Economic uncertainty and bank risk: the moderating role of risk governance

Abstract

Uncertainty is an economically important risk factor in the banking sector. Using a sample of Chinese listed commercial banks over the period 2005 − 2018, this research conducted pooled OLS and found evidence that economic uncertainty significantly increases bank risk and lowers profitability. Furthermore, we constructed a partial equilibrium model to explain how risk governance alters the risk-increasing effect and profit-decreasing effect of economic uncertainty on bank risk and profitability. Consistent with theory, empirical results suggested the effects of economic uncertainty on bank risk and performance tend to be considerably weaker when there exists a strong risk governance mechanism. These findings stand when subjected to several endogeneity and robustness checks. Risk governance plays a key role in weakening the detrimental consequences of economic uncertainty on banks and promoting a sustainable growth of the banking sector. A financial regulator entity should require banks to establish a sound risk governance system in order to mitigate financial systemic risk and safeguard overall financial stability.