Financial development, role of government, and bank profitability: evidence from the 2008 financial crisis

This study investigates the effects of financial development and government involvement on bank profitability during the 2008 financial crisis. First, it demonstrates that a large banking sector improves bank profitability and asset quality, which supports the hypothesis of financial development improvement. Second, financial liberalization is negatively associated with bank profitability and asset quality, which supports the view of external capital dependence. Finally, results confirm the role of the government during the financial crisis. The positive effect of financial development improvement is stronger on banks with weak government involvement than on banks with strong government involvement. By contrast, the negative effect of external capital dependence is less significant on banks with strong government involvement than on banks with weak government involvement. The results have two implications. First, the negative effect of financial liberalization on the banking sector is prominent during an unstable economic period and not just under a weak institutional environment. Second, although a bank cannot determine the financial development level of its country, it can adjust the involvement of its government to offset macroeconomic impact.