Dark Banking? Banks and Illicit Deposit Flows

Do banks enable organized crime? Does bank regulation insulate financial intermediation from criminal activity? I address these questions using evidence from the drug trade in Mexico, finding that local drug cartel activity causes an increase in bank deposits. Branch networks grow in affected areas; this growth is not driven by increased lending opportunities. Post-election of a "law-and-order" government, effects attenuate, with liquidity flowing into branches of U.S. banks along the border. I interpret this as evidence that "finance follows crime" in weak institutional environments, and that, absent transnational policy coordination, regulatory arbitrage via cross-border liquidity flows undermines banking regulation.