Economic policy uncertainty and bank stability

Abstract

We examine the influence of economic policy uncertainty on bank stability post-2007-2008 global financial crisis. We rely on the economic policy uncertainty (EPU) index introduced by Baker et al. (2016). We use 176,477 quarterly observations for US commercial banks over the period from 2011Q1 to 2020Q3 and find consistent and robust evidence that bank stability decreases as the level of economic policy uncertainty increases. We specifically control for demand-side effects which indicates that the decrease in bank stability not only originates from borrowers' and customers' conditions but also from a change in bank behavior. A deeper investigation shows that the negative impact of policy uncertainty on bank stability is stronger for larger banks, and weaker for highly capitalized banks as well as for more liquid banks. Our findings have important implications particularly for the COVID-19 policy implementations.