Conflicts and domestic bank lending

Recent studies of financial development have shown that the quality of institutions is an important determinant of international financial flows to a country. Our paper contributes to this literature by examining and comparing the effects of internal conflict and terrorism on domestic credits extended to the private sector by banks in developing countries. We use a panel dataset for 125 developing countries over the 1984–2012 period to explore the relationship between political instability and bank lending. Internal conflict negatively affects domestic bank credit to the private sector, and the extent of this impact depends on the degree of ethnic fractionalization. The impact of terrorism, however, is not statistically robust. Our findings are also relevant for the literature that investigates the costs of conflict.