Abstract

Purpose This paper aims to offer an empirical study of the impact of institutional quality on the banking system risk and credit risk. Design/methodology/approach Applying cross-sectional dependent tests and stationary tests to check the property of our sample, the panel corrected standard errors model is recruited as the main estimator, while feasible generalized least squares, pool ordinary least squares (OLS), robust pool OLS and other estimators are used as a robustness check for an unbalanced panel data for 56 economies divided into three subsamples between 2002 and 2015. Findings The empirical results show several significant contributions. First, an improvement in institutional quality is an important factor to reduce the banking system risk. This effect of the institutions is less important in well-capitalized, highly profitable and in high-economic growth countries. This effect is also stronger in highly liquid banking systems. Notably, a better institutional quality helps to reduce the banking system risk in the highly concentrated banking system. Second, institutional quality has a significant negative relationship with the banking credit risk, especially in highly concentrated banking systems and in high-growth countries. This influence is weaker in highly liquid and well-capitalized banking systems. Finally, better institutions reduce the positive effect of trade openness, but it induces a higher credit risk for the banking system from the trade openness. Notably, a better institutional quality enhances the negative effect of foreign direct investment (FDI) inflow on both banking system risk and credit risk. These findings are documented for a global sample and three subsamples: low and lower-middle-income economies, upper-middle-income economies and high-income economies. Originality/value This study provides some recommendations, for policymakers, on the roles of institutions in the banking system and financial stability.

Highlights

  • Speaking, the banking credit risk is defined as the risk that loans are not repaid partially or totally (Liao et al, 2009; Lopez et al, 2014), such risk can lead to the bank default.Since 2008 and the banks’ failure leading to the global financial crisis, the determinants of the banks default\credit risk became an important topic (Jaloudi Mutasem, 2019; Ngo Tra et al, 2019)

  • Our study finds that better institutions indexed by the mean of six institutional quality reduce the default risk, especially the credit risk of the banking systems

  • Our analysis suggests that institutional quality can act as a useful tool to reduce the default risk in highly liquid and concentrated banking systems, especially in high-growth economies with high economic integration

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Summary

Introduction

Since 2008 and the banks’ failure leading to the global financial crisis, the determinants of the banks default\credit risk became an important topic (Jaloudi Mutasem, 2019; Ngo Tra et al, 2019). The existing literature dealing with macroeconomics determinants under-investigates the influence of the institutional quality on the credit risk and default risk of the banking system. The literature on the impacts of macro institutional quality on credit risk in the banking system is scary. There are likely no studies on the association between institutional quality with other determinants of bank risk such as economic conditions or banking system characteristics. The improvement in institutional quality may have important impacts on credit risk in the banking system. The bank managers’ behaviours may be different under different contexts of their bank’s situation and economic conditions (Vo and Nguyen, 2014)

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