Examining the Impacts of Regulatory Framework on Risk in Commercial Banks in Emerging Economies

The relationship between decision-making and risk carries significant implications, particularly within the context of financial institutions. Understanding the causal connection between these two factors is essential, especially when considering the broader implications of social responsibility. This is especially true in sectors where legal and regulatory frameworks are not sufficiently predictive or comprehensive. Recognizing the foundational elements of risk is crucial for problem identification and the effective allocation of resources to mitigate these risks. In our study, we explored this relationship by focusing on 100 commercial banks operating in emerging markets over the period from 2004 to 2023. The aim was to empirically test the effects of various factors, including regulatory frameworks, competitive pressures, and ownership structures, on the risk-taking behaviors of these banks. We specifically examined the behaviors both before (ex-ante) and after (ex-post) the provision of credit. To conduct this analysis, we employed two models i.e. the Z-Score and the Non-Performing Loan ratio, utilizing panel data for our assessments. The Z-Score is a well-established metric that gauges the stability and insolvency risk of financial institutions, while the NPL ratio serves as an indicator of the quality of a bank's loan portfolio, reflecting the proportion of loans that are in default or close to default. Our findings indicate that regulatory measures have a significant impact on the risk-taking behavior of banks. Stricter regulations tend to reduce risk-taking by imposing constraints and ensuring greater oversight. Conversely, high levels of competition can drive banks to take on more risk, as they strive to maintain or expand their market share. Ownership structures also play a critical role, with different ownership models influencing the risk appetite of banks in varying ways. This study underscores the importance of a balanced approach to regulation and competition within the banking sector. Effective regulatory frameworks, coupled with a keen understanding of competitive dynamics and ownership structures, can help mitigate risks and promote more stable financial environments in emerging markets. Our research provides valuable insights for policymakers, regulators, and banking executives aiming to foster safer banking practices and enhance the overall stability of the financial system.