Does bank regulatory requirements affect risk‐taking behaviour of private banks in Ethiopia?

This study examines the effect of monetary policy instruments on bank risk‐taking behaviour of private commercial banks in Ethiopia. Using Panel Dynamic OLS estimator, the empirical results suggested that private banks would take more risks in response to lower regulatory capital ratio, lower reserve requirements, the expansion of domestic credit, and large real asset size in the long run. In addition, the dynamic causal interactions showed that bank risk‐taking Granger causes only bank size in the system, but both capital adequacy and liquidity ratio Granger causes bank risk‐taking and bank size. With estimation results of generalized impulse function, bank risk have generally have a positive shock in response to regulatory capital ratio while a negative shock in response to liquidity for the first two periods. The variance decomposition results also suggested that all variables are relatively exogenous, and the forecast error for all variables is largely explained by their own innovations.