Transcript Re-Rethinking Bank Regulation F. Montes-Negret Director, ECSPF October, 2007 Dubious Policy Conclusion & Data “Across the different statistical approaches, we find that empowering direct official supervision.

Re-Rethinking Bank
Regulation
F. Montes-Negret
Director, ECSPF
October, 2007
Dubious Policy Conclusion & Data
“Across the different statistical approaches, we find that
empowering direct official supervision of banks and
strengthening capital standards do not boost bank
development, improve bank efficiency, reduce corruption
in lending, or lower banking system fragility. Indeed, the
evidence suggests that fortifying official supervisory
oversight and disciplinary powers actually impedes the
efficient operation of banks, increases corruption in
lending, and therefore hurts the effectiveness of capital
allocation without any corresponding improvement in
bank stability” (p.12).
 Yes, supervision is deficient and yes, there is no “silver
bullet”, but abolishing the “police force” can be extremely
costly!. Bankers driven by balance between greed & fear
(of loss) and by supervisors constraints on behavior!!.
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A Policy Recommendation Nobody Can Disagree
With
- “In contrast to these findings on capital
regulations and direct supervisory oversight of
banks, bank supervisory and regulatory policies
that facilitate private sector monitoring of banks
improve bank operations, which endorses
Basel’s II third pillar”.
But how do we get there?
Which are the pre-conditions to make it work?
Who provides the market discipline and how?
Do you still trust the private rating agencies?
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Need for a more nuanced approach
 The first conclusion is entirely anchored in a model of
complete “regulatory capture” (private interest approach to
regulation), where the interests of the public are totally
subordinated to the different interests of industry and
corrupt politicians  the back-door privatization of the
State by the “oligarchs”.
– “ All politics is business in Russia today, and all
business is acutely political”, Quentin Peel, “Between the Lines”, FT.
– If all institutions fail, bank supervision also fails: Anything new or
surprising?. Failure of the State!.
 Need for a more nuanced approach;
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Need for a more nuanced approach
 No disagreement wit the second conclusion, but
most likely if the authors’ first conclusion holds, the
second one cannot be implemented!.  Captured
public sectors are often correlated with weak, also
captured private mechanisms to oversee banks!
(no independent press, etc..).
 Real dilemma is how to enhance the (internal)
check & balances (independent supervisors) and
(external) effective market discipline (absence of
moral hazard and preconditions for effective
market enforcement) .
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How does an Efficient & Effective Supervisory
System Look Like? *
 It must create financial stability and a dynamic and
competitive sector;
 The supervisory structure must be cost efficient;
 It must be competitively neutral (leveled playing field);
 It must be transparent;
 It must provide an effective crisis management framework;
 It must foster market integration and efficiency; and
 It must have political accountability;
 Asking too much?
* “Towards a new structure for EU financial supervision”, Deutsche Bank Research, August 22, 2007
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Four Very different Classes of Capitalism One
Common Element: Private Ownership*
 State-Guided Capitalism  Colbert & Picking
winners  public banks a problem;
 Oligarchic Capitalism  Privatizing the KGB.
Irrelevance of the “public interest”;
 Big Firm Capitalism  GM/GE runs the place;
 Entrepreneurial Capitalism  Schumpeterian
Competitive markets,
Impossibility of having an independent supervisory
function in the first three classes!
* Good Capitalism, Bad Capitalism and the economics of growth and prosperity, W. Baumol et. al., Yale, 2007.
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Is Pillar 3 only enough?
 While there has been successful cases of laissezfaire approaches to banking regulation (ex. the
Scottish free banking era), such approaches are
not feasible today.
 The terrifying counterfactual: abolishing the
police!.
 Need to accept the imperfections of regulations,
maybe limit its scope, but hard to agree with the
book’s conclusions: Abolish supervision and
believe Pillar 3 measures will solve all problems!
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A new regulatory model is emerging
 Meta-Regulation  Devolution of
responsibilities to Sr. bank Managers and
Boards of Directors, while regulators focus
on the adequacy of banks’ governance (
integrity of internal controls, avoidance of
conflicts of interests, accountability,
incentives, etc.) and enforcement.
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The Dangers of Excessive Empiricism
 Simple questions for complex topics not
advisable – Credibility of self assessments;
 Quality of data: Dubious?
 Comparability across countries?
 Methodology:
– Discrete questions: events versus processes;
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Concluding Remarks
Dangerous for the WB to give non-nuanced
and unqualified policy advice:
 “strengthen official supervision and
regulation” (traditional WB advice with
vague meaning) or
 “regulation and supervision are
counterproductive” (Caprio et. al.).
=> Crisis of the supervisory framework or
crisis of the State?
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No Easy Solutions
 Greed > Fear => bubbles, speculation, etc.
validated by lax M&F policies.
 Greed < Fear => recessions, risk-aversion,
higher unemployment, etc.
validated by tight M&F policies.
Difficulty of allocating losses to the “guilty
parties”.
Importance of institutional development,
good governance and disclosure.
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