How Vulnerable are Commercial Banks to Macroeconomic Shocks? The Case of Bangladesh
34 Pages Posted: 18 Aug 2017 Last revised: 26 Sep 2017
Date Written: August 18, 2017
Innovative financial products and services of commercial banks increase the exposure to liquidity, market and operational risks resulting in the banks facing vulnerable circumstances. Even the smallest unexpected loss, with a low capital to assets ratio, tends to jeopardise the survival of the banks in developing economies. In addition, banking crises due to financial instability can be very costly for any economy in terms of systematic disruption and contraction of activities in other industries. In view of these concerns, this study examines the impact of macroeconomic dynamics on credit risk of commercial banks in Bangladesh and assesses the extent of default rate in the banking system as a result of adverse macroeconomic shocks.
In order to identify the comprehensiveness of structural shocks, applying a VAR model in this study we impose sign-restricted 99th percentile value to disseminate shocks for each variable. The study finds that in extreme adverse inflation situations, contractionary monetary policy, and unexpected increase in exchange rate gap can boost the default rate by over 1%, 0.57% and 0.92% respectively. In addition, if all the extreme historical events occur for all macroeconomic variables, the default rate would increase by 2.52% after a lag. It indicates, adverse economic condition can threaten the banking sector in Bangladesh. From the operational and regulatory perspective of banks, our findings are motivating. The results might help the policy makers to focus on the key macro variables for smooth operation and stability of the banking system.
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