Economic Freedom and Banking Performance: Capital Buffers as the Key to Profitability and Stability in Liberalized Markets

Wahyu Ario Pratomo (), Ari Warokka, Rizky Yudaruddin and Aina Zatil Aqmar
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Wahyu Ario Pratomo: Faculty of Economics and Business, Universitas Sumatera Utara, North Sumatera 20222, Indonesia
Ari Warokka: Global Business Department, Busan International College, Tongmyong University, Busan 48520, Republic of Korea
Rizky Yudaruddin: Faculty of Economics and Business, Mulawarman University, East Kalimantan 75119, Indonesia
Aina Zatil Aqmar: Prosemora Consulting, Jakarta 13220, Indonesia

JRFM, 2025, vol. 18, issue 10, 1-25

Abstract: This study examines the moderating effect of bank capitalization on the relationship between economic freedom and banking performance, offering comparative evidence from both advanced and emerging economies. Using an unbalanced panel of 213 countries from 1993 to 2018, this study applies a two-step System Generalized Method of Moments approach to address dynamic effects, endogeneity, and unobserved heterogeneity. The results show that economic freedom exerts a negative and significant impact on bank profitability (ROA and ROE), particularly in emerging markets with weaker institutional safeguards. Strong internal capital buffers, on the other hand, mitigate these adverse effects and enhance resilience, supporting stable profitability under liberalized conditions. Regulatory capital shows a less consistent and sometimes restrictive role. Disaggregated results indicate that equity buffers most effectively cushion the risks of financial and investment freedom, whereas trade freedom is less sensitive to capital levels. The findings emphasize that successful liberalization depends on institutional capacity and capitalization strength, highlighting the importance of tailored prudential frameworks. The study contributes to debates on financial liberalization, Basel III, macroprudential regulation, and bank risk management, underscoring that a “one-size-fits-all” liberalization strategy may undermine stability and efficiency unless supported by robust capital buffers.

Keywords: economic freedom; bank capitalization; profitability; financial liberalization; banking stability; emerging markets; system GMM; capital regulation (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2025
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