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Politics of Bank Failures: Evidence from Emerging Markets

5/17/2004 --

Political concerns delay regulatory interventions in failing banks in emerging countries

ANN ARBOR, Mich. – Bank failures are very common in emerging markets where political concerns about the timing and outcome of elections often delay critical government interventions in failing financial institutions, say researchers at the University of Michigan Business School.

Serdar Dinc, assistant professor of finance, and Craig O'Neil Brown, a doctoral student in finance, studied government responses between 1994 and 2000 to the 10 largest banks in 21 major emerging countries, which had free or partially free elections. In all, 25 percent of the private banks failed during the sample period.

The researchers report that 75 percent of all government takeovers or bank closings of failing banks–30 of 40 bank failures–took place within 18 months after elections were held. By contrast, only four takeovers or license revocations–roughly 10 percent–occurred in the 12 months immediately preceding elections.

The regulatory delay that Dinc and Brown demonstrate is not driven by changes in the party in power after elections. International Monetary Fund lending, they say, does not seem to have an effect on the regulatory delay in emerging markets, either. Nor do political, legal, historical, institutional or geographic differences across countries explain the absence of government interventions in troubled financial institutions before elections. Yet, government interventions do increase substantially in the post-election period, even in countries facing a major crisis, they say.

The researchers suggest several reasons why political considerations strongly impact regulatory behavior in the emerging-market banking sector. Politicians, they say, will avoid any action, such as a bank failure, that might create a major economic disruption before elections. Similarly, they will defer until after elections any action that is costly for taxpayers.

Political influences on banking policy and enforcement, they add, tend to be stronger in emerging markets because government agencies and political and economic institutions often function less effectively. However, developed countries like the United States are not immune from the impact of politicking on government interventions in banking affairs, either.

"The incentives for regulators and politicians to defer the day of ultimate reckoning of the problems in banking were demonstrated during America's savings and loan crisis in the 1980s," Dinc says. "The slow pace of regulatory actions against distressed banks in Japan is another example of how political concerns can affect government oversight."

For more information, contact:
Bernie DeGroat
Phone: (734) 936-1015 or 647-1847