Beyond Government Support: The Role of Efficient Banks in Reducing Volatility and Expediting Economic Recovery During the COVID-19 Crisis

Abstract

Amid an economic crisis, banking institutions that operate efficiently can provide liquidity to the private sector at a lower intermediary cost, thereby enhancing the financial slack for credit constrained corporations. We hypothesize that efficient banks help reduce market turmoil during an economic crisis and facilitate post-crisis output growth. In this study, we use the Covid-19 pandemic as a quasi-natural setting to test our hypotheses. Our empirical findings demonstrate that countries with efficient banking systems experienced significantly lower market volatility than their counterparts with inefficient banking systems during the pandemic. Moreover, countries with efficient banking institutions also exhibited considerably higher post-crisis output growth prospects based on professional analyst forecasts. Our results underscore the previously overlooked role of banking institutions efficiency in mitigating volatility during an economic crisis and expediting the post-crisis recovery.

Keywords: volatility, Covid, pandemic, financial institutions efficiency, banking efficiency, economic recovery

JEL Classification: G01, G21, G28