Nexus between Economic Freedom and Bank Risk-taking: Evidence from US Commercial Banks

Abstract

Using the two-stage generalized linear modelling (GMM) technique, we examine the connection between economic freedom and its constituents and bank risk-taking in the US. The findings indicate that bank risk-taking restrictions are caused by restrictions on property rights, government honesty and accountability, government expenditure and taxation, and monetary, commercial, and financial independence. But financial institutions benefit from taking more chances when they are free to trade and invest anywhere, they like. The risk of well-capitalized banks is reduced by economic freedom while the danger of undercapitalized banks is increased. Banks with enough capitalization benefit more from economic freedom and its component than do those with insufficient capital. According to the data, risk management contributes more to good governance than any other factor. The findings hold up across different risk metrics and sample sizes. Our findings have ramifications for monetary liberty and the willingness of commercial banks to take risks.

JEL: G21, G28