Revisiting the effect of regulation, supervision and risk on banking performance. Evidence from European banks based on PSTR model

Author:Houssem Rachdi, Faten Ben Bouheni
Position:Faculty of Law, Economics and Management of Jendouba, University of Jendouba, Jendouba, Tunisia; TELECOM Business School
Pages:24-40
SUMMARY

Purpose - This paper aims to present an analysis of how regulatory and supervisory policies affect risk-performance nexus. Design/methodology/approach - Empirically, on a sample of 60 large European banks over the period 2005-2011, the authors explore this relationship by using the panel smooth transition regression (PSTR) modeling... (see full summary)

 
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Revisiting the effect of
regulation, supervision and risk
on banking performance
Evidence from European banks based on
PSTR model
Houssem Rachdi
Faculty of Law, Economics and Management of Jendouba,
University of Jendouba, Jendouba, Tunisia, and
Faten Ben Bouheni
TELECOM Business School
Abstract
Purpose – This paper aims to present an analysis of how regulatory and supervisory policies affect
risk-performance nexus.
Design/methodology/approach – Empirically, on a sample of 60 large European banks over the
period 2005-2011, the authors explore this relationship by using the panel smooth transition regression
(PSTR) modeling because the nexus between risk and performance is nonlinear and it depends on
specic national factors especially regulatory and supervisory policies.
Findings – The major nding of this study is that the effect of risk on banking performance is
conditional by the improvement of banking governance in Europe.
Practical implications – The PSTR helps to account for a change of regime in the effects of risk on
performance.
Originality/value – This paper explains the use of PSTR modeling.
Keywords Performance, Risk-taking, European banks, PSTR, Regulation and supervision
Paper type Research paper
1. Introduction
The global nancial crisis that erupted in 2008 had consequences which we still
experience. It has generally been interpreted as evidence that there is a need to redesign
the global nancial system to make it more robust against similar future shocks.
Perhaps, the most important lesson from the early stage of the crisis was that the
sturdiness of the banking system is vital for the whole economy, as banks inuence
economic growth, poverty, entrepreneurship, labor market conditions and the economic
opportunities available to people (Demerguç-Kunt and Levine, 2010). Thus, examining
the impact of banking regulatory and supervisory policies on protability and
risk-taking is a critical area of inquiry.
In the spring of 2007, it was clear that a housing bubble had burst on American
mortgages. At that time, the USA had cautiously overcome the banking crisis. However,
banking problems still plague many European countries in 2013 (Barth et al., 2013). The
central theme in the agenda of European governments is nancial regulation and
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1358-1988.htm
JFRC
24,1
24
Received 31 July 2014
Revised 7 October 2014
Accepted 27 November 2014
Journalof Financial Regulation
andCompliance
Vol.24 No. 1, 2016
pp.24-39
©Emerald Group Publishing Limited
1358-1988
DOI 10.1108/JFRC-07-2014-0034
supervision, and their concern is how to promote banking protability and stability.
The theory and the existing empirical evidence on the relationship between regulation,
supervision, protability and stability provided mixed results and led to ambiguous
implications (Barth et al., 2001,2004,2008,2010;Laeven and Levine, 2009;Pasiouras
et al., 2009;Klomp and De Haan, 2012;Chortareas et al., 2012;Lee and Hsieh, 2013).
This paper is an attempt to investigate the impact of regulatory and supervisory
policies (restriction on bank activities, capital requirement, deposit insurance,
supervisors’ power and independence of supervisory authority) and risk on the
protability of the biggest European banks. To this end, we analyze a database,
compiled from the World Bank by Barth et al. (2001,2004,2006,2008), as our sample,
which consists of the ten largest European banks of the selected European countries –
France, Germany, UK, Spain, Italy and Greece – over the period 2005-2011.
The rest of the study is organized as follows. Section 2 presents the literature review.
In Section 3, we present the methodology and the data and discuss the main results. In
Section 4, we conclude.
2. The literature review
There is mixed evidence on the impact of regulatory and supervisory policies on bank
performance. Barth et al. (2004) provide empirical evidence on the impact of specic
regulatory and supervisory practices on bank development and stability. Their results
indicate that there is no statistically signicant relationship between capital stringency,
ofcial supervisory power and bank performance. However, they nd that regulatory
and supervisory practices that force accurate information disclosure empower private
sector monitoring of banks, and foster incentives for private agents to exert corporate
control to best promote bank protability and stability. Specically, in a cross-country
setting, they show that regulatory and supervisory regimes with these features have
suffered fewer crises in the past two decades, have lower non-performing loans and have
deeper credit markets.
Laeven and Levine (2009), by using the ten largest publicly listed banks, nd that
capital stringency has little impact on actual bank risk and that capital requirements
affect bank stability, but only through their bank valuations. They nd also that activity
restrictions and deposit insurance increase bank risk, conrming the ndings of
Demerguç-Kunt and Detragiache (2002) and Barth et al. (2004,2006). The role of banking
regulation and supervision consists in enhancing protability and decreasing
risk-taking. Buch et al. (2008), using the database compiled by Barth et al. (2001), nd
that supervisory systems inuence the total risk of cross-bank mergers. They conclude
that the impact of banking regulations and supervisions on performance depends on
inuence factors.
The international empirical evidence by Barth et al. (2010) indicates that tighter
restrictions on bank activities exert a negative impact on bank efciency, while greater
capital restrictions are marginally and positively associated with bank efciency. They
nd also that although there is no signicant relationship between ofcial supervisory
power and bank efciency, there is a signicant and positive relationship between the
latter and supervisory authority independence. Chortareas et al. (2012) investigate the
dynamics between regulatory and supervisory policies and European banks
performance over 2000-2008. They nd that strengthening capital restrictions and
ofcial supervisory powers can lead to an efcient functioning of banks. Their results
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PSTR model

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