Country Risk and Bank Stability

This paper examines the impact of country risk on bank stability using data for more than 500 banks from 21 developed and 18 emerging countries over the period 2009-2018. As country risk is a multi-faceted concept, we employ three one-dimensional factors from 22 indicators of the ICRG country risk rating system: political risk, economic risk and financial risk. Likewise, we apply the dynamic factor analysis on 25 CAMEL indicators of banking risk to come up with our preferred measures of bank stability. And then, we construct a multilevel quantile regression model to estimate the effect of country risk on bank stability. Our main findings are as follows. First, political risk, economic risk and financial risk as well as country risk have a negative and significant effect on bank stability. Moreover, the effect seems to be stronger among high-instability banks. Second, the financial liberalization, bank concentration, size of bank, and dispersed ownership do not have a uniform impact on bank stability across quantiles although they are the factors significantly decreasing the stability of banks which are highly unstable. Third, the impact of country risk on bank stability is more pronounced in the emerging countries as compared to the developed countries. Overall, country risk will remain crucially important for explaining the variation in bank stability, especially in the emerging countries.