Caudillo banking: political instability and banking fragility in Mexico, 1925-1929

What are the effects of political instability on the banking sector? This article examines the short-term impacts on banking activities in Mexico during the late 1920s, a decade marked by civil conflicts and political violence. Although political upheavals affected some regions more than others, banks and depositors were compelled to respond to a general atmosphere of political violence. Drawing on new qualitative and quantitative evidence, this article analyzes how banks and depositors behaved in the context of armed conflicts and assesses the consequences for the banking sector. Our results show a negative effect of political violence on bank deposits and banks' capitalization. We also account for the geographic proximity of violent regions to neighboring municipalities and observe that political instability promoted capital flight, particularly in the northern region of the country, where episodes of political violence were more severe. We conclude that political instability likely contributed to the lack of financial development in Mexico.