Regime Switching Dynamic Impact of Risk Management on Bank Profitability: Evidence from South Africa

Dumisani Pamba

doi:10.37075/FABA.2026.1.13

Authors

Dumisani Pamba School of Accounting, Economics and Finance, University of KwaZulu-Natal, South Africa https://orcid.org/0000-0002-1911-5671

DOI:

https://doi.org/10.37075/FABA.2026.1.13

Keywords:

Bank profitability, Risk management, Regime switching, Return on Equity (ROE), South Africa

Abstract

Purpose: This study investigates the regime-switching dynamic impact of key risk management variables (liquidity risk, credit risk, exchange rate risk, and inflation risk) on bank profitability in South Africa, measured by return on equity (ROE) from 2000Q1 to 2024Q4. The aim is to determine whether these relationships differ between two economic regimes: regime 1 (stable) and regime 2 (crisis).

Design/Methodology/Approach: The study employs a Markov Switching Means Vector Autoregressive (MSM-VAR) model using quarterly data to capture nonlinear and state-dependent dynamics in the risk–profitability relationship. The model distinguishes between low-risk (stable) and high-risk (crisis) regimes, accounting for structural breaks and changing macroeconomic conditions.

Findings: The results reveal strong evidence of regime-dependent dynamics. Liquidity risk has a significant positive impact on ROE during crises but is insignificant during stable periods. Credit risk positively influences profitability during stable periods but has a strong negative effect during crises. Conversely, exchange rate risk and inflation risk do not show statistically significant effects in either regime. The results validate the importance of incorporating non-linear modelling approaches when assessing risk–performance linkages in volatile emerging market contexts.

Practical Implications: The findings highlight the need for state-contingent risk management strategies. Banks should enhance liquidity buffers and implement countercyclical credit risk practices during stable periods to mitigate the adverse effects of downturns. Policymakers and regulators should consider macroprudential tools that adapt to shifting economic conditions to sustain the banking sector's resilience.

Originality/Value: This study applies a regime-switching framework to evaluate the risk–profitability nexus in South African banking. It provides empirical evidence on how risk management effectiveness varies across macroeconomic regimes, offering insights into financial stability, risk management, and banking regulation in emerging markets.

Paper Type: Research Paper

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