National Culture, Political Institutions, Openness And Bank Risk-Taking Behavior

In a cross country setting, institutions and integration in world markets are likely to be critical for bank risk-taking decisions. This dissertation aims to analyze the impact of national culture, political institutions and trade-and capital-openness on bank risk-taking behavior.For national culture, we hypothesize that four dimensions of national culture, uncertainty avoidance, masculinity, individualism and power distance, can influence bank risk-taking directly as well as indirectly by conditioning the configuration of banking regulations. Analyzing a sample of banks from75countries, findings support that national culture has significant direct effects on bank risk-taking showing that the bank risk-taking is significantly higher in high individualism, low uncertainty-avoidance, and low power distance countries. For indirect effects, findings suggest that regulators in high individualism cultures use fewer restrictions on bank activities and allow more competition for banks that further reinforce risk increasing impact of higher cultural individualism. Conversely, regulators in high power distance cultures use higher activity restrictions and allow less competition for banks that further reinforce risk reducing impact of higher cultural power distance. Analysis for cultural effects on foreign banks operating in a country suggests that home country national culture explains risk-taking behavior of foreign banks more than the national culture of host country. Finally, analysis whether cultural dimensions explain the probability of a systemic banking crisis occurrence in a country suggests that significantly higher (lower) crises occurred in individualistic (high power distance) countries during recent global turmoil. These results have important implications for academicians who study capital markets in international contexts, for regulators while drafting bank regulations and for multinational banks while formulating strategies for multinational operations.For political institutions, we examine the first order influence of political institutions on bank risk-taking behavior using a sample of banks from98countries. We find robust evidence that bank risk-taking is significantly higher in sound political institutions countries suggesting that increased competition from alternate sources of financing due to financial constraints mitigation effect and moral hazard problems linked with better political institutions lead banks to increase bank risk-taking. Further analysis shows that positive influence of political institutions on bank risk-taking is robust irrespective of income levels of countries, as political institutions largely enter positive and significant with bank risk-taking when sample is either divided into two developed and developing countries subsamples, or into four low income, lower middle income, higher middle income and high income OECD countries subsamples. Results also show that positive influence of political institutions on bank risk-taking is robust in countries having explicit deposit insurance and suggest that moral hazard problems linked with sound political institutions complement the moral hazard problems of explicit deposit insurance. We also examine the interdependence between political and legal institutions and find that political and legal institutions complement each other to influence bank risk-taking.For trade-and capital-openness, we test the theoretical arguments of’interest group theory of financial development’ that trade-and capital-openness increases financial development at micro-level. Specifically, we examine the impact of trade-and capital-openness on net interest margins (rents), gross loan ratios (lending), and risk-taking behavior of incumbent financial institutions. Analyzing a sample of287key banks from37emerging/developing countries, we find robust evidence that higher trade-openness cause a decrease in average bank net interest margins, an increase in average bank gross loan ratios and a decrease in average bank insolvency risk. We find limited support for the role of capital-openness however. For bank net interest margins, we find that higher capital-openness is effective in reducing average net interest margins of key banks only when considered jointly with trade-openness, but not independently. For bank gross loan ratios and risk-taking, we find that higher capital-openness cause a decrease in average bank gross loan ratios and an increase in average bank risk-taking in emerging economies. Thus, our findings support that trade-openness is effective tool for increasing banking sector development in emerging economies. However, emerging economies must be cautious while opening capital accounts because capital-openness although causes a decrease in rents of incumbent financial institutions but it increases overall fragility of key banks.