non-common equity based sources and can impose more stringent risk based capital requirements to restrict banks from dividend over-payments in good times. While regulators can use blanket restrictions on sector wise dividend payments in bad times

COVID-19 social distancing measures and economic growth: Distinguishing short- and long-term effects

Social distancing policies have been criticized for their adverse effect on economies. However, we evidence that while they have a short-run adverse effect, they also have a long-run recovery effect on economic growth. Utilizing quarterly gross domestic product (GDP) growth rate data from OECD member states, we find that the medium-term recovery effect of stringent social distancing policies on economic growth is three times higher the short-term adverse effect. We additionally investigate social distancing measures with sub-components of GDP, as well as the conditioning roles of institutional factors