Factors Influencing Bank Risk-Taking With an Emphasis on Monetary Policy, Regulations, and Macroeconomics

Dehghan Dehnavi, Mohammad Ali; Amiri, Meysam; Khorshidsavar, Amin

doi:10.22054/ijer.2024.77944.1260

Document Type : Research Paper

Authors

¹ Assistant Professor, Department of Finance and Banking, Allameh Tabataba’i University, Tehran, Iran

² MSc Department of Finance and Banking, Allameh Tabataba’i University, Tehran, Iran

https://doi.org/10.22054/ijer.2024.77944.1260

Abstract

Banks play a crucial role in maintaining financial stability within an economy. Their importance arises from the various functions they perform, which contribute to the overall stability and growth of the financial system. Additionally, the significance of banks for real economic growth lies in their role as financial intermediaries that facilitate allocating capital efficiently, supporting businesses and individuals, and contributing to the economy’s overall stability and development. Relying on data from 16 banks in Iran between 2011 and 2023, this research aimed to investigate the factors influencing bank risk-taking, with a focus on monetary policy, regulations, and macroeconomic variables. The analysis used two models and the Generalized Method of Moments (GMM) as the estimation method. The results of the research show that there is an inverse relationship between monetary policy and risk-taking. The results indicated an inverse relationship between monetary policy and risk-taking. Moreover, while the capital adequacy ratio (a regulatory factor) and GDP growth rate positively influence risk-taking, there is an inverse relationship between the inflation rate and risk-taking.

Introduction

Borio and Zhu (2012) introduced a new transmission mechanism of monetary policy known as the risk-taking channel. Building on the seminal work of Borio and Zhu (2012), numerous theoretical and empirical studies have validated and expanded this channel in various countries, including China (Li & Tian, 2020; Tan & Li, 2016). In general, the risk-taking channel is underpinned by three key mechanisms: search-for-yield; valuation, income, and cash flow expansion; and central bank communication, announcements, and feedback (Altunbas et al., 2012; Borio & Zhu, 2012; De Nicolò et al., 2010). Since interest rates influence banks’ risk-taking behavior through agency problems (Altunbas et al., 2012), other bank characteristics must also influence bank risk-taking via the same channel (Bonfim & Soares, 2018). Altunbas et al. (2011) note that banks with less capital, more assets, and a greater reliance on short-term market funding are exposed to higher risk. In addition, most studies have explore this theme from the perspective of internal bank characteristics, such as capital, liquidity, leverage, and the proportion of traditional business (Altunbas et al., 2012; Bonfim & Soares, 2018).
Traditional moral hazard theory suggests that under-capitalized banks face significant agency problems and are more likely to take excessive risks (Jiang et al., 2020). Shim (2013) demonstrates that a capital buffer (i.e., capital above the required minimum) helps limit moral hazard and absorbs adverse economic shocks. During the early stages of a financial crisis, banks with higher Tier I capital and more liquid assets tend to perform better (Beltratti and Stulz, 2009; Demirgüç-Kunt et al., 2013). Some empirical studies of the U.S. banking system suggest that capital is an effective risk indicator, showing a significant negative correlation with bank risk-taking (Hogan, 2015). Overall, it is widely accepted among scholars that holding more capital reduces bank risk-taking.
The findings of Gizki et al. (2001) support the relationship between financial institutions and the real economy. First, the effect of real credit growth on banks’ credit risk and profitability aligns with the view that challenges in monitoring bank performance can lead to weakened credit standards during periods of rapid aggregate credit expansion.
Second, the observed relationship between property prices and bank risk supports the proposition that difficulties in monitoring borrowers’ viability—coupled with the effect of collateral values on signaling borrower creditworthiness—play a crucial role in determining credit supply. Third, the results are consistent with theoretical analyses suggesting that cyclical changes in agents’ preferences for leverage significantly influence bank risk and profitability.

Materials and Methods

A key assumption of regression analysis is that the right-hand side variables are not correlated with the disturbance term. If this assumption is violated, both ordinary least squares (OLS) and weighted least squares (WLS) estimations become biased and inconsistent. There are several situations in which some of the right-hand side variables may be correlated with the disturbance term. Classic examples of such cases include: 1) There are endogenously determined variables on the right-hand side of the equation, and 2) these right-hand side variables are measured with error. For simplicity, we refer to variables that are correlated with the residuals as endogenous, and those that are not correlated with the residuals as exogenous or predetermined. The standard approach when right-hand side variables are correlated with the residuals is to estimate the equation using instrumental variables regression. The concept behind instrumental variables is to identify a set of variables, called instruments, that are both correlated with the explanatory variables in the equation and uncorrelated with the disturbances. These instruments are then used to remove the correlation between the right-hand side variables and the disturbances. There are several approaches to using instruments to eliminate the effect of variable and residual correlation. The current study proposed instrumental variable estimators that employ the Generalized Method of Moments (GMM).

Results and Discussion

The GMM was used to estimate the model. The results are shown in Table 1.
Table 1. Model estimation results

Model 2

Model 1

Symbol

Variable

-

0/07***

RWA

lag dependent variable

0/57***

-

NPL

lag dependent variable

-0/33***

-1/48***

Overnight

Interbank interest rate

0/16***

0/48***

CAR

Capital adequacy ratio

0/07**

0/25***

GDP_Growth

Gross domestic product growth

-0/02**

-0/35***

inflation

Inflation rate

-0/13***

-0/03

Size

Size

0/000**

0/00*

Leverage

Leverage

0.99

0/99

Sargan

Sargan

-0/13**

-1/99**

AR(1)

First-Order Autoregressive

-0/06

-1/67

AR(2)

Second-Order Autoregressive

* The coefficient is significant at 10% level.
** The coefficient is significant at 5% level.
*** The coefficient is significant at 1% level.
Source: Research calculations.

Conclusion

The role of the financial system in the economy, along with its development and health, forms the foundation for strengthening and driving economic growth. Monitoring and reforming this system contribute to stability by addressing needs and reinforcing the real sector of the economy. The research findings indicated an inverse relationship between monetary policy and risk-taking. While the capital adequacy ratio (a regulatory factor) and GDP growth rate have a positive effect on risk-taking, there is an inverse relationship between the inflation rate and risk-taking.

Keywords

Main Subjects

Banking

References

Adrian, T. & Shin, H.S. (2010). Financial intermediaries and monetary economics. In Handbook of Monetary Economics, 3, 601–650

Acosta-Smith, Jonathan, Grill, Michael, Lang, Jan H. (2020). The leverage ratio, risk-taking and bank stability. J. Financ. Stab. doi:1010.1016/j.jfs.2020.100833.

Agur, I., & Demertzis, M. (2010). Monetary Policy and Excessive Bank Risk Taking. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1950167

Aiyar, S. (2012). From financial crisis to great recession: the role of globalized banks. American Economic Review, 102(3), 225–230. https://doi.org/10.1257/aer.102.3.225

Altunbas, Y., Gambacorta, L. & Marques-Ibanez, D. (2012). Do bank characteristics influence the effect of monetary policy on bank risk? Economics Letters, 117(1), 220–222.

https://doi.org/10.1016/j.econlet.2012.04.106

Angeloni, I. & Faia, E. (2013). Capital regulation and monetary policy with fragile banks. Journal of Monetary Economics, 60(3), 311–324. https://doi.org/10.1016/j.jmoneco.2013.01.003

Arellano, M. & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment. Rev. Econ. Stud, 58, 277–297.

Asadi, Z. , Yavari, K. and Heydari, H. (2020). The study of the effects of liquidity and credit risk on bank stability in Iran using the Z-score index. The Journal of Economic Policy, 12(23), 1-31. doi: 10.22034/epj.2020.10430.1832 [In Persian]

Athari, S.A. & Irani, F. (2022). Does the country’s political and economic risks trigger risk-taking behavior in the banking sector: a new insight from regional study. Journal of Economic Structures, 11(1), 32. https://doi.org/10.1186/s40008-022-00294-4

Barra, C. & Ruggiero, N. (2021). Do microeconomic and macroeconomic factors influence Italian bank credit risk in different local markets? Evidence from cooperative and non-cooperative banks. Journal of Economics and Business, 114, 105976. https://doi.org/10.1016/j.jeconbus.2020.105976.

Beltratti, A. & Stulz, R.M. (2009). Why did some banks perform better during the credit crisis? a cross-country study of the impact of governance and regulation. SSRN Electronic Journal. NBER Working Papers 15180, National Bureau of Economic Research, Inc.h ttps://doi.org/10.2139/ssrn.1433502

Besanko, D. & G. Kanatas (1996). The regulation of bank capital: Do capital standards promote bank safety? Journal of Financial Intermediation, 5, 160-183.

Bonfim, D. & Soares, C. (2018). The risk‐taking channel of monetary policy: exploring all avenues. Journal of Money, Credit and Banking, 50(7), 1507–1541. https://doi.org/10.1111/jmcb.12500

Borio, C. & Zhu, H. (2012). Capital regulation, risk-taking and monetary policy: A missing link in the transmission mechanism? Journal of Financial Stability, 8(4), 236–251. https://doi.org/10.1016/j.jfs.2011.12.003

Boyd, J.H., Levine, R. & Smith, B.D. (2001). The impact of inflation on financial sector performance. Journal of Monetary Economics, 47(2), 221–248. https://doi.org/10.1016/S0304-3932(01)00049-6

Buch, C.M. & DeLong, G. (2008). Do weak supervisory systems encourage bank risk-taking? Journal of Financial Stability, 4(1), 23–39. https://doi.org/10.1016/j.jfs.2007.12.002

Bui, D.T., Nguyen, C.P. & Su, T.D. (2021). Asymmetric impacts of monetary policy and business cycles on bank risk-taking: Evidence from Emerging Asian markets. The Journal of Economic Asymmetries, 24, e00221. https://doi.org/10.1016/j.jeca.2021.e00221

Cole, R. A., & White, L. J. (2012). Déjà Vu All Over: The Causes of U.S. Commercial Bank Failures This Time Around. Journal of Financial Services Research, 42(1–2), 5–29. https://doi.org/10.1007/s10693-011-0116-9

Danielsson, J., Valenzuela, M. & Zer, I. (2018). Learning from history: volatility and financial crises. The Review of Financial Studies, 31(7), 2774–2805. https://doi.org/10.1093/rfs/hhy049.

Dehghan Dehnavi, M.A., Moharram Oghli, O. & Baei, M. (2017). Determinants of banks' risk-taking in Iran with emphasis on ownership structure. Financial Research Journal, 19(1), 80-61. doi: 10.22059/jfr.2017.206195.1006192[In Persian]

Delis, M.D. & Kouretas, G.P. (2011). Interest rates and bank risk-taking. Journal of Banking & Finance, 35(4), 840–855.

https://doi.org/10.1016/j.jbankfin.2010.09.032

Delis, M.D., Hasan, I. & Mylonidis, N. (2017). The risk‐taking channel of monetary policy in the U.S.: evidence from corporate Loan data. Journal of Money, Credit and Banking, 49(1), 187–213. https://doi.org/10.1111/jmcb.12372

Dell’Ariccia, G., De Nicolo, G., Laeven, L. & Valencia, F. (2010). Monetary policy and bank risk-taking. IMF Staff Position Notes, 2010(09), 1. https://doi.org/10.5089/9781455253234.004

DellʼAriccia, G., Laeven, L. & Suarez, G.A. (2017a). Bank leverage and monetary policy’s risk‐taking channel: evidence from the United States. The Journal of Finance, 72(2), 613–654. https://doi.org/10.1111/jofi.12467

Demirguc‐Kunt, A., Detragiache, E. & Merrouche, O. (2013). Bank capital: lessons from the financial crisis. Journal of Money, Credit and Banking, 45(6), 1147–1164. https://doi.org/10.1111/jmcb.12047

Derbali, A. (2011). determinants of banking profitability before and during the financial crisis of 2007: the case of Tunisian banks. Interdisciplinary Journal of Contemporary Research in Business, 3, 1256-1269.

Diamond, D. & Raghuram R. (2001). Liquidity risk, liquidity creation, and financial fragility: A theory of banking. Journal of Political Economy, 109, 287-327. https://doi.org/10.1086/319552

Eslamloueyan, K., Yazdanpanah, H. & Khalilnezhad, Z. (2018). The existence of a risk-taking channel of monetary policy transmission in Iran’s banking system. Journal of Economic Modeling Research, 9(31), 7-40 [In Persian]

Festic, M., Kavkler, A. & Repina, S. (2011). The macroeconomic sources of systemic risk in the banking sectors of five new EUmember states. Journal of Banking and Finance, 35, 310–322.

Francis, W. B., & Osborne, M. (2012). Capital requirements and bank behavior in the UK: Are there lessons for international capital standards? Journal of Banking & Finance, 36(3), 803–816.

https://doi.org/10.1016/j.jbankfin.2011.09.011

Gaganis, C., Pasiouras, F., Doumpos, M. & Zopounidis, C. (2010). Modelling banking sector stability with multicriteria approaches. Optimization Letters, 4, 543-558. https://ssrn.com/abstract=1531837

Gale, D. (2010). Capital regulation and risk sharing. International Journal of Central Banking, 6(4).

Ghosh, S. (2014). Risk, capital and financial crisis: Evidence for GCC banks. Borsa Istanbul Review, 14(3), 145–157. https://doi.org/10.1016/j.bir.2014.06.003

Gorton, G. & Winton, A. (2017). Liquidity provision, bank capital, and the macroeconomy. Journal of Money, Credit and Banking, 49(1), 5–37. https://doi.org/10.1111/jmcb.12367

Hamerle, A., Dartsch, A., Jobst, R. & Plank, K. (2011). Integrating macroeconomic risk factors in credit portfolio models. The Journal of Risk Model Validation, 5(2), 3–24. https://doi.org/10.21314/JRMV.2011.070

Hellmann, T.F., Murdock, K.C., & Stiglitz, J.E. (2000). Liberalization, moral hazard in banking, and prudential regulation: are capital requirements enough? American Economic Review, 90(1), 147–165. https://doi.org/10.1257/aer.90.1.147

Hogan, T.L. (2015). Capital and risk in commercial banking: A comparison of capital and risk-based capital ratios. The Quarterly Review of Economics and Finance, 57, 32–45. https://doi.org/10.1016/j.qref.2014.11.003

Illueca, M., Norden, L., Pacelli, J. & Udell, G.F. (2022). Countercyclical prudential buffers and bank risk-taking. Journal of Financial Intermediation, 51, 100961. https://doi.org/10.1016/j.jfi.2022.100961

Ioannidou, V., Ongena, S. & Peydró, J.L. (2015). Monetary policy, risk-taking, and pricing: evidence from a quasi-natural experiment. Review of Finance, 19(1), 95–144. https://doi.org/10.1093/rof/rfu035

Jiang, H. & Yuan, C. (2022). Monetary policy, capital regulation and bank risk-taking: Evidence from China. Journal of Asian Economics, 82, 101512. https://doi.org/10.1016/j.asieco.2022.101512

Jiang, H., Zhang, J. & Sun, C. (2020). How does capital buffer affect bank risk-taking? New evidence from China using quantile regression. China Economic Review, 60, 101300. https://doi.org/10.1016/j.chieco.2019.04.008

Jiménez, G., Ongena, S., Peydró, J.L. & Saurina, J. (2014a). Hazardous times for monetary policy: what do twenty-three million bank loans say about the effects of monetary policy on credit risk-taking? Econometrica, 82(2), 463–505. https://doi.org/10.3982/ECTA10104

Jokipii, T. & Monnin, P. (2013). The impact of banking sector stability on the real economy. Journal of International Money and Finance, 32, 1–16. https://doi.org/10.1016/j.jimonfin.2012.02.008

Kashyap, A.K., Kovrijnykh, N., Li, J. & Pavlova, A. (2021). The benchmark inclusion subsidy. Journal of Financial Economics, 142(2), 756–774. https://doi.org/10.1016/j.jfineco.2021.04.021

Kaufman, G.G. (1999). Financial problems and macroeconomic stability. International Banking Crises: Large-Scale Failures, Massive Government Interventions, 264.

Koehn, M. & Santomero, A.M. (1980). Regulation of bank capital and portfolio risk. Journal of Finance, 35, 1235-1244.

Laeven, L. & Levine, R. (2009). Bank governance, regulation and risk taking. Journal of financial Economics, 93(2), 259–275. https://doi.org/10.1016/jfineco.2008.09.003.

Lee, P.L., Lye, C.T. & Lee, C. (2022). Is bank risk appetite relevant to bank default in times of Covid-19? Central Bank Review, 22(3), 109–117. https://doi.org/10.1016/j.cbrev.2022.08.003

Li, S. & Tian, G. (2020). Bank competition and bank risk-taking channel of monetary policy: Theoretical and empirical. Analysis Management Word, 04, 149–168.

Lindgren, C.J., Saal, M.I. & Garcia, G.G. (1996). Bank soundness and macroeconomic policy. International Monetary Fund. https://doi.org/10.5089/9781557755995.071

Linsmeier, T.J. (2011). Financial reporting and financial crises: The case for measuring financial instruments at fair value in the financial statements. Accounting Horizons, 25(2), 409–417. https://doi.org/10.2308/acch-10024

Maddaloni, A., Scopel, S. & Peydr´o-Alcalde, J.L. (2008). Does monetary policy affect bank lending standards? Evidence from the Euro area bank lending survey. In presentado en la CEPR BIS ESI 2008 Conference on Monetary Policy.

Marcucci, J. & Quagliariello, M. (2008). Is bank portfolio riskiness procyclical? Journal of International Financial Markets, Institutions and Money, 18(1), 46–63. https://doi.org/10.1016/j.intfin.2006.05.002

Martinez-Miera, D. & Suarez, J. (2012). A macroeconomic model of endogenous systemic risk taking. CEPR Discussion Paper No. DP9134, Available at SSRN: https://ssrn.com/abstract=2153575.

Mehran, H. & Thakor, A. (2011). Bank capital and value in the cross-section. Review of Financial Studies, 24(4), 1019–1067. https://doi.org/10.1093/rfs/hhq022

Mehrara, M. & Sehati, E. (2011). The impact of macroeconomic uncertainty on bank lending behavior (the case of Iran). Economics Research, 11(43), 1-21. [In Persian]

Meyer, A.P. & Yeager, T.J. (2001). Are small rural banks vulnerable to local economic downturns? Review, 83(2). https://doi.org/10.20955/r.83.25-38

Micco, A. & Panizza, U. (2004). Bank ownership and lending behavior, Inter-american development bank, Working Paper. 520.

Miraskari, S.R. & Hosseini Nesaz, H. (2017). Analysing the effects of macroeconomic variables on bank's credit risk. Monetary & Financial Economics, 24(14), 175-199. doi:10.22067/pm.v24i13.53757 [In Persian]

Mishkin, F. (1996). Understanding financial crises: a developing country perspective. NBER Working Papers 5600, National Bureau of Economic Research, Inc Available at SSRN: https://ssrn.com/abstract=775. https://doi.org/10.3386/w5600

Naceur, S.B. & Omran, M. (2011). The effects of bank regulations, competition, and financial reforms on banks’ performance. Emerging Markets Review, 12(1), 1–20. https://doi.org/10.1016/j.ememar.2010.08.002

Neuenkirch, M. & Nöckel, M. (2018). The risk-taking channel of monetary policy transmission in the Euro area. Journal of Banking & Finance, 93, 71–91. https://doi.org/10.1016/j.jbankfin.2018.06.003

Nordal, K.B., Aronsen, P.A. & Turtveit, L. (2016). Banks’ adaptation to regulation: a model-based analysis. Staff Memo (11). Norges Bank.

Pozo, J. (2023). Bank risk-taking in emerging economies: Empirical evidence and theory. Journal of Financial Stability, 67, 101136. https://doi.org/10.1016/j.jfs.2023.101136

Rahmani, T., Ahmadyan, A. & Kianvand, M. (2016). An estimation of the relationship between monetary policy and bank risk-taking in Iran. Journal of Monetary & Banking Research, 29(9). 405-425 [In Persian]

Rajan, R.G. (2006). Has finance made the world riskier? European Financial Management, 12(4), 499–533. https://doi.org/10.1111/j.1468-036X.2006.00330.x

Rochet, J.C. (1992). Capital requirements and the behaviour of commercial banks. European Economic Review, 36(5), 1137–1170. https://doi.org/10.1016/0014-2921(92)90051-W

Sameti, M. & Karnameh Haghighi, H. (2013). Macroeconomic instability and commercial bank lending (case study: Iran 1974-2009). Economics Research, 13(48), 121-145. [In Persian]

Schinasi, G.J. (2003). Responsibility of central banks for stability in financial markets. IMF Working Paper WP/03/121.

Shim, J. (2013). Bank capital buffer and portfolio risk: The influence of business cycle and revenue diversification. Journal of Banking & Finance, 37(3), 761–772. https://doi.org/10.1016/j.jbankfin.2012.10.002

Shim, J. (2010). Capital-based regulation, portfolio risk and capital determination: Empirical evidence from the US property–liability insurers. Journal of Banking & Finance, 34(10), 2450–2461.

https://doi.org/10.1016/j.jbankfin.2010.04.003.

Solgi, M. & Talebi, M. (2017). Risk and capital adequacy ratio: evidence from Iranian banks. Journal of Monetary and Banking Research. 9(30).513-543 [In Persian]

Stewart, R., Chowdhury, M. & Arjoon, V. (2021). Bank stability and economic growth: trade-offs or opportunities? Empirical Economics, 61(2), 827–853. https://doi.org/10.1007/s00181-020-01886-4

Tan, Z. & Li, L. (2016). Risk and efficiency for Chinese commercial banks: From the perspective of monetary policy. Journal of Financial Research (in Chinese Jin Rong Yan Jiu), 06, 112–126. CNKI:SUN:JRYJ.0.2016-06-008.

Thiagarajan, S. (2011). Credit risk determinants of public and private sector banks in India. European Journal of Economics, Finance and Administrative Sciences, 34, 147-153.

Tongurai, J. & Vithessonthi, C. (2020). Bank regulations, bank competition and bank risk-taking: Evidence from Japan. Journal of Multinational Financial Management, 56, 100638. https://doi.org/10.1016/j.mulfin.2020.100638

Trethowan, J. & Scullion, G. (1997). Strategic responses to change in retail banking in the UK. International Journal of Bank Marketing, 15(2), 60-68. https://doi.org/10.1108/02652329710160475.

Valencia, F. (2014). Monetary policy, bank leverage, and financial stability. Journal of Economic Dynamics and Control, 47, 20–38.

https://doi.org/10.1016/j.jedc.2014.07.010

Van den Heuvel, S. J. (2008). The welfare cost of bank capital requirements. Journal of Monetary Economics, 55(2), 298–320.

https://doi.org/10.1016/j.jmoneco.2007.12.001

Wang, C. & Zhuang, L. (2022). Bank liquidity and the risk-taking channel of monetary policy: An empirical study of the banking system in China. PLOS ONE, 17(12), e0279506. https://doi.org/10.1371/journal.pone.0279506.

Wong, J., Wong, T.C. & Leung, P. (2010). Predicting banking distress in the EMEAP economies. Journal of Financial Stability, 6(3), 169-179

Zribi, N. & Boujelbegrave, Y. (2011). The factors influencing bank credit risk: The case of Tunisia. Journal of Accounting and Taxation, 3(4), 70-78.doi.org/10.5897/JAT11.006

Iranian Journal of Economic Research

Factors Influencing Bank Risk-Taking With an Emphasis on Monetary Policy, Regulations, and Macroeconomics

References

References

Volume 29, Issue 101 - Serial Number 101
February 2025
Pages 83-118

Factors Influencing Bank Risk-Taking With an Emphasis on Monetary Policy, Regulations, and Macroeconomics

References

References

Volume 29, Issue 101 - Serial Number 101February 2025Pages 83-118

Volume 29, Issue 101 - Serial Number 101
February 2025
Pages 83-118