Re-Rethinking Bank Regulation

1
Re-Rethinking Bank Regulation

• F. Montes-Negret
• Director, ECSPF
• October, 2007

2
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!!.

3
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
  Basels 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?

4
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

5
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) .

6
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

7
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.

8
Is Pillar 3 only enough?

• While there has been successful cases of
  laissez-faire 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
  books conclusions Abolish supervision and
  believe Pillar 3 measures will solve all
  problems!

9
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.

10
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

11
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.).
• gt Crisis of the supervisory framework or crisis
  of the State?

12
No Easy Solutions

• Greed gt Fear gt bubbles, speculation, etc.
  validated by lax MF policies.
• Greed lt Fear gt recessions, risk-aversion,
  higher unemployment, etc. validated by
  tight MF policies.
• Difficulty of allocating losses to the guilty
  parties.
• Importance of institutional development, good
  governance and disclosure.