Rethinking Bank Regulation: Till Angels Govern James Barth Gerard Caprio Ross Levine.
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Transcript of Rethinking Bank Regulation: Till Angels Govern James Barth Gerard Caprio Ross Levine.
Rethinking Bank Regulation: Rethinking Bank Regulation: Till Angels GovernTill Angels Govern
James BarthJames Barth
Gerard CaprioGerard Caprio
Ross LevineRoss Levine
““Narrow” MotivationNarrow” Motivation
Banks matterBanks matter– Growth, Income Distribution, & Poverty AlleviationGrowth, Income Distribution, & Poverty Alleviation– Crises ($1 trillion in DCs), which hurt poorCrises ($1 trillion in DCs), which hurt poor
BIS / IMF / WB matter BIS / IMF / WB matter best practice recommendations best practice recommendations– ““If countries adopt sound policies …”If countries adopt sound policies …”– Apply “checklist” of best practices around the worldApply “checklist” of best practices around the world– An FSAPAn FSAP
Is there any support for these recommendations? Is there any support for these recommendations?
““Broader” MotivationsBroader” Motivations
Epic debates about the role of governmentEpic debates about the role of government– Public interest view vs. Private interest viewPublic interest view vs. Private interest view
Why countries choose different policies?Why countries choose different policies?– If political institutions matter, then this should change If political institutions matter, then this should change
the approach to reformthe approach to reform
Bank regulation seems like a boring, technical subfield of finance, But …
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, Number 51
Our Contributions:Our Contributions:
Collect Collect new datanew data and assess … and assess …
Which Regulatory Policies Works Best?Which Regulatory Policies Works Best?
Public vs. Private Interest Theories?Public vs. Private Interest Theories?
Do Political Institutions Shape Regulations?Do Political Institutions Shape Regulations?
Debate about government’s roleDebate about government’s rolePublic interest viewPublic interest view
Gov’t maximizes social welfareGov’t maximizes social welfare
Gov’t has incentives / ability to Gov’t has incentives / ability to ameliorate market failuresameliorate market failures
If we identify “best practices,” If we identify “best practices,” countries will change.countries will change.
Private interest viewPrivate interest view
Gov’t maximizes Gov’t welfareGov’t maximizes Gov’t welfare
Gov’t does not necessarily have Gov’t does not necessarily have incentives / ability to fix failuresincentives / ability to fix failures
Need more than “best practices”:Need more than “best practices”:
Laissez-Faire : Market failures minor no need for government
Private vs. Public interest: Different predictionsPrivate vs. Public interest: Different predictions
Entry restrictions, bank activity restrictions, etc.Entry restrictions, bank activity restrictions, etc.– Needed to overcome market failures … Needed to overcome market failures … predictionspredictions..– Used to protect elite … Used to protect elite … predictionspredictions..
Strong official supervisory oversight and state-owned banksStrong official supervisory oversight and state-owned banks– Needed to overcome market failures …. Needed to overcome market failures …. predictionspredictions..– Used to protect elite … Used to protect elite … predictionspredictions..
Private monitoringPrivate monitoring– Insufficient to overcome market failures … Insufficient to overcome market failures … predictionspredictions..– Necessary to protect against control by elite … Necessary to protect against control by elite … predictionspredictions..
Aside: Debate about BaselAside: Debate about Basel
Basel II assumes public interest Basel II assumes public interest incentives and focuses on ...incentives and focuses on ...
1.1.Capital Capital
2.2.Official Supervisory OversightOfficial Supervisory Oversight3.3. Market DisciplineMarket Discipline
Thus, our work provides the first cross-country Thus, our work provides the first cross-country evaluation of the validity of the Basel approach and its evaluation of the validity of the Basel approach and its specific recommendationsspecific recommendations
Institutional EnvironmentDemocratic, Political Structure/System
Technology, Information Infrastructure
Judi
cial
, Leg
al,
Reg
ulat
ory
Env
iron
men
tM
arket Structure
Media
The Market:Depositors,creditors,
rating agencies
Politicians
Regulators andsupervisors
Borrowers, counterparties
Corruption
corruption Banks
The Public
corruption
DataData
There are 150 pages of data There are 150 pages of data description in the book!description in the book!
DataData
Structure, scope, Structure, scope, independence of independence of regulatory agencyregulatory agencyBank activitiesBank activitiesEntry requirementsEntry requirementsCapital requirementsCapital requirementsSupervisory powersSupervisory powers
Deposit insuranceDeposit insurance
Private monitoringPrivate monitoring
External governanceExternal governance
OwnershipOwnership
Data are online.
Regulatory restrictions on activitiesRegulatory restrictions on activities
36
13 11
31
40
4220
34
33
18
21
26
46
3231
41
7
97 4
0
20
40
60
80
100
Securities Insurance Real estate Bank ownership of nonfinancial
firms
Nonfinancial firm
ownership of banks
PercentUnrestricted Permitted Restricted Prohibited
Entry Entry
ForeignForeign1.1. limitations on foreign entry/ownershiplimitations on foreign entry/ownership
2.2. % of entry applications denied% of entry applications denied
DomesticDomestic1.1. summary indicator of rules to obtain a licensesummary indicator of rules to obtain a license
1.1. draft by-laws, organizational chart, financial projections, draft by-laws, organizational chart, financial projections, financial background information on major owners, financial background information on major owners, background of directors/managers, sources of capital, etc.background of directors/managers, sources of capital, etc.
2.2. % of entry applications denied% of entry applications denied
Official supervisionOfficial supervision
Supervisory powerSupervisory power– Power to take legal action against auditors, director, Power to take legal action against auditors, director,
officersofficers– Force bank to provision, change organizational structureForce bank to provision, change organizational structure– Power to suspend dividends, bonuses, management feesPower to suspend dividends, bonuses, management fees– Legal power to declare insolventLegal power to declare insolvent– Power to supercede shareholder rights, remove/replace Power to supercede shareholder rights, remove/replace
managers, directorsmanagers, directors
Private monitoringPrivate monitoring
Certified audit requiredCertified audit required
Percent of 10 biggest banks rated by Percent of 10 biggest banks rated by international rating agenciesinternational rating agencies
Accounting disclosure and liabilityAccounting disclosure and liability– accrued but unpaid interestaccrued but unpaid interest– consolidated statements consolidated statements – liability of directorsliability of directors
No deposit insuranceNo deposit insurance
! Private monitoring ≠ Laissez-Faire
Private monitoring involves “strong” supervision
Government-owned BanksGovernment-owned Banks
Percentage of banking system assets Percentage of banking system assets held by banks that are 50% or more held by banks that are 50% or more owned by the government.owned by the government.
Correlations (ignores within category corr’s!)Correlations (ignores within category corr’s!)Entry
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**
Gov’t ownership more entry restrictions & less reliance on private sector
Few tradeoffs with generous deposit insurance
Private monitoring associated with fewer regulatory restrictions on entry / competition
What Works Best?What Works Best?What “works”What “works”
– Bank development (country-level)Bank development (country-level)– Efficiency (bank-level data)Efficiency (bank-level data)
Net interest marginsNet interest margins Overhead costsOverhead costs
– Integrity (firm-level data)Integrity (firm-level data)– Stability (country-level data)Stability (country-level data)
Systemic crisesSystemic crises Non-performing loansNon-performing loans
– Bank governance: Market valuations (bank-level)Bank governance: Market valuations (bank-level)
Results on Bank DevelopmentResults on Bank Development
Basel IIBasel II– Capital requirements: ?Capital requirements: ?– Official supervisory power: hurtsOfficial supervisory power: hurts
But, not if high level of democracy (“top 10”)But, not if high level of democracy (“top 10”)– Private monitoring: helpsPrivate monitoring: helps
SOBs are bad. SOBs are bad.
Entry & Activity Restrictions: hurtEntry & Activity Restrictions: hurt
These results are more consistent with private rather than a public interest view
-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 (Confirmed using Net Interest Margin)
Also includes bank-level variables: Market share, total assets, liquidity, bank equity, etc.
Economic SizeEconomic Size
If Mexico had Private Monitoring as the U.S. If Mexico had Private Monitoring as the U.S. (0.97 instead of –0.43) …(0.97 instead of –0.43) …
This would reduce the average Overhead Costs This would reduce the average Overhead Costs of Mexican banks from 6 to about 5. of Mexican banks from 6 to about 5.
This would reduce the difference between This would reduce the difference between Mexico & U.S., where Overhead Costs average Mexico & U.S., where Overhead Costs average a little over 3.a little over 3.
-1 -2 -3 -4 -5 -6 -7 -8
Bank Corruption
Bank Corruption
Bank Corruption
Bank Corruption
Bank Corruption
Bank Corruption
Bank Corruption
Bank Corruption
O fficial Power
0.144*** 0.131*** 0.161*** 0.076*** 0.172*** 0.143*** 0.117*** 0.144***
Private Monitoring
-0.271*** -0.231*** -0.106** -0.174*** -0.298*** -0.232*** -0.136*** -0.295***
GDP Growth
-12.052*** -8.183*** -0.582 -4.153** -13.104*** -9.854*** -5.402** -4.181*
Political Violence
-0.137** 0.674*** 0.632***
Political Voice
-0.403*** -0.674*** -0.735***
Corruption -0.245*** -0.165*** -0.179***
Gov't Banks
0.226* 0.32** 0.499***
Firm O bstacles
0.262*** 0.23*** 0.225***
GDP per Capita
0.16***
firms 2259 2259 2259 2259 2124 2259 2124 2124
countries 33 33 33 33 31 33 31 31
Results on Corruption in Lending
Controls for firm level traits: foreign, exporter, government, manufacturing, services, sales, & competitors
SummarySummary
Bank Development
EfficiencyStability/Loan
QualityLending Integrity
Capital Regulation +Supervisory Power - - (*) - - -Private Monitoring ++ ++ ++Activity Restrictions - - - - / - -Entry Restrictions - - -Government Banks - - - - -
Basel II: Remember Pillar III Private vs. Public interest: Private vs. Public interest: Suggests wariness of relying Suggests wariness of relying on official interventionon official intervention
Choosing policiesChoosing policies
Q1: Why do some countries choose policies that foster sound Q1: Why do some countries choose policies that foster sound banking, while others choose policies that encourage banking, while others choose policies that encourage
inefficiencies and corruption? inefficiencies and corruption?
Q2: What does the answer imply about the usefulness of Q2: What does the answer imply about the usefulness of identifying what works best?identifying what works best?
An example from Stephen HaberAn example from Stephen Haber
Mexico-Diaz (1876)Mexico-Diaz (1876)– Porfirio Diaz consolidates powerPorfirio Diaz consolidates power– Loans Loans Bank Charter Bank Charter– 2 banks / They write regulations!2 banks / They write regulations!– Directors of Banamex: Directors of Banamex:
President of Congress, Under-President of Congress, Under-Secretary of the Treasury, Senator Secretary of the Treasury, Senator for the Federal District, President’s for the Federal District, President’s Chief of Staff, brother of the Chief of Staff, brother of the Secretary of the TreasurySecretary of the Treasury, etc., etc.
ALL loans ALL loans directors directors
– Self-reinforcing – durable Self-reinforcing – durable
U.S. States post 1789U.S. States post 1789– States short of revenuesStates short of revenues– Loans Loans Bank Charter Bank Charter– Links: federalists-banks!Links: federalists-banks!– But:But:
Political competitionPolitical competition– PhiladelphiaPhiladelphia– NYNY– JeffersonJefferson
Competition for peopleCompetition for people– SuffrageSuffrage– Free bankingFree banking
Political system mattered for bank regulation
Social conflict view: PredictionsSocial conflict view: Predictions
Regimes that are uncompetitive with unconstrained executivesRegimes that are uncompetitive with unconstrained executives: : – Avoid: transparency and private monitoring, state banksAvoid: transparency and private monitoring, state banks– Construct: barriers to entry & perhaps restrictions on Construct: barriers to entry & perhaps restrictions on
activitiesactivities– ?: official supervisory power?: official supervisory power
Regimes that are competitive, democratic, constrained Regimes that are competitive, democratic, constrained executivesexecutives: : – Construct: transparency and private monitoringConstruct: transparency and private monitoring– Avoid: barriers to entry / restrictions on activities, state Avoid: barriers to entry / restrictions on activities, state
banksbanks– ?: official supervisory power?: official supervisory power
Alternative viewAlternative view
Govts maximize social welfare, but Govts maximize social welfare, but
– … … have limited informationhave limited information
– … … make and inherit mistakes / accidentsmake and inherit mistakes / accidents
So, “ what works best” So, “ what works best” reform reform social welfare. social welfare.
But, Argentina believes this optimism:But, Argentina believes this optimism:
“The Argentines alter their currency almost as frequently as they change presidents”
British Observer, 1899 !!
5. Political differences explain sup. & reg.5. 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). Control for legal origin. Or, simply run reduced form.
How Do Countries Choose?How Do Countries Choose?
Key results Key results – Open, competitive, democratic political institutions:Open, competitive, democratic political 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 political systems:Closed, uncompetitive, autocratic political systems:
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.
Qualified ConclusionsQualified ConclusionsUntil angels govern, need to rethink to bank regulation …Until angels govern, need to rethink to bank regulation …– Basel II is likely to be ineffective and may be harmfulBasel II is likely to be ineffective and may be harmful– Avoid relying excessively on official oversight, restrictions, & ownershipAvoid relying excessively on official oversight, restrictions, & ownership– Emphasize private monitoring / incentives (deposit insurance)Emphasize private monitoring / incentives (deposit insurance)
Confirmation of the private interest theory of regulation. No Confirmation of the private interest theory of regulation. No support for the public interest viewsupport for the public interest view
Political institutions influence bank regulatory choicesPolitical institutions influence bank regulatory choices– Reform will require customization: F{ political institutions }Reform will require customization: F{ political institutions }– Standardized “best practice” recommendations are unlikely to foster Standardized “best practice” recommendations are unlikely to foster
socially efficient reform.socially efficient reform.