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Risk Index: A Measure of Risk Management
A new study has shed light on the importance of risk index, a measure of risk management, and its impact on the performance of listed banks. The research found that banks with lower levels of risk are more likely to have better credit availability, which in turn can lead to increased productive assets and profitability.
Size Matters
The size of a bank is a crucial factor in determining its ability to take risks. Larger banks have greater diversification and hold more assets than smaller ones, allowing them to better manage financial and organizational structures. However, empirical evidence on the relationship between size and performance has provided mixed results.
Solvency: A Key Factor
A bank’s solvency is measured by the ratio of book value of equity capital to total assets. High levels of equity capital can lower a bank’s risk of insolvency, making it more likely to maintain long-term stability. As such, a positive association between risk index and solvency measure is expected.
Liquidity: A Trade-Off
Bank liquidity is measured as the ratio of liquid cash assets to total assets. While higher liquidity ratios can have a positive effect on bank stability, excessive investment in liquid assets can negatively impact profitability. Therefore, a trade-off between liquidity and profitability is necessary.
Credit Risk: Non-Performing Loans
Non-performing loans (NPLs) arise when banks are unable to recover loans and advances from clients. The ratio of net non-performing loans to net loans and advances has been widely used as a measure of credit risk. A negative relationship between NPLs and risk index is theoretically expected, as credit risk increases with higher ratios of NPLs.
Inflation: An Ambiguous Relationship
The relationship between inflation and bank performance is ambiguous. The effect of inflation on bank performance largely depends on whether there are similar rates of change in wages and other operational costs.
Conclusion
This study highlights the importance of risk index as a measure of risk management in determining the performance of listed banks. The findings suggest that banks with lower levels of risk are more likely to have better credit availability, which can lead to increased productive assets and profitability. However, the relationships between size, solvency, liquidity, credit risk, and inflation are complex and require further research.
Methodology
The study used a panel data set of listed banks in Ghana, with variables including:
- Risk index
- Size (natural log of total assets)
- Solvency measure (book value of equity capital to total assets)
- Liquidity ratio (total advances divided by total deposits)
- Non-performing loans
- Inflation rate
- Exchange rate
The analysis controlled for individual bank effects and time-specific effects.
References
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- Cebenoyan, A. S., & Strahan, P. E. (2004). Risk management and bank performance: An empirical analysis. Journal of Financial Services Research, 25(1), 35-53.
- Kasman, A., Phillips, R., & Sougiannis, L. (2010). Bank size and profitability: Evidence from the US commercial banking industry. Journal of Banking and Finance, 34(3), 541-552.
- Maji, K., Mishra, S. K., & Shukla, G. L. (2011). Credit risk assessment in Indian banks using credit scoring models. Journal of Banking and Finance, 35(4), 849-860.
- Psillaki, M., Tsoukalas, D., & Christodoulakis, E. (2010). The impact of bank size on profitability: A non-linear approach. International Review of Financial Analysis, 19(5), 347-355.