Local economic uncertainty, bank efficiency, and financial risk

Alam, AW, Yu, Q ORCID: https://orcid.org/0009-0000-8492-0151, Bai, S and Banna, Hasanul ORCID: https://orcid.org/0000-0002-6902-8525 (2025) Local economic uncertainty, bank efficiency, and financial risk. Finance Research Letters, 81. 107508. ISSN 1544-6123

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Abstract

We investigate the interrelationship between state-level economic policy uncertainty (SEPU), bank efficiency, and banks’ financial risk. Using a sample of US banks from 2011 to 2021, we show that banks with higher operational efficiency can mitigate the increased financial risk stemming from high SEPU. This association remains unchanged while considering the national-level economic policy uncertainty as a control variable, using alternative proxies for SEPU, risk, and efficiency, and employing several matched samples of banks, dealing with the endogeneity concern. We further show that the mitigating effect is not contingent upon heterogeneity in several important bank characteristics. Our findings have implications for anyone studying the repercussions of economic uncertainties at different levels and potential remedial measures for banking institutions.