Lending behaviour, political environment and systemic banking crisis in developing economies

Abstract

The paper examines the impact of bank lending behaviour and political events (i.e., election cycles) on the predicted probability of a systemic banking crisis in developing countries. Using an instrumental variable probit regression for a panel dataset of 137 developing countries over the period 2004–2020, the study found that beyond the estimated thresholds for bank lending, which ranged from 0.2804 to 0.6513, a systemic banking crisis is likely to occur. The study shows that average bank lending increases the likelihood of a systemic banking crisis around election episodes, but it decreases the likelihood of a systemic banking crisis a few years before and after an election. Based on marginal effects, the study found that the negative impact of average bank lending on the likelihood of a systemic banking crisis reverses or diminishes during an election year, but the impact amplifies immediately after the election. The study provides evidence to support that the average bank lending behaviour during the upturn phases of political business cycle reduces the likelihood of a systemic banking crisis, while the average bank lending behaviours during the downturn phases of political business cycle lead to a banking crisis over the electoral cycles.