National Culture and Bank Risk

Abstract

Purpose: Bank risk - taking is essential to bank performance but could become detrimental to the stability of the domestic and global financial system. To control bank risk and potential ruinous consequences, we need to identify all its possible origins. Prior literature identifies financial factors influencing bank risk including bank size, loan loss provisions, bank leverage and interest rates (García-Kuhnert et al. (2015)

Craig and Dinger (2013)

Delis and Kouretas (2011)

Jordà et al. (2011)). Our paper adds national culture to the financial factors influencing bank risk. We identify three specific national cultural values (individualism, trust and hierarchy) which are associated with bank risk after controlling for country macroeconomic and legislative differences. Methodology: We apply a multi-level linear model to observations for the years 1999 to 2014 inclusive. We measure risk as the volatility of the earnings on a five year rolling basis. Independent variables include the three national culture variables (data obtained from the World / European Values Survey which is used extensively by academics and numbers over 400 publications), macroeconomic and legislation variables at country level as well as financial variables at bank level. We include year fixed effects to control for significant changes in the world market valuations and macroeconomic shocks. We test our results for robustness first by controlling for endogeneity. Even though reverse causality is not a concern in our setting, given that national cultures evolve slowly over very long periods, our results could be affected by omitted variable bias. We instrument for national culture variables using GMM instrumental variables regressions with 2SLS. Our findings remain robust to these tests. To further strengthen the robustness of our conclusions, we test our hypotheses using two alternative risk proxies, z-score and loan loss provisions. Finally, we add country - level fixed effects to our specification that help mitigate concerns about the impact of unobservable time-invariant country characteristics. The results remain unchanged. Findings: First, we find that cultural values are important determinants of bank risk. There is a positive and significant association of individualism and hierarchy with bank risk, and a negative and significant association between trust and bank risk, controlling for bank and country-level characteristics. Second, we show that national culture influences affect primarily domestic systemically important financial institutions (D-SIFIs) as opposed to global systemically important financial institutions (G-SIFIs). Finally, we demonstrate that during financial crises the relationship between bank risk and national cultural values weakens. Implications: One would expect managerial decisions to be free of cultural influences given the market efficiency and heavy regulatory global oversight of the banking sector. However, we find strong evidence of an economically significant impact of cultural values on bank risk. Excessive risk which leads to financial crises costs governments a significant GDP percentage (European commission report 2014). Given that international banking integration transmits financial instability between sovereigns, identifying and addressing factors associated with bank risk safeguards the global financial system and could contribute to the success of the imminent European banking union. ABSTRACT FROM AUTHOR]

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