Description:
This study provides a novel attempt to evaluate whether a logit early warning system (EWS) for systemic banking crises can produce better predictions when political indicators are employed alongside traditional macro-financial indicators. Based on a dataset covering 32 advanced economies for the period 1975-2017, we show that the inclusion of political indicators significantly improves the model’s predictive performance. Besides, our results suggest several channels through which the political environment could influence a banking system’s stability. Notably, we find that majority governments, left-wing governments, and a longer time in office of the executive party are negatively correlated with systemic risks. The results are statistically significant and robust across different specifications. Furthermore, our results suggest that long-established institutional systems and plurality electoral rules (compared to proportional representation formulas) are associated with lower crisis likelihood. At the same time, crises are more likely when the incumbent government constitutes a nationalist platform