The impact of monetary policy on banks' risk-taking behavior in an emerging economy: The role of Basel II

Abstract

<abstract> <p>The main goal of this study is to investigate the impact of monetary policy (MP) on the risk-taking behavior of Bangladeshi banks. It also attempts to examine the role of Basel II in the association between MP and bank risk-taking pre- and post-2010. This study analyzes data from 33 commercial banks in Bangladesh over the 20 years from 2002 to 2021 and uses the two-step system generalized method of moments to address heteroscedasticity and autocorrelation issues. Unlike previous research, this study confirms the significant effect of Basel II on the relationship between MP and banks' risk-taking behavior. The main findings are first that a non-linear U-shaped relationship exists between MP and banks' risk-taking behavior, implying that when bank rate (BR) and cash reserve ratio (CRR) increase, bank credit risk first decreases, then later increases. Second, bank-level characteristics such as liquidity, regulatory capital, and size have a significant effect on risk, whereas bank age has an insignificant effect on risk-taking behavior. Third, MP and Basel II jointly influence risk-taking so that banks take higher risks before implementing Basel II. Overall, thisstudy offers significant practical implications for academics, researchers, and regulators interested in leveraging the findings.</p> </abstract>