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The Impact of Macroeconomic Factors on Risks in the Banking Sector: A Cross-Country Empirical Assessment

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    Abstract

    This paper explores the links between macroeconomic conditions and individual bank risk. Using capital adequacy ratios as a broad measure of risk sustainability, a linear mixed effects model for a large international panel of banks for the years 2001-2005 is estimated. In OECD countries, banks tend to hold higher capital ratios during business cycle highs, this effect being even stronger for a subsample of EU banks. In non-OECD countries, periods of higher economic growth are associated with lower capital ratios. This indicates procyclical behavior. Banks accumulate risks more rapidly in economically good times and some of these risks materialize as asset quality deteriorates during subsequent recessions. Furthermore, higher inflation rates are associated with higher capital ratios of banks, implying that inflation-induced economic uncertainty stimulates banks to restrict credit. As far as regulatory and institutional environment is concerned, econometric estimates show that banks in non-OECD countries with deposit insurance tend to be more risky, whereas evidence of a negative relationship between concentration of the banking sector and banks’ risk taking is statistically less robust.

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    File URL: http://www.iaw.edu/RePEc/iaw/pdf/iaw_dp_44.pdf
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    Bibliographic Info

    Paper provided by Institut für Angewandte Wirtschaftsforschung (IAW) in its series IAW Discussion Papers with number 44.

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    Length: 26 pages
    Date of creation: Sep 2008
    Date of revision:
    Handle: RePEc:iaw:iawdip:44

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    Keywords: international banking; macroeconomic conditions; banking risk;

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    1. Frederic S. Mishkin, 1997. "Understanding Financial Crises: A Developing Country Perspective," NBER Working Papers 5600, National Bureau of Economic Research, Inc.
    2. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
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    7. L. Baele & R. Vander Vennet & A. Van Landschoot, 2004. "Bank Risk Strategies and Cyclical Variation in Bank Stock Returns," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 04/217, Ghent University, Faculty of Economics and Business Administration.
    8. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-81, December.
    9. Claudia M. Buch & Gayle L. DeLong & Katja Neugebauer, 2007. "International Banking and the Allocation of Risk," IAW Discussion Papers 32, Institut für Angewandte Wirtschaftsforschung (IAW).
    10. Ari Hyytinen, 2002. "The time profile of risk in banking crises: evidence from Scandinavian banking sectors," Applied Financial Economics, Taylor & Francis Journals, vol. 12(9), pages 613-623.
    11. Sironi, Andrea, 2003. " Testing for Market Discipline in the European Banking Industry: Evidence from Subordinated Debt Issues," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(3), pages 443-72, June.
    12. Matutes, Carmen & Vives, Xavier, 1995. "Imperfect Competition, Risk Taking, and Regulation in Banking," CEPR Discussion Papers 1177, C.E.P.R. Discussion Papers.
    13. Boyd, John H. & Levine, Ross & Smith, Bruce D., 2001. "The impact of inflation on financial sector performance," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 221-248, April.
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