Political institutions and foreign banks’ risk-taking in emerging markets

Abstract

This paper investigates the impact of political institutions in host countries on the risk-taking of foreign banks. We first propose several channels through which political institutions theoretically affect foreign banks’ risk-taking. We then empirically examine the relationships by using bank-level data from 2000 to 2013 in 35 emerging markets. Research evidence suggests that foreign banks’ stability increases with the democracy of political institutions. However, the benefits of democratic institutions weaken for foreign banks established through mergers and acquisitions, financial institutions with relatively short operating periods in host markets, and those with inefficient operations. Moreover, the positive effect is also undermined by improvements to the deposit insurance system of the host country. Finally, a country’s political institutions tend to further strengthen the stability of foreign banks when the host country has sound legal institutions.