Reciprocity in Bank Regulatory Reforms and Income Inequality - First Evidence from a Panel Vector Autoregression Analysis

Our study examines the dynamics between variations in bank regulatory policies and the income distribution, using an IMF database of quantified measures for financial reforms as well as the Standardized World Income Inequality Database. The unbalanced panel comprises 36 developed countries and covers a period over three decades from 1973 to 2005. We assess the potential endogeneity between bank regulations and inequality via a panel vector autoregression model. Among the regulatory reforms, we consider the deregulation of securities markets, entry barriers, credit and interest rate controls as well as the extent of privatization, international capital flows and banking supervision. We are able to provide support for the hypotheses that (i) overall, abolishing bank regulations enhances inequality in income and (ii) higher levels in inequality encourage laissez-faire policies in the banking sector. Moreover, our results highlight the importance of examining each regulatory reform individually. In particular, we endorse a relaxation of entry barriers for financial intermediaries while promoting interest rate controls, capital account restrictions and deliberate government intervention in securities markets.