Does societal trust affect banking activity? European evidence

PurposeThis paper provides empirical evidence on the impact of societal trust in three dimensions of banking activity: the quantity and quality of credit granted by banks and their economic performance.Design/methodology/approachThe paper uses a sample of 1,366 European banks from 36 countries between 2014 and 2020. In our estimations, we control for bank-specific and country-specific determinants of banking activity. Moreover, we perform several robustness tests, including estimation by instrumental variables and hierarchical linear methods, variable definitions, and subsamples.FindingsSocietal trust increases the weight of credit on the balance sheets of banks and decreases the weight of nonperforming loans and net interest margins. Moreover, the results suggest a smaller (higher) impact of trust on loans and net interest margins (nonperforming loans) in the European Monetary Union (EMU) countries. Also, on the importance of loans and net interest margins, our results suggest a substitution effect between trust and the credit-favorable nature of the legal environment.Research limitations/implicationsThe symmetrical sign of the effect of societal trust on the importance of loans - positive - and nonperforming loans and net interest margins - negative - suggests that potential asymmetric information biases may be less severe or better accounted for by the credit risk evaluation in highly trustworthy environments. Also, bank managers should recognize risk factors related to trust levels and benefit from targeted risk mitigation measures and from implementing strategies aimed at enhancing profitability in different societal trust scenarios.Originality/valueThis paper provides empirical evidence on the impact of societal trust on banking activity from the perspective of the lending activity, risk and performance of banks. It also analyses the effects of EMU membership and the credit-favorable nature of the legal environment.