Democracy and Financial Stability: The Impact of Economic and Political Risks on Bank Performance in G7 Countries

Abstract

Purpose - This study aims to examine the relationship between the level of democracy and bank risk and bank performance using panel data from the G7 countries for the period 2013–2023.
Desing/ Methodology/ Approach- Empirical analyses employed the ADF-Fisher panel unit root test, Pedroni cointegration test, FMOLS, Panel Least Squares (PLS), and Panel ARDL models. Data were obtained from secondary data sources.
Findings: It was observed that the level of democracy has a positive and significant effect on bank performance in the long term. Banking risk, on the other hand, has negative effects on performance in the short term. In country-based analyses, it was observed that the effect of democratic institutions varies across countries, and that short-term democratic changes in some countries cause temporary uncertainties.
Discussion- The findings reveal that democratic institutions support bank performance through their regulatory and transparency-enhancing structures in the financial sector. In country-based analyses, the impact of democratic institutions varied, with short-term uncertainties observed in some countries. The study comprehensively addresses this relationship in the context of G7 countries for the first time in the literature using multiple panel data methods, revealing the structural links between democracy and financial performance at both theoretical and empirical levels and providing important insights for policymakers.