The impact of bank size and funding risk on bank stability

Michael Adusei,Caroline Elliott

doi:10.1080/23322039.2015.1111489

Michael Adusei, Caroline Elliott

Open Access

https://doi.org/10.1080/23322039.2015.1111489

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Abstract

AbstractDoes bank size significantly explain the variations in bank stability? Does bank funding risk significantly impact bank stability? This paper addresses these two questions with data from the rural banking industry in Ghana. Controlling for credit risk, liquidity risk, diversification in the business model, profitability, inflation, financial structure and gross domestic product, the results suggest that an increase in the size of a rural bank results in an increase in its stability. The results also show that funding risk positively impacts bank stability. The positive relationship between size and bank stability has important repercussions for the current debate on whether or not to constrain bank size to insulate the financial system from future crisis. The positive relationship between funding risk and bank stability also has important implications for the current debate on funding of retail banks.

Highlights

The issue of limiting bank size as a way of ensuring stability in the financial system has always been at the centre of bank supervision and regulation
This paper examines the impact of bank size and bank funding risk on bank stability with focus on the rural banking industry in Ghana
The Hausman tests as well as the redundant fixed effect (FE) tests results reported in Tables 6–8 indicate that the FE model is the optimal estimation technique to use for analysis

Summary

Introduction

The issue of limiting bank size as a way of ensuring stability in the financial system has always been at the centre of bank supervision and regulation. The issue has gained much prominence since the 2007/2008 global financial crisis This is because evidence abounds that large banks accounted for the crisis that caused a significant damage to many economies across the globe. Ever since the world emerged from the crisis, the debate on the optimal size, organizational complexity and a range of activities of banks has heightened (Viñals et al, 2013). This debate has flourished against the backdrop of a financial landscape that has developed markedly over the past two decades, fuelled by financial innovation and deregulation (Laeven, Ratnovski, & Tong, 2014). Regulators in the US (under the Dodd Act, 2010) and in the European Union [as in recommendations by the Liikanen (2012) implemented into EC law as well as the recommendations by the Vickers Report (2011) implemented into UK law] are making strenuous efforts to constrain the size of banks by demanding more capital and liquidity in line with Basel III requirements and restricting bank’s involvement in riskier areas of activity

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