Policy Responses to Banking Crises Over the Longer Run

Abstract

What determines government policy responses to banking crises? One prominent analysis of pre-1999 post-war crises claims that democratic governments seek to minimize the public burden of bank insolvency to avoid electoral sanction, and thus are less likely to bail out banks than authoritarian governments. We find no evidence to support this contention. On the contrary, we contend that this limited time window of analysis omits some important dynamic trends; most notably, financialization, that are shaping policy responses to crises in all countries, democratic or otherwise. Drawing on a new dataset of policy responses since the mid-1970s, we use a broader time window to investigate the role of different factors in the evolving policy responses to such crises. We find that rising financialization creates both a generalized bailout propensity for all governments operating in economies likely to be more open to financial innovation, more complexity, and interconnectedness. There is also a specific bailout propensity in democratic countries associated with the relative importance of banks and private sector leverage.