The Politics of Bank No-Lending Activities Regulation: A Cross Country and Time Dynamic Study of the Role of Government and Private Industry Groups

Abstract

I run a cross country study that narrows down the evidence in favor of the influence of industrial private interests on bank legislation, specifically bank non-lending activities like non-financial firm, insurance, real estate and securities activities entry. Building on the methodology proposed by Braun and Raddatz (2008) I find that industry promoters of financial development have a preference to restrict bank entry into non-lending activities, a result that is consistent with a bank power aversion flavor of private interest theory. Through the proposed methodology, I am also able to disentangle evidence supportive of tollbooth theory where governments restrict the law to generate opportunities for rent extraction. I also find some weak support for public interest theory and in various cases, governments that are perceived as of high regulatory quality, tend to resemble a flip flopping pattern of regulatory changes more consistent with tampering theory.As a whole, a puzzle emerges because current theoretical and empirical research suggests that financial development is favored by providing greater freedoms in bank-non lending activities, however, the private interest story suggest the opposite. As a possible resolution to the puzzle I suggest that the restrictions on bank non lending activities favored by industrial interests drive financial development only when they are supported by industries with external capital needs and with growth opportunities. Further, such beneficial impact from restrictions will become evident only under such specific conditions and on the longer term. However a more immediate and stronger impact on financial development is possible when control of government corruption improves and non lending activities such as non financial firm and insurance activities bank entry are freed.