Impact of activity restrictions on risk taking of banks: does competition matter during crisis?
| Date | 09 July 2020 |
| Pages | 79-103 |
| Published date | 09 July 2020 |
| DOI | https://doi.org/10.1108/JFRC-07-2019-0095 |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation |
| Author | Abu Hanifa Md. Noman,Che Ruhana Isa,Md Aslam Mia,Chan Sok-Gee |
Impact of activity restrictions on
risk taking of banks: does
competition matter during crisis?
Abu Hanifa Md. Noman
Department of Finance and Banking, Faculty of Business and Accountancy,
University of Malaya, Kuala Lumpur, Malaysia
Che Ruhana Isa
Department of Accountancy, Faculty of Business and Accountancy,
University of Malaya, Kuala Lumpur, Malaysia
Md Aslam Mia
School of Management, Universiti Sains Malaysia, Pulau Pinang, Malaysia, and
Chan Sok-Gee
Institute of China Studies, University of Malaya, Kuala Lumpur, Malaysia
Abstract
Purpose –This study aims to examine the impact of activity restrictions in shaping the risk-taking
behaviourof banks through the channel of competition in different economicconditions.
Design/methodology/approach –The authors use a dynamic panel regressionmethod, particularly a
two-step system generalised method of moments to address the risk-taking persistence of banks and
endogeneity of activity restrictions and competition with banks’risk-taking using financial freedom and
property rights as instrumentalvariables. Activity restrictions are computed by constructingan index based
on the survey results of Barth et al. (2001,2006,2008 and 2013a). Competition is measured by the Panzar–
Rosse H-statistic and risk-takingbehaviour are measured by non-performing loan ratio and lnZ-score.In the
investigation process, the authors control bank characteristics –size, efficiency, ownership and loan
composition and macroeconomicfactors –gross domestic product growth and inflation, and use 2,527 bank-
year observations from 180 commercial banks of Associationof the Southeast Asian Nations-five countries
over the 1990–2014period.
Findings –This study finds that activity restrictions exacerbate the risk-taking behaviour of the banks
leading to changes in the channel of competition because of the “risk-shifting effect”of competition. The
finding is robustby considering the financial crisis and alternativespecifications.
Research limitations/implications –This study contributesto bank literature and policy formulation
regarding the effectof activity restrictions on the risk-taking behaviour of banks, which is an issue of concern
amongst bank regulators, policymakersand academics, especially in the aftermath of the 2008–2009 global
financialcrisis.
Practical implications –Understanding how the competition plays a role in the relationship between
activityrestrictions and the risk-taking of banks in differenteconomic situations.
This research has been funded by GERAN PEYELIDIKAN FACULTI, University of Malay (Grant #
GPF0051-2019). Special thanks to the editor (John Ashton) and two anonymous referees for their
constructive comments and suggestions. We believe that the quality of the paper has substantially
improved after addressing the comments and suggestions. We would like to thank Jens Hagendorffof
CardiffUniversity, the UK for his valuable comments and suggestions in preparing this manuscript.
All remaining errors are our own. The usual caveats apply.
Impact of
activity
restrictions
79
Received24 July 2019
Revised3 February 2020
22April 2020
Accepted11 June 2020
Journalof Financial Regulation
andCompliance
Vol.29 No. 1, 2021
pp. 79-103
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-07-2019-0095
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1358-1988.htm
Originality/value –This study provides new insight into the bank literature by investigating the
moderating role of competitionon activity restrictions and the risk-taking behaviour ofbanks in a different
economicenvironment.
Keywords Competition, Bank, Risk-taking, ASEAN-5 countries, Activity restrictions
Paper type Research paper
1. Introduction
The impact of regulatory restrictions on certain banking activities, such as branching,
insurance, securities, real estate or owning and controlling non-financial firms, remains an
important issue amongst bank regulators and practitioners. Recent literature reveals that
improper use of bank regulations is the principal cause of excessive risk-taking for banks,
which, in turn, made them vulnerable to the 2008–2009global financial crisis (GFC) (OECD,
2010;Shehzad and Haan, 2015;Loveland, 2016;Li, 2019). Against this backdrop, Keeley
(1990) identifies liberalisation of restrictions intensified the risk-taking incentives of banks
by eroding their franchise value while Beck (2008) claims that more restrictions also
intensify their risk-taking incentives[1]. Given the theoretically contrasting views and
inconclusive findings on the relationshipbetween activity restrictions and risk-taking, bank
regulators and policymakers are interested in investigating the channels that influence the
risk-taking incentivesof the banks.
Berger et al. (2009),Schaeckand Cih
ak (2014),Fu et al. (2014),Nomanet al. (2017),Albaity
et al. (2019) and Barra and Zotti (2019) identifycompetition as one of the prime determinants
of risk-taking in banks. Conversely, activity restrictions also influence bank competition
because of the franchise value effect, as well as the scale and scope of operations and risk
diversification (Keeley, 1990;Boyd et al.,1998;Li, 2019). Not only do these firm or industry
level factors affect the risk-takingincentives of banks but also those incentives also depend
on macroeconomic conditions (Anginer et al.,2014). However, how these macroeconomic
factors affect the risk-takingincentives of banks through the channel of competition has not
been thoroughly investigated in existing literature, particularly in the context of Southeast
Asian countries. Thus, we explore the interplay between activity restrictions and
competition to evaluatebank behaviour under varying economic conditions.
Our study pertains to the works of Barth et al. (2001,2004,2008), Beck et al. (2006) and
Laeven and Levine (2009), where country-specific data is used to evaluate the impact of
activity restrictions on theprobability of a banking crisis and bank risk-taking. The results
of the previous studies have shown that greater restrictions on non-banking activities,
including insurance, securities, real estate and owning non-financial firms, are associated
with a high probability ofcrisis and fragility (Barth et al.,2001,2004,2008;Becket al.,2006)
and lower financial stability (Laeven and Levine, 2009). On the other hand, we investigate
the role of activity restrictions on bank risk-taking through the channel of competition
during the financial crisisand non-crisis periods. We aim to help regulators consider activity
restrictions in shapingbank risk-taking behaviour based on the level of competition. Thisis
vital as banks served as the main transmission of monetary policy in developingeconomies,
especially during the financial crisis period. Therefore, appropriate activity restrictions are
important given the competitivenature of the banking industry in the developing countries.
For this investigation, we have considered banking sectors of the five original member
countries of the Association of the Southeast Asian Nations (ASEAN), also known as
ASEAN-5, which includes Indonesia, Malaysia, the Philippines, Singapore and Thailand.
One of the potential reasons for choosing this region is that regulatory changes and bank
restructuring became more prominent in ASEAN-5 countries due to the experience of the
JFRC
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