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

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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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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  1. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
  2. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
  3. Frederic S. Mishkin, 1996. "Understanding Financial Crises: A Developing Country Perspective," NBER Working Papers 5600, National Bureau of Economic Research, Inc.
  4. Matutes, Carmen & Vives, Xavier, 1995. "Imperfect Competition, Risk Taking, and Regulation in Banking," CEPR Discussion Papers 1177, C.E.P.R. Discussion Papers.
  5. 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.
  6. repec:ner:tilbur:urn:nbn:nl:ui:12-3125518 is not listed on IDEAS
  7. 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.
  8. 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).
  9. 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.
  10. Demirguc-Kunt, Asli & Karacaovali, Baybars & Laeven, Luc, 2005. "Deposit insurance around the world : a comprehensive database," Policy Research Working Paper Series 3628, The World Bank.
  11. 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.
  12. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
  13. 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.
  14. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December.
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