Policy Uncertainty and Bank Stability: Investigation From Supply-Side Effect

Abstract

The paper uses the most up-to-date data from US banks to investigate the impact of economic policy uncertainty (EPU) on bank stability. The results reveal that elevated uncertainty makes banks more fragile and prone to crash events through profitability erosion, capital buffer, and exacerbating return volatility. This negative impact of EPU is more pronounced for highly risky and large-size banks. The risk-increasing-effect of policy uncertainty was amplified during the global financial crisis. We provide insights into the uncertainty-bank fragility nexus under different circumstances related to the option-to-wait strategy, the pressure of the markets, and the dividend policy. The paper also highlights the bright side of diversification and transparency during the time of high policy turbulence. The study has implications for policy makers, regulators, and investors.