Financial and Political Institutional Problems as Instigators of Banking Crises

Abstract

The question of why some countries suffer from crises, while others escape them, is challenging. Empirical evidence in the literature suggests that countries with stronger financial institutions are more able to withstand crises. This study empirically investigates whether the probability of crisis depends on the political institutional structure. More specifically, we question whether the failure to democratize polity successfully creates an environment for financial institutional weaknesses, which have the potential to lead to banking crises. It is found that the effectiveness of the prudent supervision of the financial sector in lowering the probability of banking crises is more pronounced in more democratized countries and when the political framework is more institutionalized.