Economic policy uncertainty, bank competition and financial stability
Journal of Financial Economic Policy
ISSN: 1757-6385
Article publication date: 2 February 2023
Issue publication date: 13 March 2023
Abstract
Purpose
This study aims to examine the impact of economic policy uncertainty and bank competition on the financial stability of the Chinese banking industry. This study answers two fundamental questions. First, does economic policy uncertainty (EPU) affects the financial stability of banks in China? Second, does competition affect the financial stability of the Chinese banking sector?
Design/methodology/approach
The sample includes all commercial banks to provide a full picture of the Chinese banking sector. This study covers the time between 2011 and 2019. The sample period captures different EPU spikes and key policy changes. This study used different econometric methodologies such as the generalized method of moments and the fixed effect and ordinary least square estimation models. Furthermore, this study used the Instrumental Variable model to solve endogeneity, autocorrelation and unobserved heterogeneity concerns. Besides, alternative EPU and financial stability measures were used. Moreover, this study reestimates the model after dropping the big five state-owned banks.
Findings
This study found that both EPU and competition reduce financial stability. This implies that EPU has a negative impact on financial stability. This shows that uncertainty distorts resource allocation efficiency and creates confusion, leading to financial instability in the banking sector. Besides, this study found that competition negatively affects financial stability. This result implies that high competition pushes banks toward riskier activities that ultimately lead to increased financial instability.
Originality/value
This study is the first of its kind that examines the impact of EPU and competition on the financial stability of the Chinese banking sector. This study conducted several robustness tests such as the instrumental variable model, alternative measurement and sample construction methods. This study brings policy implications and lessons for the banking sector.
Keywords
Acknowledgements
The authors would like to acknowledge the funding from National Nature Science Foundation of China [grant number 71773100, 91746109, 72073109] and Humanities and Social Science Fund of Ministry of Education of the People’s Republic of China [grant number 18YJA790048, 17XJC790009].
Citation
Desalegn, T.A., Zhu, H. and Borojo, D.G. (2023), "Economic policy uncertainty, bank competition and financial stability", Journal of Financial Economic Policy, Vol. 15 No. 2, pp. 123-139. https://doi.org/10.1108/JFEP-04-2022-0106
Publisher
:Emerald Publishing Limited
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