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Conflicts and domestic bank lending

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Abstract

Recent studies of financial development have shown that the quality of institutions is an important determinant of international financial flows to a country. Our paper contributes to this literature by examining and comparing the effects of internal conflict and terrorism on domestic credits extended to the private sector by banks in developing countries. We use a panel dataset for 125 developing countries over the 1984–2012 period to explore the relationship between political instability and bank lending. Internal conflict negatively affects domestic bank credit to the private sector, and the extent of this impact depends on the degree of ethnic fractionalization. The impact of terrorism, however, is not statistically robust. Our findings are also relevant for the literature that investigates the costs of conflict.

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Notes

  1. Beck and Demirguc-Kunt (2006) argue that, despite a significant contribution to total employment in many developing countries, small and medium-sized enterprises (SMEs) face greater growth obstacles. In particular, limited access to credit for SMEs is a major growth constraint in these economies. Using survey data on firms in 69 developing countries, Leon (2015) shows a positive effect of bank competition on credit availability.

  2. Terrorism also adversely affects economic growth and investment (e.g., Bandyopadhyay et al. 2014; Meierrieks and Gries 2013; Younas 2015).

  3. Other exogenous factors can make it difficult for firms to cooperate, even if some of them agree to compensate the firm that is most affected by conflicts. Examples of such factors could be: (1) a terror-ridden country may impose strenuous procedures for obtaining loans from banks; and (2) consumers may reduce current consumption spending owing to income uncertainties.

  4. Barro and Sala-i-Martin (2003) offer an exhaustive discussion in this regard.

  5. Gaibulloev et al. (2014), however, show that the average impact of terrorism on economic growth for a sample of world countries is not statistically significant.

  6. As described by the World Bank (2014), “Domestic credit to the private sector by banks refers to financial resources provided to the private sector by other depository corporations (deposit taking corporations except central banks), such as through loans, purchases of non-equity securities, and trade credits and other accounts receivable, that establish a claim for repayment. For some countries these claims include credit to public enterprises”.

  7. Although banks remain the largest source of lending for businesses and entrepreneurial activities, non-traditional loans can make up a sizeable portion of total lending. The sources of these loans may include friends and relatives, the Small Business Corporations, venture capital firms, and personal or corporate credit cards. Our analysis is limited to the bank lending owing to the lack of availability of data on nontraditional loans for the majority of developing countries.

  8. The standard deviations for MEPV conflict and institutional risk are 1.74 and 13.16. Therefore, [EXP(−0.053 × 1.74) − 1] × 100 = 8.8 % and [EXP(−0.015 × 13.16) − 1] × 100 = 17.9 %.

  9. The results for the other components of the institutional index—government stability, corruption, and democratic accountability—are not reported to save space. These components are not statistically significant and their inclusion does not affect our main conclusion (available upon request).

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Acknowledgments

While assuming full responsibility for any remaining shortcomings, the authors have profited by the comments from William F. Shughart II, Todd Sandler and an anonymous referee. We also received helpful comments from the seminar participants at the Political Violence and Policy Conference 2016 held at University of Texas-Dallas, Lahore University of Management Sciences and Middle East Economic Association Conference 2016 in San Francisco.

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Authors and Affiliations

  1. Department of Economics, School of Business Administration, American University of Sharjah, Sharjah, UAE

    Khusrav Gaibulloev & Javed Younas

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  1. Khusrav Gaibulloev
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  2. Javed Younas
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Correspondence to Javed Younas.

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Gaibulloev, K., Younas, J. Conflicts and domestic bank lending. Public Choice 169, 315–331 (2016). https://doi.org/10.1007/s11127-016-0362-3

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