Financial Liberalization: Commercial Bank's Blessing or Curse?

Abstract

The purpose of the paper is to evaluate and measure the effect of financial liberalization (FL) on bank risk exposure. We pursue these questions by assessing the changes in market-based asset values and risk exposure measures for commercial banks (CB) before and during a FL program. We do this for a sample of three countries: Malaysia, Taiwan and Thailand. We use a model based on the options pricing theory. We obtain estimates of the first and second moment of bank returns using an asset pricing model in which these two moments are a linear projection of a set of conditioning variables. This model was estimated using a GMM statistical procedure. Then we perform regressions explaining the evolution of bank risk measure around the FL event. The analysis and statistical test indicate that risk exposure of banks increases following a FL program, and this as a result of macroeconomic policy as well as changes in management controlled variables. This is so even for banks operating in countries that have undertaken very cautious FL processes such as Thailand and Malaysia. The results tend to support the proposition that moral hazard and bank risk taking may increase following FL. The results also suggest that banking crisis that often have followed FL may be more due to the behavior of banks' managers than previously reported in the FL literature.