Transcript Do regulation and ownership affect bank performance and

How do regulation and
ownership affect banking
sector performance and
stability?
Budapest 2006
Introduction
Regulation environment of banking system
• capital requirements
• restrictions on bank activities:
• securities
• insurance
• real estate
• mixing banking and commerce:
• banks own non-financial firms
• bank entry
Ownership structure of banks
• government ownership
How does regulation affect
banking sector performance
and stability?
Capital Requirements
Positive views:
• serves as a buffer against losses and hence
failure (Dewatripont and Tirole, 1994)
• reduces incentives for banks to engage in higher
risk activities, especially generated by deposit
insurance (Berger, Herring, Szego, 1995)
Negative views:
• may cause bank to reduce its lending (Brealey, 2001)
• may encourage banks to take more credit risk (Kim
and Santomero, 1988; Blum 1999)
What is Basel Accord?
Basel Accord I - In 1988 the Basel Committee of
Banking Supervision in Basel, Switzerland published
a set of minimal capital requirements for
internationally active banks based on credit risk;
updated in 1996 to cover market risk
Basel Accord II - was issued by BCBS in 2004;
addressed shortcomings in the treatment of credit
risk and incorporated operational risk. It is based on
three pillars:
• minimum capital requirements
• supervisory review practices
• market discipline
Capital adequacy ratios
MinTier 1 =
Tier 1 capital
credit risk +market risk +operational risk
MinCapital =
 4%
Total Capital
credit risk +market risk +operational risk
 8%
Tier I capital > Tier II capital,
where
Tier I capital - shareholders’ equity and disclosed reserves
Tier II capital - undisclosed reserves and subordinated term debt
instruments
Total capital = Tier I capital + Tier II capital
credit risk = sum of risk-weighted asset values
market risk = VaR/8%
VaR - category that describes probabilistically the market risk
Deficiencies in Basel Accord II
• ignore the degree to which the bank portfolio is
diversified
• unlikely to incorporate differences in loan maturity or to
provide solution to better quantified measures of risk
and economic capital
• no consideration of the probability and cost of bank
failures and their impact on the system as a whole
Does regulation of capital
adequacy actually achieve
its desired result?
Finding: the relationship between
stringency of regulation of capital ratios
and bank development, performance and
stability is weak, but still positive
* Imposition of capital standards have not
prevented banking crises
Why to regulate bank activities and
mixing banking and commerce?
• conflict of interests arise when banks
engage in non-traditional activities (John, John
and Saunders, 1994; Saunders, 1985)
• may provide more opportunities for risky
behavior( Boyd, Chang, Smith 1998)
• complex banks are difficult to monitor
• financial conglomerates may reduce
efficiency and competition
Why not to regulate bank activities
and mixing banking and
commerce?
• enables banks to exploit economies of scale and
creates more diversified, hence more stable banks
(Claessens and Klingebiel, 2000)
• increases the franchise value of banks and thus
incentives to behave prudently  creates more
stability
• enables banks to adapt and hence provide more
efficiently the changing financial services
Country data on bank regulation
Argentina
Australia
Austria
Belgium
Brazil
Canada
Chile
Denmark
Egypt
France
Germany
Greece
India
2.50
2.00
1.25
2.50
2.50
2.25
2.75
1.75
2.50
2.00
1.75
2.25
3.00
Indonesia
Israel
3.50
1.00
Italy
Japan
2.25
3.25
Mexico
3.25
Republic of Korea
Spain
Sweden
Switzerland
turkey
United Kingdom
2.25
1.75
3.00
1.50
3.00
1.25
United States
3.00
* index equals the average of the four indicators (1-4) of the regulatory
restrictions imposed on banks, specifically on securities, insurance, real estate
and banks owning non financial firms
The empirical evidence:
Restrictions on non-traditional activities of
banks and mixing banking and commerce
are:
• negatively associated with bank
development
• positively with greater financial fragility
and a likelihood of crises
Regulation on bank entry
Theoretical views:
positive:
• effective regulation of bank entry can promote stability
• banks with monopolistic power possess greater franchise
value, which enhances prudent risk behavior (Keeley, 1990)
negative:
• competition is beneficial because it eliminates inefficient
banks (Shleifer, Vishny, 1998)
Finding: restrictions on bank entry are associated with
greater bank fragility
How does ownership affect
banking sector performance
and stability?
Average equity of top 10 banks
owned by the government, %
Types of laws
Common
French
German
Scandinavian
Socialist
Average
1970
34.53
65.37
43.59
43.44
100
59
1995
28.16
45.45
33.67
25.54
61.76
42
Views of government ownership
of banks
• Development - projects financed by the
government are socially desirable. It encourages
development of the institution of lending
(Gerschenkron, 1962)
• Political - projects are not necessarily socially
efficient, but politically desirable. It politicizes
resource allocation and thus slows down financial
development (Shleifer, Vishny, 1994)
Empirical Evidence:
The empirical evidence is consistent with political
view:
• government ownership of banks reduces
efficiency and subsequent development of
banking sector
• is associated with greater financial instability
Conclusion:
Both the practice and empirical findings show that:
• countries with greater regulatory restrictions have
less developed, less efficient banking systems and
higher probability of banking crises
• countries with greater government ownership have
less developed, less efficient and more unstable
banking systems
Thank you!