The interest group theory of financial development: Evidence from regulation

► We use a new panel dataset of de jure measures of regulation for 91 countries. ► We test Rajan and Zingales’s (2003) interest group theory of financial development. ► Trade liberalization is a leading indicator of domestic financial liberalization. ► We do not find consistent evidence of an effect of capital account liberalization. We use a new dataset of de jure measures of trade, capital account, product market, and domestic financial regulation for 91 countries from 1973 to 2005 to test Rajan and Zingales’s (2003) interest group theory of financial development. In line with the theory, we find strong evidence that trade liberalization is a leading indicator of domestic financial liberalization. This result is robust to the use of different data frequencies (annual, 5-year intervals), estimation methods (OLS, 2SLS, system GMM) and a check for non-linear effects. However, in contrast to the theory, we do not find consistent evidence of an effect of capital account liberalization.