Abstract
Abstract This paper investigates the impact of capital flows on bank risk-taking behavior. It undertakes two levels of empirical estimations, namely (i) single-country industry-level; and (ii) multi-country industry-level estimations, covering emerging market economies. The results suggest that capital inflows, in the form of portfolio investment, is significant in raising risk-taking behavior. Large banks are less aggressive in their risk-taking behavior vis-à-vis smaller banks. Such impact of portfolio investment on risk-taking behavior is also shown in the multi-country level estimates.
Highlights
The paper explores the impact of capital flows on bank risktaking in Indonesia
By estimating the specifications using the Seemingly Unrelated Regression (SUR) methodology and applying the Breusch–Pagan Lagrange Multiplier (LM) and Pesaran cross-sectional dependence (CD) tests, we find no evidence of cross-sectional residuals
This paper investigates the response of bank risk-taking behavior to capital inflows
Summary
The paper explores the impact of capital flows on bank risktaking in Indonesia. In the aftermath of the Lehman crisis, advanced countries implemented an extensive accommodative monetary policy to revive economic growth Central banks in those countries employed unconventional methods of monetary policy through assets purchase programs, known as quantitative easing.3 This phenomenon induced large and volatile international capital flows, including to emerging economies (Ahmed and Zlate, 2014), such as Indonesia (Figure 1). Our empirical assessment contributes to this broad literature by showing that capital flows are an important determinant of risk-taking behavior of banks in emerging markets small open economies. Rumondor, Kusuma, & Idham (2017), and Harahap and Bary (2017b) find that financial cycle (credit growth) in Indonesia is influenced by global financial cycles (capital inflows) None of these studies examine the impact of capital flows and banking risk-taking behavior in Indonesia—a research gap that our study fills.
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