Bank capitalization and credit risk: the conditional role of innovation and institutional quality

This article investigates the relationship between bank capitalization and credit risk in the West African Economic and Monetary Union (WAEMU) using a panel of 130 banks over 2018–2022, a period that coincides with the implementation of Basel II and Basel III prudential standards by the Central Bank of West African States (BCEAO). The empirical strategy combines fixed-effects estimations with Driscoll-Kraay standard errors, panel-corrected standard errors, cluster-robust fixed-effects models and instrumental-variable checks. Across specifications, better-capitalized banks tend to record lower loan-loss provisions. The analysis also reveals that the capitalization-risk relationship varies across innovation and institutional environments. Stronger innovation ecosystems reinforce the risk-reducing association between capitalization and credit risk, highlighting complementarity between capital buffers and ex ante screening and monitoring mechanisms. Institutional quality further conditions this nexus, with capitalization being more strongly associated with lower credit risk in environments characterized by stronger governance and regulatory enforcement. Overall, the findings support a context-sensitive prudential approach that combines adequate capitalization with improved institutional quality and innovative credit-risk management tools in WAEMU.