The Political Economy of Financial Sector Supervision and Banking Crises: A Cross-Country Analysis

This study investigates the relationship between banking crises, financial supervision and institutional veto players in an empirical study consisting of 65 advanced and developing countries from 1976-2005. While the literature relating banking crises and supervision is extensive, discussions of precisely how domestic political institutions influence the design of banking supervision have not been commonplace. We test whether these political institutions which reflect checks and balances affect the probability of a banking crisis, by way of shaping the quality of a country's financial supervisory policies. We find a significant and negative relationship between banking crises probabilities and the strength of financial sector supervision. Our results highlight the important role of financial regulation and supervision in reconciling the benefits of a liberalised financial system (ie enhanced economic growth) with its costs (ie increased financial fragility).