What Drives International Bank Flows? Politics, Institutions & Other Determinants

This paper uses a large panel of bilateral bank flow data to assess how institutions and politics affect international capital -bank in particularflows. The following key findings emerge: 1) The empirical "gravity" model is the benchmark in explaining the volume of international banking activities. 2) Conditioned on standard gravity factors (distance, GDP, population), well-functioning institutions are a key driving force for international bank flows. Specifically, foreign banks invest substantially more in countries with i) uncorrupt bureaucracies, ii) high-quality legal system, and iii) a non-government controlled banking system. 3) Beyond legal institutions, politics exert also a first-order impact and reforms (democratizations, privatization, decentralizations of power) are followed with a significant increase of foreign bank investment. 4) The European Integration process has spurred cross-border banking activities between member states. These results are robust to various econometric methodologies, samples, and the potential endogeneity of political and institutional characteristics. The strong institutions/politics-bank flows nexus has strong implications for asset trade and international macro theories, which have not modelled these relationships explicitly. JEL Classification: .F34, F21, G21, K00