Do regulations affect banking performance? Government governance may matter

The authors study the impact of restrictions on commercial banks' engagement in securities, insurance, and real estate, as well as a mix of banking and commerce. The model specifies the impact as a function of government governance (the rule of law), which allows the authors to investigate two conflicting hypothesis, i.e., the restriction-enhancing hypothesis and facility-supporting hypothesis. The former effect suggests that good-governance enhances the hypothesized adverse effect of restrictions, and the latter suggests that good governance mitigates this adverse effect. The study clearly demonstrates that restrictions on commercial banks' right to engage in securities and insurance, along with restrictions on the mixing of banking and commerce, reduce bank profits. However, good governance mitigates such an adverse impact, i.e., the facility-supporting hypothesis is supported. Restrictions on real estate, on the other hand, seem to have positive effects on bank profits. The results are robust to different specifications.