Country risk factors and banking sector stability: Do countries’ income and risk-level matter? Evidence from global study

Abstract

Extant literature suggests the essential role of a country's vulnerability in decreasing the stability of the banking sectors. However, the effect of country-specific risks on banking sector stability remains largely understudied. This study specifically examines the impact of country risk, encompassing political, economic, and financial risks, on the banking sector stability from a global perspective. Furthermore, we attempt to provide more insight by answering how this relationship varies by grouping countries based on income and risk levels. To achieve this purpose, we focus on 107 countries and employ a dynamic panel data model (SYS-GMM) between 2004 and 2017. The results indicate that a reduction in a country's vulnerability to specific political, economic, and financial risks, contributes to enhanced stability in the banking sector. This positive effect is particularly pronounced as countries move from low to medium and high-income levels. Furthermore, the study reveals that a decrease in country risk leads to increased banking sector stability in both low and high-risk countries, but the effect is more outstanding in low-risk environments. Moreover, the results highlight the significant influence of banking sector-specific factors and country-level determinants on stability, however, the magnitude and direction of these factors' coefficients depend on the income and risk levels of the countries. The results are robust and can have important suggestions to policymakers, regulators, and bank executives in understating and mitigating risk factors to enhance the stability of their banking sectors.