Bank Regulation Is Changing: But for Better or Worse?

1. Bank Regulation Is Changing: But for Better or Worse? Gerard Caprio Williams College

2. 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

3. Institutional EnvironmentDemocratic, Political Structure/System The Public Politicians Corruption Judicial, Legal, Regulatory Environment Market Structure Media corruption Regulators andsupervisors Banks The Market:Depositors,creditors,rating agencies corruption Borrowers, counterparties Technology, Information Infrastructure A Framework for Bank Regulation

4. Public interest view Gov’t maximizes social welfare Gov’t has incentives / ability to ameliorate market failures If we identify “best practices,” countries will change. Private interest view Gov’t maximizes Gov’t welfare; so do regulatees Gov’t does not necessarily have incentives / ability to fix failures Need more than “best practices”: Combination of incentives for regulators and regulatees will not maximize social welfare 2. Debate about government’s role Laissez-Faire : Market failures minor no need for government

5. 3. Collecting the data... • 3 Surveys • 1st: 1998-99-2000 • 107 countries • 175 questions • 2nd: 2003 • 152 countries • 275 questions • 3rd: 2006 • 142 countries • 300+ questions

6. Sudan 14% Bank Assets/GDP Mexico 28% Russia 34% Argentina 45% United States 64% Singapore 117% Japan 159% Germany 361% Vanuatu 14,342% Size of Banking Systems Differs Widely Median=68%

7. Ratio of Bank Assets to GDP 64% 361% 14%

8. Government-Owned Banks

9. Government Ownership of Banks Differs Widely Median = 5%

10. Government-Owned Bank’s Share of Total Bank Assets 78 Percent 68 Percent

11. Foreign Ownership of Banks Differ Widely Median = 39%

12. Foreign-Owned Banks’ Share of Total Bank Assets 98 Percent 11 Percent

13. Structure, scope, independence of regulation and supervision Bank activities Entry requirements Capital requirements Deposit Insurance Supervisory powers Private monitoring External governance Ownership characteristics Grouping and Aggregating Data to Assess What Works Best All the data is online in the hopes of lowering the entry barriers to conducting better research.

14. How Many Bank Supervisory Authorities Do Countries Have?

15. Is the Central Bank a Supervisory Authority?

16. Who Funds Supervision in Countries?

17. What Is a Bank?Regulatory Restrictions on Activities Unrestricted Permitted Restricted Prohibited Percent 100 4 7 9 31 18 80 32 41 46 60 21 40 33 26 40 42 34 20 20 36 31 13 11 7 0 Securities Insurance Real estate Bank ownership of nonfinancial firms Nonfinancial firm ownership of banks

18. Entry • Foreign • limitations on foreign entry/ownership • % of entry applications denied (foreign & domestic) • Domestic • summary indicator of rules to obtain a license • draft by-laws, organizational chart, financial projections, financial background information on major owners, background of directors/managers, sources of capital, etc.

19. Capital • Summary measure of initial and general capital stringency • Basel C/A • Capital varies with market risk • loan securities, FX losses deducted from capital • initial capital only with cash and government securities • borrowed funds for initial capital • verify capital sources

20. Are Countries Planning on Adopting Basel II?

21. Which Approach Do Countries Plan to Adopt? Standardized Approach Advanced IRB Approach Foundation IRB Approach

22. Deposit Insurance Generosity • Explicit • Level of coverage • Coinsurance • Coverage (e.g., FX, interbank deposits) • Funding (source; flat or risk based) • Management • Membership

23. Do Countries Have Explicit Deposit Insurance Schemes? Survey III 143 Countries Survey II 152 Countries Countries recently adopting deposit insurance: Armenia, Hong Kong, Malaysia, Moldova, Russia, Singapore, Tajikistan, Uruguay, and Zimbabwe

24. Percent of the Commercial Banking System’s Assets Funded by Deposits

25. Percent of the Commercial Banking System’s Assets Funded with Insured Deposits 62 countries with no assets funded with insured deposits Angola, Anguilla, Antigua and Barbuda, Australia, Belize, Benin, Bhutan, Bolivia, Botswana, British Virgin Islands, Burkina Faso, Burundi, Cameroon, Cayman Islands, Central African Republic, Chad, China, Congo, Cook Islands, Costa Rica, Cote d'Ivorie, Dominica, Dominican Republic, Equatorial Guinea, Ethiopia, Fiji, Gabon, Ghana, Grenada, Guernsey, Guinea Bissau, Guyana, Jersey, Kosovo, Kuwait, Kyrgyz Republic, Lesotho, Macau, China, Malawi, Maldives, Mali, Mauritius, Montserrat, Mozambique, New Zealand, Niger, Pakistan, Panama, Papua New Guinea, Senegal, Seychelles, South Africa, Sri Lanka, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, Syria, Thailand, Togo, Vanuatu

26. Official Supervision • Supervisory power • Power to take legal action against auditors, director, officers • Force bank to provision, change organizational structure • Power to suspend dividends, bonuses, management fees • Legal power to declare insolvency • Power to supercede shareholder rights, remove/replace managers, directors • Forbearance discretion • Loan classification and provisioning stringency • Diversification: domestically and abroad • Supervisory resources

27. What Powers Do Supervisors Possess?

28. What Powers Do Supervisors Possess?

29. Are Courts Supervisory Authorities Too?

30. 3. Private monitoring • Certified audit required • Percent of 10 biggest banks rated by international rating agencies • Accounting disclosure and liability • accrued but unpaid interest • consolidated statements • liability of directors • No deposit insurance Private monitoring ≠ Laissez-Faire Private monitoring involves supervision

31. Do Countries Require a Simple Leverage Ratio?

32. 4. What Works Best? What “works” Bank development Efficiency Integrity Stability Bank governance?

33. 4. Bank development Bank Development =  + s + X + u s = Z +  • s = Supervisory/regulatory indicators • X = Exogenous determinants of Bank Development, identified by existing research (legal origin, ethnic diversity, settler mortality, etc.) • Z = Instrumental variables for the bank supervision and regulation variables (religious orientation, endowments, latitude) • u and  are error terms • , , , and  are the estimated parameters

34. Private monitoring boosts bank development

35. Official supervisory power lowers bank development

36. 4. Summary Private vs. Public interest: Suggests wariness of relying on official intervention Basel II: Remember Pillar III

37. Changes in Restrictions on Banks

38. Impact of Changes in Restrictions

39. Changes in Entry Requirements

40. Impact of Entry Changes

41. Impact of ‘Improved’ Supervision

42. Impact of Private Monitoring

43. Impact of Diversification

44. 6. Qualified Conclusions • Until angels govern, the data suggest … • Avoid relying on official oversight, restrictions, & ownership • Emphasize private monitoring / incentives (deposit insurance) • Stress Basel II’s 3rd pillar (not capital and official oversight) • Supervisors have crucial role • Support market discipline, not supplant it • Foster / force information disclosure • Do not fax “best practices to countries! Empiricists / Researchers deserve a seat at the regulatory reform table

45. What to do? • Data say that capital and supervision do not work • Implications: • Emerging markets need to emphasize infrastructure first, with better information, incentives to use it • Look to why supervision has not been working (politics). • Focus on private sector incentives and diversify • State guarantees (deposit insurance) and/or state ownership reduces monitoring • Limits on activities are bad • Diversification (activities, portfolios) is essential • Foreign entry matters, esp. for small countries • Go slow on Basel II (wait for version II.x, or later) • Emphasize pillar 3…Till Angels Govern.

46. Our Limitations • Measurement • Errors, omissions, time-series in measuring supervision / regulation? • Impact of supervision on the ground (only have proxies) • Better aggregate indexes of approaches to supervision / regulation? • Solution: get better data • Gauging Government Role • Policies may work differently in different political / institutional regimes • Do we capture these nuances? • Solution: add case studies • Regulatory choices • Does X-C evidence add much? • Solution: add time series data

47. Our Limitations • Measurement • Errors, omissions, time-series in measuring supervision / regulation? • Impact of supervision on the ground (only have proxies) • Better aggregate indexes of approaches to supervision / regulation? • Solution: get better data • Gauging Government Role • Policies may work differently in different political / institutional regimes • Do we capture these nuances? • Solution: add case studies • Regulatory choices • Does X-C evidence add much? • Solution: add time series data

48. Percent of the Commercial Banking System’s Assets Denominated in Foreign Currency

49. Percent of the Commercial Banking System’s Liabilities Denominated in Foreign Currency

50. Percent of the Commercial Banking System’s Assets in Government Securities