Does economic policy uncertainty affect bank profitability?

Abstract

PurposeManagers are concerned about how the macroeconomic environment affects business profit. Focusing on banks, this study aims to investigate the effect of economic policy uncertainty (EPU) on bank profitability in 22 advanced countries.Design/methodology/approachThe study used the panel fixed effect regression methodology to assess the effect of EPU on several measures of bank profitability for 22 advanced countries from 1998 to 2017. The measures of bank profitability are net interest margin, lending-deposit spread, non-interest income (NII) ratio, after-tax return on asset, before-tax return on asset, after-tax return on equity and before-tax return on equity.FindingsThe findings reveal that high EPU negatively affects bank NII. Real gross domestic product growth rate, nonperforming loans and regulatory capital ratio are negatively related to profitability in times of high EPU. The findings also reveal that high EPU has a positive effect on bank profitability in Asia and the region of the Americas, as these regions witnessed high return on equity in times of high EPU.Practical implicationsThe implication of the findings is that, although EPU has a depressive effect on some indicators of bank profitability, regional characteristics can ameliorate the depressive effects of EPU on bank profitability.Originality/valueThis study contributes to the literature that examine the economic consequences of EPU on firms. To the best of the authors’ knowledge, this study is among the first to examine how regional characteristics affect the relationship between EPU and bank profitability using cross-country data.