A great number of the studies that were conducted to examine and explain the banks profitability proved that most of them focused on production, with a common denominator being the factors that influence the effectiveness of banks, mostly on the American market.. The financial performance of European banks have been put in focus (see, for example, Bătae, 2020 ; Doumpos et al., 2016; Chen et al. 2022). More attention was divided to the profitability and the risk-taking of banks in emerging markets in the recent decades (see, for example, López-Penabad et al.2022 and Mateev et al. 2022) for recent studies of banking firms' performance. Studies on the effects of financial regulations that primarily targeted principles and procedures for determining bank risks on assets and capital adequacy requirements (see, for example, Wang et al. 2022; Mateev et al. 2022). An alternative approach is adopted by our paper that focused on performance analysis used with return to bank assets and equity with a more eclectic one-step estimation procedure based on a behavioral model of the banking firm. Bank performance is usually demonstrated in this approach as a function of internal and external determinants. The empirical works on bank performance have been drawn from both cross-national and national banking systems. Internal drivers of bank performance include typically variables like bank size, bank deposits, and equity in most researches. Size is used to determine whether or not there are economies or diseconomies of scale in the banking industry. The empirical findings offered contradictory evidence. According to Rehman, (2022), Abisola, (2022), Hannoon et al. (2021), deduced a positive and significant association between bank size and performance. Kosmidou and Holt (2022) on the other hand, showed that tiny UK banks were more profitable than larger ones over the 1998 time frame. On a panel of 431 banks in 39 countries, Carvallo and Kasman (2017) found that size had a negative and statistically significant impact on the net interest margin. The connection between bank capital and profitability was debatable. Naceur and Goaied (2001) was the first to investigate the capital–earnings link in depth. According to conventional wisdom, a greater capital ratio (CAR) was associated with a lower Return on Equity (ROE), because a higher CAR reduced the risk associated with equity and the tax benefit offered by interest deductibility. He attributed this finding to two theories. The first was that the growing capital reduces the interest rate paid on unsecured debt, and second, that the bank used extra capital to advertise that its future projects would be better., Pasiouras and Kosmidou (2007), and Ben Naceur and Goaied (2008) all demonstrated a favorable association between bank performance and capitalization in more recent studies. Bank risk was a significant source of risk for commercial banks. While creating liquidity was a fundamental function of banks, as Cooper and Ross,(1998) demonstrated, it also carried significant risk for them. Bank risk could be a severe hazard to financial organizations, as the subprime mortgage crisis of 2007–09 demonstrated (Brunnermeier et al. (2012); Al-Farisi and Hendrawan (2011). During the financial crisis, banks with higher bank risk performed poorly in the stock market, they reduced loan creation more substantially, and charged higher interest rates on deposits (Cornett et al., 2016; Fahlenbrach et al. (2012); Ahmad et al. (2019); Yin et al., (2021). The Basel Committee on Banking Supervision implemented two new bank liquidity restrictions, the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR), in order to maintain financial stability to the banking system and to ensure that banks have enough cash to deal with future crises. However, it is debatable whether risk could inflict major damage to commercial banks during financial crises. If this is the case, bank risk would not have a large impact. Second; banks could reduce bank risk by adjusting the composition of their assets, liabilities, and off-balance-sheet things. To mitigate the negative effects of liquidity shocks, they may, for example, boost liquid assets or limit credit supply (Acharya et al., 2011; Cornett et al., 2016; Acharya and Mora, 2015). Bank risk will not have a significant impact on bank performance during financial crises if these modifications are not excessively costly. Negative influence on bank performance after bank regulatory capital may be controlled. This study investigates the following research issues in order to better understand the relationship between bank risk and bank performance during financial crises.
Proceeding by the following question: Can bank risk negatively impact bank performance during financial crises? If the answer is yes, we must look at whether the damage that bank risk causes varies depending on the characteristics of the bank. We predict the bank risk in order to have a greater negative impact on bank performance for banks with lower capital buffers. Because these banks are financially weaker, they may need to make more modifications to manage bank risk, experience more depositor withdrawals, and pay higher deposit interest rates to prevent withdrawals. As a result, they are expected to perform poorly during financial crises. We use commercial bank data from the GCC from 2000 to 2018 to answer these questions. Our sample period contains one banking crisis (the subprime crisis of 2007–09), according to Berger and Bouwman (2013)'s definitions of financial crises. We also consider the rest of years to represent normal times, as Berger and Bouwman (2013) did. This research contributes to increasing awareness about the inter-dependent relationship between bank profitability and risk-taking. Profitability is a static term; bank franchise value and charter value are dynamic opposites. Higher profitability, according to conventional wisdom, reduces bank risk-taking incentives (Paltrinieri, 2021 ; Sondakh, al., 2021); Rakshit, 2022).
We have examined how bank risk in pre-crisis periods influenced bank performance during crises, as well as whether a bank could survive a crisis by omparing the analysis of the difference in a bank's return on assets (ROA) between the crisis and pre-crisis periods. To better understand the mechanisms through which bank risk affects a bank's ROA, we have concentrated on the effects of bank risk on two key components of bank ROA: the return on assets (ROA) and the return on equity (ROE). This paper adds to the literature in a number of ways. For starters, it provides new insight into how bank risk affects banks during financial crises. During the subprime crisis, bank risk did not only affect banks' asset and liability allocations (Acharya et al., 2011; Cornett et al., 2016; Acharya and Mora, 2015), but also increased the likelihood of bank defaults and stock price crashes (Acharya et al., 2011; Cornett et al., 2016; Acharya and Mora, 2015). (Imbierowicz and Rauch, 2014; Yin et al., 202)). In addition to previous research, our paper indicates that during the subprime crisis, bank risk contributed to worsen the survival probability and ROA. Furthermore, banks with smaller capital levels suffered deeply. According to Calomiris et al. (2015), banks with more cash had a stronger incentive to manage risk. We extend their reasoning by claiming that banks with more liquidity are better by far at risk management, and our finding that banks with more bank risk have lower capital ratios during the subprime crisis supports this argument. The paper is structured as follows. Section 1 deals with Literature survey of bank capital, performance and risk. Section 2 sets up the model and solves the baseline model. Section 3 discusses the empirical and the policy implications. Section 4 is about conclusion.