Financial liberalization and bank risk-taking: International evidence

• Financial liberalization is a source of bank risk in countries all over the world.
• Liberalization increases risk through bank competition in more developed countries.
• The effect occurs by expanding opportunities to take risk in developing countries.
• Capital requirements reduce the negative impact of liberalization on bank stability.
• Supervision and financial transparency are only effective in developing countries.

This paper analyzes the channels through which financial liberalization affects bank risk-taking in an international sample of 4333 banks in 83 countries. Our results indicate that financial liberalization increases bank risk-taking in both developed and developing countries but through different channels. Financial liberalization promotes stronger bank competition that increases risk-taking incentives in developed countries, whereas in developing countries it increases bank risk by expanding opportunities to take risk. Capital requirements help reduce the negative impact of financial liberalization on financial stability in both developed and developing countries. However, official supervision and financial transparency are only effective in developing countries.