Institutions and Bank Behavior: Legal Environment, Legal Perception, and the Composition of Bank Lending


  • We would like to thank the seminar participants at the CEPR/EBRD Tokyo Conference April 2006, the 12th Dubrovnik Economic Conference June 2006, the 10th Conference of the Swiss Society for Financial Market Research 2007, the European Economic Association Budapest Meeting 2007, Limoges University, 2007, the Society for Empirical Legal Studies, New York 2007, and RMIT University Melbourne 2009 for comments on preliminary versions of this paper.


This paper explores how the legal environment affects bank behavior in 20 transition economies. Based on a newly constructed data set we find that banks’ loan portfolio composition depends on the legal environment. If banks operate in a well-functioning legal environment they lend relatively more to SMEs and provide more mortgages. On the other hand, banks lend more to large enterprises and to the government if the legal system is unsound. As a transmission channel we identify the banks’ willingness to accept collateral which depends on the bankers’ perceptions of the prevailing laws regarding collateral.