Does bank size matter when it comes to political environment and banking performance ?

Based on an article by Marc Kouzez, published with the title “Political environment and bank performance: Does bank size matter?” dans Economic Systems, 2022

Issue

Globalisation, technological change and the free movement of capital have transformed banking systems, fostering mergers and acquisitions. This restructuring results in large institutions that are more efficient than smaller banks, partly thanks to economies of scale and the benefits of diversification. In parallel, rising political risks both nationally and internationally perturb the banking industry and impact bank performance.

Data and methods

The study employs a sample of over 1,600 banks operating in 58 developed and developing countries from 2006 to 2018. Different banking performance measures are implemented to ensure that results are reliable. Political risk is measured using numerous scores that take into account different dimensions (political instability, corruption, external conflict, etc.), ranging from 0 to 100, and provided by the Economist Intelligence Unit database. Five bank categories are defined based on size, and several econometric estimation methods are employed to ensure the robustness of the results.

Research questions

To what extent does political uncertainty undermine banking performance? Are big banks more resilient to political risks?

Key messages

  • All other things being equal, a one-point increase in political risk triggers an average 4% drop in the return on assets (from 2.8% to 6.4% depending on specifications).
  • The smaller the bank, the more negatively affected its performance is by political risk. In other words, small and medium-sized banks that operate in countries exposed to low political risks perform better than those operating in countries with high political risks.
  • However, the performance of large, and even very large, banks is not significantly affected by political risk.
  • These results suggest that large banks are more effectively protected from political risks and that they probably benefit more from bailout measures from public authorities acting as a “lender of last resort”.
  • The results are robust to estimation methods, political risk measurement indicators, and other performance measurements, like return on equity, pre-tax profit rate, and doubtful loan ratio.
  • To conclude, a political environment that is more stable, sound and efficient improves banks’ operating conditions, particularly for the smallest banks.

Key words: political risk, bank size, banking performance