Banking on Democracy: The Political Economy of Private Bank Flows in Emerging Countries Javier Santiso Chief Economist & Deputy Director OECD Development Centre ABCDE World Bank Conference 2007 Bled, Slovenia May 2007

2 2  Wall Street and the City are starting to take a fresh look at emerging markets. During the 1990s, financial and economic variables dominated their analysis. Over the 2000s, political and ethical variables are increasingly growing in relevance.  In 2004 Rexiter Capital Management, a UK based asset maneger, launched the world’s first “sustainability” investment strategy exclusively focused on emerging markets.  Previously, Calpers - a major US pension fund with nearly USD 170 billion of assets under, which started to invest in emerging markets by the beginning of the 2000s – also started to consider non-financial criteria such as political stability, transparency and labour rights.

3 3  Bankers also started to increasingly take into account other variables to assess their investment decisions around the world.  In 2003, a leading group of top global bankers launched the Equator Principles, an initiative led by 10 of the world’s largest banks to address the social and environmental impact of the projects that they finance.  Political issues such as human rights seem to be now on their radar screens. But what about democracy ? What about political regimes? Are they taken into account by banks when they decide to invest or not in a country? Put in another way, do banks have political preferences?

4 1 Banks in Emerging Countries: Stylized Facts Banks and Political Regimes 2 Banks and Policy Stability. 3

5 5 Banking on Demorcacy: Politics Matters  Institutional and political environment influence international capital transactions.  Institutional quality is the most important variable explainging Lucas’ Paradox (Alfaro et al., 2003 and 2005).  FDI in particular is sensitive to politics. Countries with weaker democratic rights tend to attract less US FDI capital (Rodrik, 1996). FDI private investors significantly increased their investments in the three years following the shift to democratic rule (Pei and Lyon, 2003).  Investments made by multinationals are higher in democratic countries in terms of FDI per capita (Harms and Ursprung, 2002, Busse, 2003).

6 6 Politics Matters  Regarding banks, politics and institutions are also key determinants of international banking activities (Papaioannou, 2004): a fall of five percent in the political risk of the recipient country is accompanied by a two percent rise in the volume of bilateral bank lending.  The claims of US, Spanish and Italian banks tend to be sensitive to transaction costs (i.e. informational costs) but also to the role of government intervention in the financial sector as well as country risk, which includes not only economic and financial variables but also political factors (García-Herrero and Martínez-Peria, 2004).  All in all, banks tend to invest in countries with high-quality institutions and allocate credit to countries that are not characterised by corruption, and which have efficient legal systems.

7 7 Two synchronized trends  Over the past decade, foreign bank claims took off as part of the process of greater financial integration and the opening up of emerging countries to capital flows  Among emerging countries, Latin America and Eastern Europe experienced the biggest increase, rising by more than 110% and 165% respectively.  In both areas democratization has been particularly intensive.

8 8 Some stylized facts: The 90’s recovery Source: Javier Rodríguez and Javier Santiso, OECD Development Centre, Working Paper 2007

9 9 Some stylized facts: Where? Source: Javier Rodríguez and Javier Santiso, OECD Development Centre, Working Paper 2007

10 Some stylized facts: A Latin American perspective Source: Javier Rodríguez and Javier Santiso, OECD Development Centre, Working Paper 2007

11 Some stylized facts: Who? Source: Javier Rodríguez and Javier Santiso, OECD Development Centre, Working Paper 2007

12 The political economy of bank lending: The French Touch French Foreign Claims to countries that are non-recipients of US finance in 2004 and 2005 (% of the total emerging countries receive) Source: Javier Rodríguez and Javier Santiso, OECD Development Centre, Working Paper 2007

13 1 Banks in Emerging Countries: Stylized Facts Banks and Political Regimes 2 Banks and Policy Stability. 3

14 Do bankers love democracy? A Latin American Perspective

15 Do bankers love democracy? A Latin American Perspective

16 Executive assaults and foreign banks in Latin America

17 Blind to political colors

18 Bankers and Cabinet Turnover

19 1 Banks in Emerging Countries: Stylized Facts Banks and Political Regimes. 2 Banks and Policy Stability. 3

20 Bankers and Economic Policy Stability in Latin America

21 Bankers and Economic Policy Stability in Latin America

22 The Search for Economic Policy Stability in Emerging Markets

23 Correlations of Foreign Claims with: Economic Policy Stability Index, Consolidation of Democracy Index and Democracy Score.

24 Based on :  Javier Rodríguez and Javier Santiso, “Banking on Democracy: The Political Economy of International Private Bank Lending in Emerging Countries”, OECD Development Centre, Working Paper, 259, March  Javier Rodríguez and Javier Santiso, “Banking on Development: Private Banks and Aid Donors in Developing Countries”, OECD Development Centre, Working Paper, 261,May

Banking on Democracy: The Political Economy of Private Bank Flows in Emerging Countries Javier Santiso Chief Economist & Deputy Director OECD Development Centre ABCDE World Bank Conference 2007 Bled, Slovenia May 2007