Financial innovation, systematic risk and commercial banks’ stability in China: theory and evidence

We are dedicated to revealing the impacts of financial innovation and systematic risk on commercial banks’ stability in China, both theoretically and empirically. We established a theoretical model and derived a theoretical mechanism from this model revealing two distinctive patterns of the impacts determined by the profitability of financial derivatives: the impacts of financial innovation and systematic risk on banks’ stability in China are linear under the circumstances of a positive expected risk premium of financial derivatives; conversely, the impacts can be linear, U-shaped or cubic when the expected risk premium is negative. We make three propositions to analyse the patterns and conditions of these impacts in detail. In the empirical analysis, we do not focus only on the banking industry but also on individual commercial banks. The empirical results demonstrate that the impact of financial innovation on both the banking industry’s and most individual commercial banks’ stability are U-shaped, and the impact of systematic risk on the banking industry’s and on only one commercial bank’s stability are significantly linear, which confirms certain conditions mentioned in the theoretical propositions. Finally, the study’s conclusions are presented, and the contributions of the article to future study are also mentioned.