Bank Risk and Financial Development: Evidence From Dual Banking Countries

ABSTRACT

This study examines the impact of financial development on bank risk-taking, measured as bank capitalization and bank income diversification. We observe the relationship using annual bank-level data from countries with dual-banking systems. The dataset spans from 2000 to 2014. Our results suggest that the impact of financial development on bank capitalization is heterogeneous across Islamic and conventional commercial banks. Moreover, the effect is different across listed and unlisted banks. However, on average, the response of income diversification to financial development is similar across most specifications. Additionally, bank risk is found to be countercyclical, suggesting that bank risk increases in good times. On average, these results (countercyclical evidence) hold across bank types (Islamic and conventional) and ownership structure (listed and unlisted). However, these results are contingent on the size (small vs. large) factor. The results are robust to alternative proxies of financial development.

KEY WORDS:

• bank capitalization
• dual-banking system
• financial development
• income diversification
• Islamic banks

JEL:

• G21
• E22
• O16

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

1. We use nontraditional income and revenue diversification terms interchangeably throughout the paper.

2. We follow the strategy of Beck, Demirgüç-Kunt, and Merrouche (2013) in considering unconsolidated and consolidated financial statements.

3. For the purpose of uniformity, non-interest income refers to income other than the intermediation-based income at both conventional and Islamic banks. Islamic banks, however, are not involved in interest-based activities.

4. These results are available on request.