Legal Origin, Creditor Protection and Bank Lending Around the World

Abstract

In this study, we investigate whether bankers make more loans when they enjoy superior creditor protection. We formulate a number of hypotheses, which we test using bank-level data from 31 developed countries and 96 developing countries over the period 2000-2006 and using a random-effects model that controls for bank heterogeneity as well as a between-effects model. We find that bankers allocate a significantly lower portion of their assets to risky loans: (i) when they enjoy French civil-law legal origin rather than English common-law legal origin; (ii) when creditors’ rights are stronger; (iii) when their banks are smaller and better capitalized; and (iv) when the controlling shareholder is a State or foreign entity. We also find that bankers in developing countries, but not in developed countries, allocate a significantly larger portion of their assets to risky loans when legal enforcement of creditor rights is more efficient. Overall, these results provide strong support for the theory of legal origin but provide only mixed support for the “power” theories of credit.

Keywords: banking, bank loans, bank risk-taking, creditor protection, creditors' rights, emerging markets, investor protection, judicial enforcement, law and finance, legal origin, legal rights

JEL Classification: G21, G34