IDEAS home Printed from https://ideas.repec.org/a/spr/empeco/v61y2021i2d10.1007_s00181-020-01886-4.html
   My bibliography  Save this article

Bank stability and economic growth: trade-offs or opportunities?

Author

Listed:
  • Robert Stewart

    (University of the West Indies)

  • Murshed Chowdhury

    (University of New Brunswick)

  • Vaalmikki Arjoon

    (University of the West Indies)

Abstract

Recent debates on banking regulation indicate that regulatory capital improves banking stability but may also impede economic growth. These outcomes suggest that regulatory capital reform may induce a trade-off between bank stability and economic growth. We enter this conversation by investigating the direct relationship between bank stability and economic growth and, further, examine the effect that regulatory capital and institutional quality have on this relationship. Using generalized method of moments on a global panel data set of over 100 countries, across the period 1995–2015, we find no support for a regulatory capital-induced trade-off between banking stability and economic growth. On the contrary, we observe a positive relationship. Moreover, using an innovative approach based on a trade-off metric, we find strong support for the role of regulatory capital in simultaneously maintaining high levels of economic output and banking stability. Institutional quality, however, does not provide evidence of such an effect directly, but enhances the positive effects of regulatory capital. These results provide strong support for the current implementation of increased regulatory capital.

Suggested Citation

  • Robert Stewart & Murshed Chowdhury & Vaalmikki Arjoon, 2021. "Bank stability and economic growth: trade-offs or opportunities?," Empirical Economics, Springer, vol. 61(2), pages 827-853, August.
    • Handle: RePEc:spr:empeco:v:61:y:2021:i:2:d:10.1007_s00181-020-01886-4
    DOI: 10.1007/s00181-020-01886-4
    as

    Download full text from publisher

    File URL: http://link.springer.com/10.1007/s00181-020-01886-4
    File Function: Abstract
    Download Restriction: Access to the full text of the articles in this series is restricted.
    File URL: https://libkey.io/10.1007/s00181-020-01886-4?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Loayza, Norman V. & Ranciere, Romain, 2006. "Financial Development, Financial Fragility, and Growth," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(4), pages 1051-1076, June.
    2. Berger, Allen N. & Bouwman, Christa H.S., 2013. "How does capital affect bank performance during financial crises?," Journal of Financial Economics, Elsevier, vol. 109(1), pages 146-176.
    3. Carlson Mark A & King Thomas & Lewis Kurt, 2011. "Distress in the Financial Sector and Economic Activity," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 11(1), pages 1-31, June.
    4. repec:hal:spmain:info:hdl:2441/5euk7d0f8t81prfu1k2sspdcok is not listed on IDEAS
    5. Drumond, Inês & Jorge, José, 2013. "Loan interest rates under risk-based capital requirements: The impact of banking market structure," Economic Modelling, Elsevier, vol. 32(C), pages 602-607.
    6. Jokipii, Terhi & Monnin, Pierre, 2013. "The impact of banking sector stability on the real economy," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 1-16.
    7. Levine, Ross & Zervos, Sara, 1998. "Stock Markets, Banks, and Economic Growth," American Economic Review, American Economic Association, vol. 88(3), pages 537-558, June.
    8. Berger, Allen N, 1995. "The Relationship between Capital and Earnings in Banking," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(2), pages 432-456, May.
    9. Robert M. Solow, 1956. "A Contribution to the Theory of Economic Growth," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 70(1), pages 65-94.
    10. Bermpei, Theodora & Kalyvas, Antonios & Nguyen, Thanh Cong, 2018. "Does institutional quality condition the effect of bank regulations and supervision on bank stability? Evidence from emerging and developing economies," International Review of Financial Analysis, Elsevier, vol. 59(C), pages 255-275.
    11. Babecký, Jan & Havránek, Tomáš & Matějů, Jakub & Rusnák, Marek & Šmídková, Kateřina & Vašíček, Bořek, 2014. "Banking, debt, and currency crises in developed countries: Stylized facts and early warning indicators," Journal of Financial Stability, Elsevier, vol. 15(C), pages 1-17.
    12. Rajan, Raghuram G & Zingales, Luigi, 1998. "Financial Dependence and Growth," American Economic Review, American Economic Association, vol. 88(3), pages 559-586, June.
    13. Anginer, Deniz & Demirgüç-Kunt, Asli & Mare, Davide S., 2018. "Bank capital, institutional environment and systemic stability," Journal of Financial Stability, Elsevier, vol. 37(C), pages 97-106.
    14. Jean Arcand & Enrico Berkes & Ugo Panizza, 2015. "Too much finance?," Journal of Economic Growth, Springer, vol. 20(2), pages 105-148, June.
    15. Koehn, Michael & Santomero, Anthony M, 1980. "Regulation of Bank Capital and Portfolio Risk," Journal of Finance, American Finance Association, vol. 35(5), pages 1235-1244, December.
    16. Andrea F Presbitero, 2012. "Total Public Debt and Growth in Developing Countries," The European Journal of Development Research, Palgrave Macmillan;European Association of Development Research and Training Institutes (EADI), vol. 24(4), pages 606-626, September.
    17. Levine, Ross & Renelt, David, 1992. "A Sensitivity Analysis of Cross-Country Growth Regressions," American Economic Review, American Economic Association, vol. 82(4), pages 942-963, September.
    18. Cavallo, Alberto F. & Cavallo, Eduardo A., 2010. "Are crises good for long-term growth? The role of political institutions," Journal of Macroeconomics, Elsevier, vol. 32(3), pages 838-857, September.
    19. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-276, June.
    20. Bernanke, Ben S & Blinder, Alan S, 1992. "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, American Economic Association, vol. 82(4), pages 901-921, September.
    21. Creel, Jérôme & Hubert, Paul & Labondance, Fabien, 2015. "Financial stability and economic performance," Economic Modelling, Elsevier, vol. 48(C), pages 25-40.
    22. Ross Levine & Norman Loayza & Thorsten Beck, 2002. "Financial Intermediation and Growth: Causality and Causes," Central Banking, Analysis, and Economic Policies Book Series, in: Leonardo Hernández & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.),Banking, Financial Integration, and International Crises, edition 1, volume 3, chapter 2, pages 031-084, Central Bank of Chile.
    23. Anginer, Deniz & Demirguc-Kunt, Asli, 2014. "Bank capital and systemic stability," Policy Research Working Paper Series 6948, The World Bank.
    24. Robert G. King & Ross Levine, 1993. "Finance and Growth: Schumpeter Might Be Right," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 108(3), pages 717-737.
    25. David Roodman, 2009. "How to do xtabond2: An introduction to difference and system GMM in Stata," Stata Journal, StataCorp LP, vol. 9(1), pages 86-136, March.
    26. Roulet, Caroline, 2018. "Basel III: Effects of capital and liquidity regulations on European bank lending," Journal of Economics and Business, Elsevier, vol. 95(C), pages 26-46.
    27. Anginer, Deniz & Demirguc-Kunt, Asli & Huizinga, Harry & Ma, Kebin, 2013. "How does corporate governance affect bank capitalization strategies ?," Policy Research Working Paper Series 6636, The World Bank.
    28. repec:bla:jfinan:v:43:y:1988:i:5:p:1219-33 is not listed on IDEAS
    29. Hatice Ozer Balli & Bent Sørensen, 2013. "Interaction effects in econometrics," Empirical Economics, Springer, vol. 45(1), pages 583-603, August.
    30. Fidrmuc, Jarko & Lind, Ronja, 2020. "Macroeconomic impact of Basel III: Evidence from a meta-analysis," Journal of Banking & Finance, Elsevier, vol. 112(C).
    31. Berger, Allen N. & Herring, Richard J. & Szego, Giorgio P., 1995. "The role of capital in financial institutions," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 393-430, June.
    32. Santomero, Anthony M & Watson, Ronald D, 1977. "Determining an Optimal Capital Standard for the Banking Industry," Journal of Finance, American Finance Association, vol. 32(4), pages 1267-1282, September.
    33. Moritz Schularick & Alan M. Taylor, 2012. "Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870-2008," American Economic Review, American Economic Association, vol. 102(2), pages 1029-1061, April.
    34. Ross Levine, 1997. "Financial Development and Economic Growth: Views and Agenda," Journal of Economic Literature, American Economic Association, vol. 35(2), pages 688-726, June.
    35. Abdelkader Boudriga & Neila Boulila Taktak & Sana Jellouli, 2009. "Banking supervision and nonperforming loans: a cross‐country analysis," Journal of Financial Economic Policy, Emerald Group Publishing Limited, vol. 1(4), pages 286-318, November.
    36. de Bandt, Olivier & Camara, Boubacar & Maitre, Alexis & Pessarossi, Pierre, 2018. "Optimal capital, regulatory requirements and bank performance in times of crisis: Evidence from France," Journal of Financial Stability, Elsevier, vol. 39(C), pages 175-186.
    37. Lordina P. Manu & Charles K.D. Adjasi & Joshua Abor & Simon K. Harvey, 2011. "Financial stability and economic growth: a cross-country study," International Journal of Financial Services Management, Inderscience Enterprises Ltd, vol. 5(2), pages 121-138.
    38. Raghuram G. Rajan, 2006. "Has Finance Made the World Riskier?," European Financial Management, European Financial Management Association, vol. 12(4), pages 499-533, September.
    39. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, vol. 68(1), pages 29-51, July.
    40. Law, Siong Hook & Singh, Nirvikar, 2014. "Does too much finance harm economic growth?," Journal of Banking & Finance, Elsevier, vol. 41(C), pages 36-44.
    41. Levine, Ross, 2005. "Finance and Growth: Theory and Evidence," Handbook of Economic Growth, in: Philippe Aghion & Steven Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 12, pages 865-934, Elsevier.
    42. Herbert L. Baer & John N. McElravey, 1992. "Capital adequacy and the growth of U.S. banks," Working Paper Series, Issues in Financial Regulation 92-11, Federal Reserve Bank of Chicago.
    43. Allen, Bill & Chan, Ka Kei & Milne, Alistair & Thomas, Steve, 2012. "Basel III: Is the cure worse than the disease?," International Review of Financial Analysis, Elsevier, vol. 25(C), pages 159-166.
    44. Rioja, Felix & Valev, Neven, 2004. "Does one size fit all?: a reexamination of the finance and growth relationship," Journal of Development Economics, Elsevier, vol. 74(2), pages 429-447, August.
    45. Blundell, Richard & Bond, Stephen, 1998. "Initial conditions and moment restrictions in dynamic panel data models," Journal of Econometrics, Elsevier, vol. 87(1), pages 115-143, August.
    46. Simon Kwan & Robert Eisenbeis, 1997. "Bank Risk, Capitalization, and Operating Efficiency," Journal of Financial Services Research, Springer;Western Finance Association, vol. 12(2), pages 117-131, October.
    47. Gavalas, Dimitris, 2015. "How do banks perform under Basel III? Tracing lending rates and loan quantity," Journal of Economics and Business, Elsevier, vol. 81(C), pages 21-37.
    48. Kopecky, Kenneth J. & VanHoose, David, 2006. "Capital regulation, heterogeneous monitoring costs, and aggregate loan quality," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2235-2255, August.
    49. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2007. "Network models and financial stability," Journal of Economic Dynamics and Control, Elsevier, vol. 31(6), pages 2033-2060, June.
    50. Abou-El-Sood, Heba, 2016. "Are regulatory capital adequacy ratios good indicators of bank failure? Evidence from US banks," International Review of Financial Analysis, Elsevier, vol. 48(C), pages 292-302.
    51. Fonseca, Ana Rosa & González, Francisco, 2010. "How bank capital buffers vary across countries: The influence of cost of deposits, market power and bank regulation," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 892-902, April.
    52. Papke, Leslie E & Wooldridge, Jeffrey M, 1996. "Econometric Methods for Fractional Response Variables with an Application to 401(K) Plan Participation Rates," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(6), pages 619-632, Nov.-Dec..
    53. Desai, Meghnad, 1991. "Human development : Concepts and measurement," European Economic Review, Elsevier, vol. 35(2-3), pages 350-357, April.
    54. Neanidis, Kyriakos C., 2019. "Volatile capital flows and economic growth: The role of banking supervision," Journal of Financial Stability, Elsevier, vol. 40(C), pages 77-93.
    55. Bitar, Mohammad & Pukthuanthong, Kuntara & Walker, Thomas, 2018. "The effect of capital ratios on the risk, efficiency and profitability of banks: Evidence from OECD countries," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 53(C), pages 227-262.
    56. Sagar, Ambuj D. & Najam, Adil, 1998. "The human development index: a critical review," Ecological Economics, Elsevier, vol. 25(3), pages 249-264, June.
    57. Eduardo A. Cavallo & Alberto Cavallo, 2008. "Are Crises Good for Long-Term Growth? The Role of Political Institutions," Research Department Publications 4589, Inter-American Development Bank, Research Department.
    58. Anat R. Admati & Peter M. DeMarzo & Martin F. Hellwig & Paul Pfleiderer, 2013. "Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Socially Expensive," Discussion Paper Series of the Max Planck Institute for Research on Collective Goods 2013_23, Max Planck Institute for Research on Collective Goods.
    59. Windmeijer, Frank, 2005. "A finite sample correction for the variance of linear efficient two-step GMM estimators," Journal of Econometrics, Elsevier, vol. 126(1), pages 25-51, May.
    60. Asli Demirgüç-Kunt & Enrica Detragiache, 1998. "The Determinants of Banking Crises in Developing and Developed Countries," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 81-109, March.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Seyed Alireza Athari & Farid Irani, 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, Springer;Pan-Pacific Association of Input-Output Studies (PAPAIOS), vol. 11(1), pages 1-10, December.
    2. Giraldo, Carlos & Giraldo, Iader & Gomez-Gonzalez, Jose E. & Uribe, Jorge M., 2024. "Financial integration and banking stability: A post-global crisis assessment," Economic Modelling, Elsevier, vol. 139(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Stewart, Robert & Chowdhury, Murshed & Arjoon, Vaalmikki, 2021. "Interdependencies between regulatory capital, credit extension and economic growth," Journal of Economics and Business, Elsevier, vol. 117(C).
    2. Stewart, Robert & Chowdhury, Murshed, 2021. "Banking sector distress and economic growth resilience: Asymmetric effects," The Journal of Economic Asymmetries, Elsevier, vol. 24(C).
    3. Jean Arcand & Enrico Berkes & Ugo Panizza, 2015. "Too much finance?," Journal of Economic Growth, Springer, vol. 20(2), pages 105-148, June.
    4. Gnangnon, Sèna Kimm, 2019. "Financial Development and Tax Revenue in Developing Countries: Investigating the International Trade and Economic Growth Channels," EconStor Preprints 206628, ZBW - Leibniz Information Centre for Economics.
    5. Samargandi, Nahla & Fidrmuc, Jan & Ghosh, Sugata, 2015. "Is the Relationship Between Financial Development and Economic Growth Monotonic? Evidence from a Sample of Middle-Income Countries," World Development, Elsevier, vol. 68(C), pages 66-81.
    6. Vighneswara Swamy & Munusamy Dharani, 2021. "Thresholds in finance–growth nexus: Evidence from G‐7 economies," Australian Economic Papers, Wiley Blackwell, vol. 60(1), pages 1-40, March.
    7. Raja Almarzoqi & Sami Ben Naceur & Akshay Kotak, 2015. "What Matters for Financial Development and Stability?," IMF Working Papers 2015/173, International Monetary Fund.
    8. Thorsten Beck, 2009. "The Econometrics of Finance and Growth," Palgrave Macmillan Books, in: Terence C. Mills & Kerry Patterson (ed.), Palgrave Handbook of Econometrics, chapter 25, pages 1180-1209, Palgrave Macmillan.
    9. Vighneswara Swamy & Munusamy Dharani, 2020. "Thresholds of financial development in the Euro area," The World Economy, Wiley Blackwell, vol. 43(6), pages 1730-1774, June.
    10. Swamy, Vighneswara & Dharani, Munusamy, 2019. "The dynamics of finance-growth nexus in advanced economies," International Review of Economics & Finance, Elsevier, vol. 64(C), pages 122-146.
    11. Vighneswara Swamy & Dharani M, 2020. "The tipping point of financial development? – evidence from OECD countries," International Economics and Economic Policy, Springer, vol. 17(1), pages 125-165, February.
    12. Ikonen, Pasi, 2017. "Financial depth, debt, and growth," Bank of Finland Scientific Monographs, Bank of Finland, volume 0, number e51, July.
    13. Sarah Lynne Salvador Daway-Ducanes & Maria Socorro Gochoco-Bautista, 2019. "Manufacturing and Services Growth in Developing Economies: ‘Too Little’ Finance?," Progress in Development Studies, , vol. 19(1), pages 55-82, January.
    14. Smaoui, Houcem & Nechi, Salem, 2017. "Does sukuk market development spur economic growth?," Research in International Business and Finance, Elsevier, vol. 41(C), pages 136-147.
    15. Paul Wachtel, 2018. "Credit Deepening: Precursor to Growth or Crisis?," Comparative Economic Studies, Palgrave Macmillan;Association for Comparative Economic Studies, vol. 60(1), pages 34-43, March.
    16. Arshad Ali Bhatti & M. Emranul Haque & Denise R. Osborn, 2013. "Is the Growth Effect of Financial Development Conditional on Technological Innovation?," Centre for Growth and Business Cycle Research Discussion Paper Series 188, Economics, The University of Manchester.
    17. Gouthami Kothakapa & Samyukta Bhupatiraju & Rahul A. Sirohi, 2021. "Revisiting the link between financial development and industrialization: evidence from low and middle income countries," Annals of Finance, Springer, vol. 17(2), pages 215-230, June.
    18. Thiago Christiano Silva & Iftekhar Hasan & Benjamin Miranda Tabak, 2021. "Financing choice and local economic growth: evidence from Brazil," Journal of Economic Growth, Springer, vol. 26(3), pages 329-357, September.
    19. Abdul Rahman & Muhammad Arshad Khan & Lanouar Charfeddine, 2020. "Does Financial Sector Promote Economic Growth in Pakistan? Empirical Evidences From Markov Switching Model," SAGE Open, , vol. 10(4), pages 21582440209, October.
    20. Law, Siong Hook & Kutan, Ali M. & Naseem, N.A.M., 2018. "The role of institutions in finance curse: Evidence from international data," Journal of Comparative Economics, Elsevier, vol. 46(1), pages 174-191.

    More about this item

    Keywords

    Bank stability; Regulatory capital; Institutional quality; Economic growth; Trade-off;
    All these keywords.

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G2 - Financial Economics - - Financial Institutions and Services
    • O4 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:spr:empeco:v:61:y:2021:i:2:d:10.1007_s00181-020-01886-4. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.