Is the Cost of a Safer Banking System Lower Economic Activity?

32 Pages Posted: 17 Oct 2018

See all articles by Paul-Olivier Klein

Paul-Olivier Klein

University of Aberdeen Business School; University of Strasbourg

Rima Turk-Ariss

International Monetary Fund; Economic Research Forum

Date Written: September 19, 2018


The effect of a stronger bank capital base on economic growth remains unsettled in the literature. We investigate the presence and strength of two transmission channels—financial stability and bank lending channels—to shed more light on the association between bank capital and economic activity. Drawing evidence from 47 advanced and developing countries over close to 2 decades and using a PVAR and a system GMM, we find that higher capital ratios improve financial stability and lending activity, ultimately exerting a positive influence on economic activity. The effect on real GDP growth is economically significant, reaching up to 1¼ percentage points for each percentage point acceleration in capital increases. Our main results are robust to various sensitivity tests, supporting the conclusion that safer banking systems do not bridle economic activity.

Keywords: Bank capital, Financial stability, Bank lending, Economic growth

JEL Classification: E44, E51, G21, G28

Suggested Citation

Klein, Paul-Olivier and Turk-Ariss, Rima, Is the Cost of a Safer Banking System Lower Economic Activity? (September 19, 2018). Available at SSRN: or

Paul-Olivier Klein (Contact Author)

University of Aberdeen Business School ( email )

Dunbar Street
Aberdeen, Scotland AB24 3QY
United Kingdom

University of Strasbourg ( email )

61, avenue de la foret noire
Strasbourg, Alsace 3000

Rima Turk-Ariss

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Economic Research Forum ( email )

21 Al-Sad Al-Aaly St.
(P.O. Box: 12311)
Dokki, Cairo

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