Impact of activity restrictions on risk taking of banks: does competition matter during crisis?

Purpose This study aims to examine the impact of activity restrictions in shaping the risk-taking behaviour of banks through the channel of competition in different economic conditions. Design/methodology/approach The authors use a dynamic panel regression method, particularly a two-step system generalised method of moments to address the risk-taking persistence of banks and endogeneity of activity restrictions and competition with banks' risk-taking using financial freedom and property rights as instrumental variables. Activity restrictions are computed by constructing an index based on the survey results of Barthet al.(2001,2006,2008and 2013a). Competition is measured by the Panzar-RosseH-statistic and risk-taking behaviour are measured by non-performing loan ratio andlnZ-score. In the investigation process, the authors control bank characteristics - size, efficiency, ownership and loan composition and macroeconomic factors - gross domestic product growth and inflation, and use 2,527 bank-year observations from 180 commercial banks of Association of the Southeast Asian Nations-five countries over the 1990-2014 period. Findings This study finds that activity restrictions exacerbate the risk-taking behaviour of the banks leading to changes in the channel of competition because of the "risk-shifting effect" of competition. The finding is robust by considering the financial crisis and alternative specifications. Research limitations/implications This study contributes to bank literature and policy formulation regarding the effect of activity restrictions on the risk-taking behaviour of banks, which is an issue of concern amongst bank regulators, policymakers and academics, especially in the aftermath of the 2008-2009 global financial crisis. Practical implications Understanding how the competition plays a role in the relationship between activity restrictions and the risk-taking of banks in different economic situations. Originality/value This study provides new insight into the bank literature by investigating the moderating role of competition on activity restrictions and the risk-taking behaviour of banks in a different economic environment.