Effects of inflation and macroprudential policies on bank risk: Evidence from emerging economies

Abstract

This study explores the relationship between macroprudential policies, inflation, and bank risk in emerging economies. Several significant findings emerge based on panel data from approximately 1400 commercial banks across 32 emerging economies over the period 2000–2018. Firstly, a positive correlation is observed between inflation rates and bank risk, suggesting that inflation increases financial instability. Contrary to their intended purpose, stringent macroprudential policies actually intensify bank risk during periods of high inflation rather than stabilizing economies. Secondly, the analysis indicates that macroprudential tools designed to moderate credit cycles significantly enhance the risk banks face from inflation. Varied impacts are observed among different macroprudential instruments: capital-related, reserve requirement, and foreign exchange-related tools counterproductively heighten bank risk during periods of high inflation. Conversely, asset-based and liquidity-focused tools effectively reduce bank risk under similar inflationary conditions.