Can Stringent Regulatory and Supervisory Framework Mitigate the Impact of Economic Policy Uncertainty on Bank Instability?

Abstract

This study investigates the impact of economic policy uncertainty (EPU) and the regulatory and supervisory framework on the risk-taking behavior of financial institutions. Using data from banking institutions in eight developed countries, our analysis employs panel regression models to examine whether stringent regulation and supervision can mitigate the impact of increased Economic Policy Uncertainty (EPU) on bank risks. Our findings show that higher EPU increases bank instability, while a stringent regulatory framework reduces this impact. This effect is particularly pronounced in countries with substantial deposit insurance and significant barriers to market entry. The empirical results highlight the critical role of robust regulatory and supervisory frameworks in preserving financial stability during periods of economic uncertainty, offering valuable insights for policymakers. Our robustness tests confirm the resilience and reliability of our findings, indicating that targeted regulatory measures can effectively moderate the destabilizing effects of economic policy uncertainty on banks.

Keywords: Financial Stability, EPU, Regulatory and Supervisory Framework, Banks