Does oil price aggravate the impact of economic policy uncertainty on bank performance in India?

This paper examines the relationship between Economic Policy Uncertainty (EPU) and bank performance in India over the period 2000–2016. We investigate the role of international crude oil price in this relationship that previous studies have ignored. We also investigate whether the effect of oil prices depends on inflationary conditions. Using a sample of Indian commercial banks from 2000 to 2016, we find that an increase in the Indian EPU is associated with increased risk-taking (insolvency, credit and liquidity risks), but improved cost management efficiency and profitability. The EPU and risk-taking relationships are aggravated by higher international oil prices. These effects of oil prices are not conditional on the inflation level in India. The results are robust to alternative Indian EPU calculations and estimation methods. We also investigate the role of international oil prices in the spillover of the US EPU to Indian banks' performance. We find that the US EPU affects Indian banks' credit risk, cost efficiency and profitability in the same sign as the Indian EPU, but the two latter effects are amplified by oil price rises, and the amplification effects are conditional on Indian inflation. The findings have important implications for policies for financial reform and financial stability in India. •An increase in the Indian EPU is related to increased bank risk-taking, but improved cost efficiency and profitability.•The EPU and risk-taking relationships are aggravated by higher international oil prices.•These effects of oil prices are not conditional on the inflation level.•The US EPU affects Indian banks' credit risk, cost efficiency and profitability in the same sign as the Indian EPU.•The two latter effects are amplified by oil price rises, and these effects are conditional on Indian inflation.