Moderating effects of country’s income level on relationship between country governance, and bank’s profitability and financial stability

During the last decades, some commercial banks in different countries have suffered from lower profitability, and some have become bankrupt due to financial instability. However, the usual bank-specific and macroeconomic-based investigations could not resolve this problem. Eventually, some scholars connect country governance indicators and their elements with commercial banks’ profitability and financial stability and find statistical relevance. Despite that, the limited scope and context fail to generalize the effect of country governance indicators on commercial bank profitability and financial stability. Correspondingly, this study aims to determine the impacts of country governance indicators on commercial banks’ profitability and financial stability. As the values of country governance, profitability, and financial stability indicators differ based on the Country’s Income Level (CIL), this study also measures the moderating effect of the CIL on the relationship between country governance indicators and commercial bank’s profitability and financial stability. This study uses panel data on the selected variables from 2010 to 2021 of 116 countries from the World Bank. To clean data from the outliers, this study employs the “rstudent” command using STATA-15. To identify multicollinearity, this study uses correlation matrices and VIF text statistics. Regression analysis starts with Ordinary Least Squares (OLS) estimation, and several models are developed to deal with multicollinearity among country governance indicators. Breusch-Pagan, Wooldridge, and Pesaran’s (2015) Cross-Sectional Dependence (CD) tests assess heteroskedasticity, first-order serial correlation, and CD, respectively. This study also uses the augmented component-plus-residual plot to identify nonlinearity. Based on the results of post-estimation tests, Panel Corrected Standard Error (PCSE) and Feasible Generalized Least Squares (FGLS) methods are used to measure direct and moderating effects. From the direct effect analysis, this study discovered that country governance indicators have mixed impacts (mostly negative) on profitability indicators: Return on Assets (ROA), Return on Equity (ROE), and Net Interest Margin (NIM). Only the Voice and Accountability Index (VAI) significantly enhances banks’ ROE and NIM. This study also noted significant and insignificant mixed impacts of country governance indicators on financial stability indicators. Although some country governance indicators significantly or insignificantly reduce profitability, they significantly or insignificantly positively contribute to commercial banks’ financial stability. The resulting moderating effects of the country’s High-Income (HI), Upper- Middle-Income (UMI), and Lower-Middle-Income (LMI) are also mixed. The CIL significantly strengthens or weakens the effect of some country governance indicators on the profitability and financial stability of commercial banks.The findings of this study have theoretical and practical implications for researchers, regulators, policymakers, and bank officials. This study will guide researchers in conducting further studies considering other relevant contexts. These findings will help regulators and policymakers in HI, UMI, and LMI countries formulate and implement effective rules, laws, and policies for commercial banks. Moreover, these findings will also help bank officials negotiate with the government for effective policies, regulations, and laws to reduce the negative effect of country governance on commercial banks’ profitability and financial stability.

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