Institutions, Policy and Banking Sector Development: A Reassessment

This paper investigates the links between institutional quality and government policy in banking sector development, using data from 80 low-, middle- and high-income economies during 1985–2007. In order to investigate the effect of economic, political and social institutions on bank-based development, we employ dynamic panel techniques and, more specifically, the system-GMM estimator, which controls for endogeneity among variables. The results demonstrate that: i) economic institutional quality, and especially the legal dimension, is the main determinant for banking sector development; ii) social institutions have a greater impact for low- and middle-income countries, while political institutions have a greater impact for high-income countries; and iii) government policy, in terms of government size, is crucial regardless of the stage of economic development.