Robustness Tests

The encouraging results of RGI on the selected financial soundness proxies have been supported throughout the four stages of the analysis as explained in the results summary section hence are robust in the four estimations. Also, and as part of the postestimation analysis, the Arellano-Bond tests for the first and second order serial autocorrelation in the first-differenced residuals are reported. The residuals of the differenced equation should possess serial correlation, however considering that the original errors are serially independent, the test on the differenced residuals will not exhibit significant AR (2) behaviour. The AR (2) result is of substantial importance to us as failing to reject its null hypothesis of no serial autocorrelation will indicate that the second lags of the endogenous variables are appropriate instruments for their current values (Baum, 2010). With the exception of LnZScore in Model 4, where the p-

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value is close to 5% (0.048), the Arellano-Bond test for AR (2) all other equations show p- values that are higher than the 5% threshold hence the appropriateness of the second lags of our endogenous variables used as instruments effectively holds.

A further diagnostic test concerns the validity of the overidentifying restrictions in the two-step GMM model. The Hansen J-statistic is favoured to Sargan test of overidentified restrictions because the latter is not robust although not weakened by many instruments while the former is robust although weakened by many instruments. Furthermore, and as is known when implementing instrumental variables, having an overidentified model is not an undesirable econometric issue as much as would be the case of an under-identified model. Finally, the Hansen J-Statistic is a postestimation test of special interest to two-step GMM estimations as it is only valid when the weighting matrix is optimal, which means that it equals the inverse of the covariance matrix of the moment conditions (Hall, 2005). As all this chapter’s equations are estimated through two-step GMM method, results of the Hansen J-Statistic for each equation are reported immediately after AR (2). In the eight columns of results in Table 4.6 and the eight columns of results in Table 4.7, the p-value for the J-statistic is usually above 0.99 hence never significant. Consequently, I fail to reject the null hypothesis of the Hansen test which posits that the over-identifying restrictions are valid.

4.5

Conclusion

Considering the penury of empirical explorations on the substantial role that risk management governance might play in promoting banks’ financial stability, the objective of this chapter is to contribute to the scarce literature by using the newly developed risk governance index ‘RGI’ to evaluate the possible associations between sound risk governance and bank’s financial health. In contrast with many academic papers, this research does not limit financial soundness to one indicator however extends the investigation to further key features of banks’ status. In

addition to the log z-score which conveys the distance from insolvency, capital adequacy, asset

quality and deposits run-off ratio are used recursively as proxies for financial stability.

Furthermore, the analysis was enriched by using a sample encompassing data from 53 conventional and Islamic banks in five GCC countries. The robust estimations from two-step system GMM suggest that risk governance significantly contributes to the enhancement of key financial stability measures. Specifically, improvements in the scores of RGI engender lower risk of insolvency, higher capital adequacy ratios, better loan portfolio quality and higher proportion of liquid assets to deposits and short-term funding to cover unanticipated bank runs. In the post-crisis period, results indicate that better risk governance frameworks lower the

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probability of bank insolvency. As for Islamic banks, RGI is not found to significantly affect their financial stability neither before nor after the global financial crisis. It is important to note though that these results are subject to the peculiarities of the oil-exporting countries of the GCC region where until 2006, the corporate governance reforms were recognized by Hawkamah and IIF (2006) to be far from meeting the expectations of international investors. Factors such as globalization and sharp corrections of some of the GCC stock markets happening in the beginning of year 2006 are thought to have created a more favourable environment to implement changes in the corporate governance frameworks and practices. Furthermore, the legislation on corporate governance has essentially centred on the improvement of practices and behaviour, integrating the management of business with the cultural tenets of the region as well as the commitment of the board and the senior management to the success of the organization (Ghosh, 2018).

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Chapter Five

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Risk governance in banking institutions has gained importance after financial authorities and international regulatory bodies uncovered the weaknesses that contributed to the massive losses during the global financial crisis of 2007-2008. The Basel Committee on Banking Supervision and the national regulators now consider corporate governance as whole and risk governance in particular as a key factor that can contribute to the prevention of excessive risk-taking

behaviour of bank managers to enhance the profitability of the shareholders and theirs as well34_.

As Stulz (2014) puts it, from the equity holders’ perspective ‘better risk management’ cannot mean risk management that reduces exposure to risk since reducing risk would also mean avoiding valuable investments. Consequently, banks have private incentive structures that are more performance and cost-benefit oriented. In contrast, regulatory authorities are more concerned about the stability and soundness of individual financial institutions and the overall financial sector that are both crucial to protect the interests of all stakeholders including depositors and bondholders. Financial authorities are very much concerned about systemic risks whereby shocks from the financial sphere spread to the economy at large as experienced in 2008. Regulators have therefore incentive structures that are more public and socially oriented. The main aim of this thesis was to explore whether and how the governance of risks in banks contributes to performance and stability. This last chapter synthesizes the results and answers to the research questions that were set out in the introduction chapter and that were examined in three empirical essays. It discusses how this research contributes to the existing body of knowledge and provides reflections on the policy implications of the three studies. The chapter concludes by presenting the limitations of the research and suggestions for future research development.