Threshold effect of economic openness on bank risk-taking: Evidence from emerging markets

• Published in: Economic modelling Vol. 91; pp. 790 - 803
• Main Authors: Bui, Tung Duy, Bui, Hoai Thi Mai
• Format: Journal Article
• Language: English
• Published: Elsevier B.V 01-09-2020
• Subjects: Bank risk-taking; Financial openness; Panel smooth transition regression; Trade openness; Panel smooth transition regression; F30; Financial openness; Bank risk-taking; G21; G38; Trade openness
• ISSN: 0264-9993; 1873-6122
• DOI: 10.1016/j.econmod.2019.11.013

This paper investigates the non-linear effects of two aspects of economic openness, namely, trade openness and financial openness, on banking system stability. We use a panel of 42 emerging markets from 2000 to 2014 to test whether bank risk-taking behaviour varies with the level of openness. We find that a higher degree of trade openness promotes bank stability linearly. Conversely, the non-linear effect of financial openness on bank risk-taking is evident. When the financial system is not sufficiently open, the impact of financial openness on bank stability is insignificant. However, as the domestic financial market becomes more open, financial openness can help discipline the behaviour of banks, making them more stable. We also find evidence that these effects are transmitted through the market discipline channel. Our findings highlight the importance of strengthening the domestic regulatory framework and transparency as the economy becomes more integrated.
•We control for both nonlinearity and heterogeneity in bank risk-taking.•We find a nonlinear impact of financial openness on bank risk-taking.•Beneficial effects on bank stability only appear at high levels of financial openness.•Trade openness only impacts bank risk-taking linearly.•Economic openness affects bank risk-taking through the market discipline channel.