Post on 28-Dec-2015
Rethinking Bank RegulationRethinking Bank Regulation
James BarthJames Barth
Gerard CaprioGerard Caprio
Ross LevineRoss Levine
OverviewOverview
1.1. Some findingsSome findings
2.2. Some weaknesses, and strengthsSome weaknesses, and strengths
3.3. A pleaA plea For epistemological modestyFor epistemological modesty Against faith-based policy advisingAgainst faith-based policy advising
Some Findings: Conceptual frameworkSome Findings: Conceptual framework
If men were angels, no government would be necessary.
If angels were to govern men, neither external nor internal controls would be necessary.
In framing a government which is to be administered by men over men, the great difficulty lies in this: you must first enable the government to control the governed; and in the next place oblige it to control itself.
James Madison, Federalist Papers, 1788
Bankers are not Bankers are not angelsangels
Politicians (& some Politicians (& some bank supervisors) bank supervisors) are not angels.are not angels.
Politics shapes Politics shapes bank regulatory bank regulatory choices and the choices and the effects of those effects of those choices.choices.
BCL, 2006BCL, 2006
What does this actually mean for policy?What does this actually mean for policy?
Capital regulations, entry restrictions, activity Capital regulations, entry restrictions, activity restrictions, deposit insurance, government ownership, restrictions, deposit insurance, government ownership, etc.etc. Needed to overcome market failures … Needed to overcome market failures … predictionspredictions.. In some political systems, protects elite … In some political systems, protects elite … predictionspredictions..
Strong official supervisory oversightStrong official supervisory oversight Needed to overcome market failures …. Needed to overcome market failures …. predictionspredictions.. In some political systems, protects elite … In some political systems, protects elite … predictionspredictions..
Private monitoring, transparency, market disciplinePrivate monitoring, transparency, market discipline Insufficient to overcome market failures … Insufficient to overcome market failures … predictionspredictions.. Reduces discretion of elite … Reduces discretion of elite … predictionspredictions..
Results: What Works Best?Results: What Works Best?
“ “Works” Works” Bank developmentBank development EfficiencyEfficiency StabilityStability Corruption in lendingCorruption in lending
Results:Results:Measuring regulationMeasuring regulation
““Every rule” vs. “Broad index”?Every rule” vs. “Broad index”?
Countries choose strategies! Countries choose strategies! Not a smorgasbord of rulesNot a smorgasbord of rules So, we use broad indexesSo, we use broad indexes
CorrelationsCorrelationsEntry
Applications Denied
Capital Regulatory
Index
Activities Restrictions
Private Monitoring
Index
Moral Hazard Index
Official Supervisory
Power
Limitations on Foreign Bank
Entry/Ownership
Capital Regulatory Index -0.49*** 1
Activities Restrictions 0.27 -0.20 1
Private Monitoring Index -0.55*** 0.24** 0.22* 1
Moral Hazard Index -0.17 0.32** -0.18 0.18 1
Official Supervisory Power 0.12 -0.07 -0.05 -0.11 -0.02 1
Limitations on Foreign Bank Entry/Ownership
0.30*** -0.06 -0.01 -0.23** -0.18 0.08 1
Government Owned Banks 0.40*** -0.20 -0.03 -0.39*** -0.03 -0.01 0.28**
Govt ownership more entry restrictions & less reliance on private sector
No simple tradeoffs with generous deposit insurance
Private monitoring associated with fewer regulatory restrictions on entry / competition
Bank developmentBank development
s = Supervisory/regulatory indicatorss = Supervisory/regulatory indicators
X = Exogenous determinants of Bank Development, identified X = Exogenous determinants of Bank Development, identified by existing research (legal origin, ethnic diversity, settler by existing research (legal origin, ethnic diversity, settler mortality, etc.)mortality, etc.)
Z = Instrumental variables for the bank supervision and Z = Instrumental variables for the bank supervision and regulation variables (religious orientation, endowments, regulation variables (religious orientation, endowments, latitude)latitude)
u and u and are error terms are error terms , , , , , and , and are the estimated parameters are the estimated parameters
Bank Development = Bank Development = + + s + s + X + uX + u s = s = Z + Z +
Private monitoring boosts bank developmentPrivate monitoring boosts bank development
Official supervisory power lowers bank Official supervisory power lowers bank developmentdevelopment
Some findings:Some findings:
Bank efficiencyBank efficiency Interest marginsInterest margins Overhead costsOverhead costs
-1 -2 -3 -4 -5 -6
O verhead Costs
O verhead Costs
O verhead Costs
O verhead Costs
O verhead Costs
O verhead Costs
O fficial Power -0.121 -0.203 -0.148 -0.151 -0.084 -0.123
Private Monitoring -0.713*** -0.743*** -0.631*** -0.744*** -0.576*** -0.642***
Activity Restrictions 0.154 -0.187 -0.006 0.473 0.207 0.539
GDP Growth -0.166** -0.131 -0.162** -0.215** -0.16** -0.248*
Political Violence -0.591** -0.933**
Political Voice -0.281 0.108
Corruption -0.03 0.338
Government Banks 0.553 -0.36
banks 1383 1376 1383 1214 1208 1063
countries 70 67 70 48 62 42
Results on Bank Efficiency (overhead costs or interest margin)
Also includes bank-level variables: Market share, total assets, liquidity, bank equity, etc.
Some findings: StabilitySome findings: Stability
Past work shows:Past work shows: Increases in deposit insurance Increases in deposit insurance
generositygenerosity Increase moral hazardIncrease moral hazard
Increases fragilityIncreases fragility
But, do supervision and regulation But, do supervision and regulation help?help?
NO!: Moral hazard mitigated by broad NO!: Moral hazard mitigated by broad institutions, NOT standard regulationsinstitutions, NOT standard regulations
Constant -0.314 -1.409 1.760 -0.308 -0.094
Restrictions on Bank Activities 0.647 1.880** 0.735 0.656 0.627
Entry into Banking Requirements 0.125 0.398 0.249 0.127 0.164
Capital Regulatory Index -1.035* -1.268 -1.075** -1.026** -1.201*
Official Supervisory Index -0.243 -1.190 -0.222 -0.246 -0.241
Government-Owned Banks 2.846 9.477 3.963 2.761 2.869
Inflation 0.031 0.025 0.023 0.031 0.030
Moral Hazard Index 0.719** 1.442** 2.132** 0.716**** 0.769**
Moral Hazard Index*Political Openness -0.513**
Political Openness 0.762
Moral Hazard Index*Rule of Law -0.288**
Rule of Law -0.295
Moral Hazard Index*Official Supervisory Power -0.031Moral Hazard Index*Capital Regulatory Index -0.131
N 43 40 41 43 43
Results: so far …Results: so far …
Inconsistent with …Inconsistent with … Laissez-faireLaissez-faire Angelic regulatorsAngelic regulators
Consistent with …Consistent with … Private interest viewPrivate interest view Market disciplineMarket discipline
But, corruption?But, corruption?
Some more findings: Some more findings: Corruption in lendingCorruption in lending
Corruption ObstacleCorruption Obstaclei,ki,k = a[F = a[Fi,ki,k] + b[C] + b[Cii] + c[S] + c[Sii] + u] + ui,ki,k
FFi,ki,k: Firm-specific traits : Firm-specific traits
CCii: Country-specific traits: Country-specific traits
SSii: Supervision/Regulatory indicators: Supervision/Regulatory indicators Official supervisory powerOfficial supervisory power Private monitoringPrivate monitoring
4812 firms across 49 developed and developing countries4812 firms across 49 developed and developing countries
Some findings: corruption in lendingSome findings: corruption in lending
Inflation 1.023 1.477*** 1.52* 1.67**
Growth 0.035 0.183 0.222 0.276*
Priv -6.17 -7.628 -4.999 -2.896
Supervisory Power 0.165** 0.151*** 0.155***
Private Monitoring -0.386*** -0.368*** -0.347***
General Financing Obstacle 0.298***
Observations 2510 2510 2510 2510
More Controls ...More Controls ...
Supervisory Power 0.132** 0.146*** 0.143** 0.187*** 0.149** 0.17*** 0.182*** 0.093
Private Monitoring -0.297* -0.337*** -0.422*** -0.366** -0.512*** -0.37** -0.23* -0.292***
GDP per capita -0.113
Banking Freedom -0.145
State ownership 0.407
Banking crisis 0.078
Creditor rights -0.019
Shareholder rights -0.164***
Political Voice -0.453***
Corruption -0.277***
Observations 2510 2510 2340 2010 1925 1985 2510 2510
Some findings: Political institutionsSome findings: Political institutions
Why don’t countries Why don’t countries choose good choose good regulations?regulations? Good for whom?Good for whom? Politics matters!Politics matters!
Political differences explain sup. & reg.Political differences explain sup. & reg.(This table summarizes the results from 20 regressions.)(This table summarizes the results from 20 regressions.)
Private Monitoring
Entry Applications
Denied
Official Supervisory
Power
Activity Restrictions
Government Owned Banks
Executive Constraints
0.38*** -0.126*** -0.14 -0.468*** -0.055**
Executive Openness
0.78*** -0.23** -0.156 -0.98*** -0.108*
Executive Competition
0.84*** -0.264*** -0.189 -1.057*** -0.123**
Voice & Accountability
0.661*** -0.206*** -0.358* -0.827*** -0.093**
This holds when using instrumental variables for the political system (e.g., initial political system, religious differences, endowments, independence, legal origin. Or when including these instruments directly in the regression
How Do Countries Choose?How Do Countries Choose?
Open, competitive, democratic Open, competitive, democratic institutions:institutions:
Foster private monitoring, transparency.Foster private monitoring, transparency. Less likely to limit bank entry, activities.Less likely to limit bank entry, activities. Less likely to have state banks.Less likely to have state banks.
Closed, uncompetitive, autocratic Closed, uncompetitive, autocratic institutions:institutions:
Do NOT favor transparency (surprise!).Do NOT favor transparency (surprise!). Limit bank entry, activities.Limit bank entry, activities. Tend to have state banks.Tend to have state banks.
Findings so far ...Findings so far ...
Until angels govern …Until angels govern … Avoid relying only on official oversight, restrictions, etc. Avoid relying only on official oversight, restrictions, etc. Emphasize private monitoring / incentivesEmphasize private monitoring / incentives Stress Basel II’s 3Stress Basel II’s 3rdrd pillar pillar
Supervisors have crucial roleSupervisors have crucial role Support market discipline, not supplant itSupport market discipline, not supplant it Foster / force information disclosureFoster / force information disclosure
““Best practices” depend on political system.Best practices” depend on political system.
2. Analytical Weaknesses2. Analytical Weaknesses
But, confirmatory evidenceBut, confirmatory evidence
Weaknesses, but ...Weaknesses, but ...
LimitationsLimitations1.1. Survey errorsSurvey errors
2.2. ImplementatioImplementationn
3.3. Cross-country Cross-country shortcomingsshortcomings
ResponseResponse1.1. Survey errorsSurvey errors
Errors, but bias? Errors, but bias? Do better surveys!Do better surveys!
2.2. ImplementationImplementation Recent FSAP workRecent FSAP work Do better surveys!Do better surveys!
3.3. Cross-country Cross-country shortcomingsshortcomings But, case-studiesBut, case-studies
Where is the countervailing evidence??Where is the countervailing evidence??
3. A plea ...3. A plea ...
For Epistemological For Epistemological modestymodesty Surveys have Surveys have
problemsproblems Regressions have Regressions have
problemsproblems Case studies have Case studies have
problemsproblems Expert guidelines Expert guidelines
have problemshave problems
Against Faith-based Against Faith-based policy advisingpolicy advising These policies are These policies are
very importantvery important For growthFor growth For poverty For poverty
alleviationalleviation For equality of For equality of
opportunityopportunity Need to assess Need to assess
competing views competing views systematicallysystematically