Economic policy uncertainty and bank stability: Threshold effect of institutional quality and competition

Abstract

This study examines the effect of economic policy uncertainty (EPU) on bank stability using bank-level panel data from 2005 to 2019. The findings show that EPU decreases bank stability, but the effect varies across the bank and market structure, and it is significantly higher during financial crisis periods. Moreover, we examine the roles of institutional quality and bank competition in shaping the EPU-bank stability nexus. The results show a significant threshold effect on the EPU bank stability nexus using the threshold estimation technique considering nonlinearity. Countries with institutional quality above the threshold level reduce the adverse impact of policy uncertainty on bank stability, while lower bank competition reinforces the adverse effect. In addition, EPU adversely impacts bank stability in all countries in the sample regardless of countries' development and income levels. The results are robust to alternative risk indicators and various additional tests. Our empirical work has specific policy implications for banks, regulatory bodies, and government agencies for decision-making.