Financial Development and Bank Risk-Taking: Empirical Evidence from the USA

Abstract

This study explores the impact of financial development on the risk-taking of large commercial banks over the prolonged period from 2002 to 2019 by using a two-step system GMM method. The findings confirm that financial development has a significant and positive relationship with bank risk-taking when measured by capital ratio or Z-score. In contrast, the impact of financial development on risk is negative when measured by risk- weighted assets. The empirical results explore the idea that financial development significantly impacts the risk-taking of adequately-capitalized, under-capitalized, significantly under-capitalized, high, and low liquid banks in the USA. These findings show that the impact of financial development on banks’ risk-taking was higher in the pre-crisis era than during and after the financial crisis. These results remain robust in view of different proxies and methodologies. The heterogeneous outcomes for different categories of bank in present economic conditions and in pre-, amid-, and post-crisis eras have practical implications for regulators, policymakers, investors, managers, and economists.