Modeling the Impact of Political Regimes on the Banks’ Financial Stability: Cross Country Comparative Analysis

The main aim of this research is to find out, whether democracy leads to higher banks’ financial stability. This research used banks’ credit ratings, as a proxy for their financial stability. The dataset includes 437 banks from 42 countries in the timeframe from 2007 to 2019. To find the effect of political regimes on the financial stability of banks, a multinomial ordered logit model was used, where the various regime indices and control financial and macroeconomic variables are employed as the independent variables, and the credit rating for each period of time of the particular bank is a dependent variable. The results show that the political regime is a significant variable in determining banks’ financial stability. Furthermore, democratic states have the higher financial stability of banks. Moreover, democracy has a positive impact on asset quality and capital adequacy of banks, which, in turn, leads to higher credit ratings. Besides, there is a non-linear dependence between the democracy and financial stability of banks, specifically, when the state is closer to non-democracy and experiences the rise of democracy, banks’ credit ratings will increase substantially. On the other hand, when the already democratic state increases its democracy index further, banks’ credit ratings will increase slightly. Afterwards, democracy has a larger impact on banks’ financial stability in developing states, as well as in CIS and BRICS comprised of developing states, in comparison with developed states and EU in particular. All in all, the fact that democratic states have higher banks’ financial stability than non-democracies, translates into financial power and stability of the state, which in turn leads to the growing international competitiveness of the state.