Political Institutions and Banking Systems: Lessons from the Economic Histories of Mexico and the United States, 1790-1914

The banking crises of Asia and Latin America have increased the awareness of economists of the ways that politics influence economic outcomes. Indeed, it is a commonplace to ascribe the origins and persistence of recent less-developed country (LDC) banking crises to political factors. Yet, while our analyses of the economics of banking crises are systematic, our analyses of the underlying political institutions that structure banking systems tend to be ad hoc. This paper seeks to address the relationship between political institutions and the regulation and performance of banking systems in a systematic manner. It focuses on two questions: how does the organization of decision making in the political system affect the economic institutions that govern banking; and how those economic institutions then affect the size and competitive structure of the banking system? It explores the multiple channels through which political institutions that encourage political competition limit the discretion of policy makers. It then demonstrates how the mechanisms that limit policy maker’s discretion give rise to competitively structured markets in banking services.