Navigating bank risk-taking under excess liquidity: the moderating role of economic policy uncertainty and lessons from the Global Financial Crisis

Abstract

The study investigates the moderation effect of economic policy uncertainty (EPU) towards the relationship between excess liquidity and bank risk-taking as well as explores its stronger impact in countries severely affected by the 2008 Global Financial Crisis (GFC). Using System Generalized Methods of Moments (SGMM) on an unbalanced dataset for 33 countries from 2000 to 2019, the study finds that an increase in the EPU index attenuates the positive impact of excess liquidity on bank risk-taking. The study also finds that the attenuating effect of EPU on the relationship between excess liquidity and bank risk-taking is stronger in countries that were most severely affected by the GFC. It argues that the mechanisms by which excess liquidity induces risk-taking are disrupted under high EPU. Our study also extends behavioral theories to shed light on how the GFC altered bank risk-taking in the presence of excess liquidity and high EPU.