Banking Efficiency Matters: Evidence from the COVID-19 Pandemic

Abstract

Banking efficiency is an essential catalyst in reducing uncertainty during a crisis and stimulating post-crisis economic growth. The heterogeneity in pre-crisis banking efficiency explains the differences in uncertainty — measured using stock return volatility — across countries during the COVID-19 crisis. During the crisis, volatility is lower for countries with lower banking overhead costs and net interest margins than for their more inefficient counterparts. Effectual banking institutions are better equipped to supply the much-needed credit to the private sector during a crisis. We find that countries with pre-crisis efficient banking institutions are able to supply considerably more credit to corporations and households during the crisis. In addition, we show that countries with efficient banking institutions are associated with superior post-pandemic output growth based on economic forecasts. Our findings underscore the importance of better functioning banking systems in moderating some of the corporate losses and liquidity stresses during an unanticipated economic crisis.

Keywords: volatility, COVID, pandemic, financial development, financial institutions efficiency, banking efficiency, economic recovery

JEL Classification: G01, G21, G28