Safe and Sound Banking: A Role for Countercyclical Regulatory Requirements?

Most explanations of the crisis of 2007-2009 emphasize the role of the preceding boom in real estate and asset markets in a variety of advanced countries. As a result, an idea that is gaining support among various groups is how to make Basel II or any regulatory regime less procyclical. This paper addresses the rationale for and likely contribution of such policies. Making provisioning (or capital) requirements countercyclical is one way potentially to address procyclicality, and accordingly it looks at the efforts of the authorities in Spain and Colombia, two countries in which countercyclical provisioning has been tried, to see what the track record has been. As explained there, these experiments have been at best too recent and limited to put much weight on them, but they are much less favorable for supporting this practice than is commonly admitted. The paper then addresses concerns and implementation issues with countercyclical capital or provisioning requirements, including why their impact might be expected to be limited, and concludes with recommendations for developing country officials who want to learn how to make their financial systems less exposed to crises.Financial crisis, Securitization, Regulation and Supervision, Safety Nets

Financial Regulation in a Changing World: Lessons from the Recent Crisis

The current crisis is leading many to re-think the role of finance and how it snew. This paper reviews what was regarded as the conventional wisdom on financial regulation prior to the 2007 onset of the crisis, briefly recounts some of the main factors behind the events of the 2007-09 years, and then turns to lessons for regulatory reform. At some point in the 1990s, the financial systems of high-income countries seemed to be functioning well and withstood some significant shocks, yet by 2007 much had changed. However, the regulatory structure did not change in response, and in fact eased in such a way as to exacerbate the instability that was subsequently experienced. A key theme is that financial regulation needs to be more dynamic, taking account of financial innovations and how they affect the sector. No such approach to regulation seems possible without greater accountability for regulators and attention to the incentives for those in the sector and for those who regulate it.Financial crisis, Securitization, Regulation and Supervision, Safety Nets

Financial Regulation in a Changing World: Lessons from the Recent Crisis

The current crisis is leading many to re-think the role of finance and how it snew. This paper reviews what was regarded as the conventional wisdom on financial regulation prior to the 2007 onset of the crisis, briefly recounts some of the main factors behind the events of the 2007-09 years, and then turns to lessons for regulatory reform. At some point in the 1990s, the financial systems of high-income countries seemed to be functioning well and withstood some significant shocks, yet by 2007 much had changed. However, the regulatory structure did not change in response, and in fact eased in such a way as to exacerbate the instability that was subsequently experienced. A key theme is that financial regulation needs to be more dynamic, taking account of financial innovations and how they affect the sector. No such approach to regulation seems possible without greater accountability for regulators and attention to the incentives for those in the sector and for those who regulate it.Financial crisis, Securitization, Regulation and Supervision, Safety Nets

Safe and sound banking in developing countries : we're not in Kansas anymore

Drawing on earlier work, the author reviews some of the salient facts about the boom in banking busts in developing countries. He then reviews policy responses taken by authorities in some of the"early"crisis countries, and considers a wider menu of responses -in particular the currently popular suggestion that promulgating an International Banking Standard would significantly improve the safety and soundness of banking systems in developing countries. Such a standard is not without appeal, but other approaches are probably necessary in developing countries where risks are usually greater, financial institutions are less diversified, markets are less transparent, supervision is weak, and other ingredients critical to sound banking are either missing or scarcer than in industrial countries. The author calls for a multi-pillar approach to safe and sound banking, one that would: (1) focus attention on factors that restrict banks'ability and willingness to diversify risk; and (2) Give three key groups -owners (and managers), the market (including uninsured debtholders and other possible co-owners), and supervisors- more incentive and ability to monitor banks and ensure their prudent corporate governance.Banks&Banking Reform,Labor Policies,Payment Systems&Infrastructure,Financial Crisis Management&Restructuring,Financial Intermediation,Banks&Banking Reform,Financial Crisis Management&Restructuring,Financial Intermediation,Economic Theory&Research,Settlement of Investment Disputes

Banking on crises : expensive lessons from recent financial crises

Caprio summarizes both basic and proximate factors behind financial crises, arguing that although a variety of factors contribute to the crises, the basic causes are information and incentive problems. Caprio develops a scoring system for the broad regulatory environment for a dozen Asian and Latin American financial systems in 1997. The Asian economies in crises score the lowest. Economies with the highest scores felt relatively little impact from the crises. This paper will address these issues. Section II will summarize briefly the voluminous literature on proximate and more distant causes of crises. Although both micro and macro factors are associated with crises, beyond lobbying for changes in the international financial system, national authorities are left with following sound macro policies, improving financial sector infrastructure, and upgrading regulation and supervision as mean of minimizing the likelihood and costs of financial crises. Is there a payoff to improving the regulatory framework? Tentative evidence presented in section III, which compares the broad regulatory environment in 12 selected Asian and Latin American countries, suggests that the answer is affirmative. This comparison both reveals how some countries have been progressing, and can help as a guide, indicating weak areas of regulation that should be a target for further improvement. Generally, those countries that have higher scores on their regulatory systemsappear to have weathered the latest crisis well, suggesting that improving the regulatory environment, broadly interpreted, should be a goal for countries that have not thus far made much headway in this area. A plausible hypothesis then is that authorities are learning -- at great cost - - from the last 2 decades of crises and are moving to raise the cost or otherwise tighten the safety net supporting the banking sector. Section IV concludes with unresolved issues and suggestions for future research.Financial Intermediation,Payment Systems&Infrastructure,Labor Policies,Banks&Banking Reform,Financial Crisis Management&Restructuring,Banks&Banking Reform,Financial Intermediation,Financial Crisis Management&Restructuring,Environmental Economics&Policies,Economic Theory&Research

Bank regulation : the case of the missing model

Financial reform of one type or another has been increasingly popular since the early 1970s, but disappointment with the fruits of reform has been common. Reformers in Africa and in transitional economies have been especially disappointed, perhaps because of their high expectations. Reform may also disappoint partly because of perverse sequencing. Often the more visible aspects of reform (such as complete deregulation of interest rates, recapitalization of banks, and more recently the creation of stock exchanges) are pursued before basic financial infrastructure (including auditing, accounting, and legal systems and basic regulations) are established. The author focuses here on regulatory options in banking. He argues that for reform to succeed and for financial systems to remain stable, there must be a regulatory framework that encourages prudent behavior and is attuned to both institutions and the structure of the economy. Bank failure may reflect poor management, but poor management in turn reflects regulation that is not"incentive compatible."The author reviews options that would align bankers'incentives with society's preferences for safe and sound banking. Adopting a framework that rewards prudent risk-taking will produce a more stable banking system. And because participants in the financial system - both individuals and organizations - take time to adjust to changes in incentives, it is important to begin reshaping the regulatory environment early in the reform process, at the same time as other measures are being taken to develop institutions.Payment Systems&Infrastructure,Banks&Banking Reform,Financial Intermediation,Financial Crisis Management&Restructuring,Environmental Economics&Policies,Banks&Banking Reform,Financial Intermediation,Financial Crisis Management&Restructuring,Environmental Economics&Policies,Insurance&Risk Mitigation

Safe and sound banking : a role for countercyclical regulatory requirements ?

Most explanations of the crisis of 2007-2009 emphasize the role of the preceding boom in real estate and asset markets in a variety of advanced countries. As a result, an idea that is gaining support among various groups is how to make Basel II or any regulatory regime less pro-cyclical. This paper addresses the rationale for and likely contribution of such policies. Making provisioning (or capital) requirements countercyclical is one way potentially to address pro-cyclicality, and accordingly it looks at the efforts of the authorities in Spain and Colombia, two countries in which countercyclical provisioning has been tried, to see what the track record has been. As explained there, these experiments have been at best too recent and limited to put much weight on them, but they are much less favorable for supporting this practice than is commonly admitted. The paper then addresses concerns and implementation issues with countercyclical capital or provisioning requirements, including why their impact might be expected to be limited, and concludes with recommendations for developing country officials who want to learn how to make their financial systems less exposed to crises.Banks&Banking Reform,Access to Finance,Financial Intermediation,Debt Markets,Emerging Markets

Can the unsophisticated market provide discipline?

The authors question the widespread belief that market discipline on banks cannot be effective in less developed financial environments. There is no systematic tendency for low-income countries to lack the prerequisites for market discipline. Offsetting factors to the weaker market and formal information infrastructures are (1) the less complex character of banking business in low-income countries; (2) the growing internationalization of these markets through the presence of foreign banks, and through international trading of the debt and equity of locally-controlled non-government banks; and (3) the smaller size of the business and financial community. However, continuing dominance by public sector banks in some countries limits the likely development of market monitoring, which is clearly a cause for concern, given the disappointing record of governments around the world as monitors of their self-owned banks. Countries should build on this potential for market discipline by limiting the role of explicit deposit guarantees, reducing state ownership of banks where it is prevalent, and not putting all their eggs in the supervisory basket. Greater disclosure, for example, of how risk taking is rewarded and how rating agencies earn their fees would support the development of better market monitoring. Enhancing market discipline (pillar three) is much more likely to be of use in most developing countries than addressing the refinements of the risk-weighting system of Basel II's first pillar.Banks&Banking Reform,Payment Systems&Infrastructure,Financial Intermediation,Financial Crisis Management&Restructuring,Environmental Economics&Policies,Banks&Banking Reform,Financial Intermediation,Environmental Economics&Policies,Financial Crisis Management&Restructuring,Insurance&Risk Mitigation

Banking Crises

The history of banking around the world has been punctuated by frequent systemic crises. As with Tolstoy's unhappy families, not all crises are the same; distinct roles have been played at different times by mismanagement, government interference and macroeconomic shocks. This review identifies common features of crises in recent decades and describes how costly they have been in terms of their fiscal burden and the impact on macroeconomic growth. It proceeds to outline the conceptual issues identified by theoreticians and considers appropriate policy responses. A lull in the new millennium led to optimism that banking crises might be a thing of the past, but the events of 2007-8 have shown such optimism, often characteristic of previous macro upswings, to be unwarranted.

Finance for Growth: Policy Choices in a Volatile World

Understanding just how finance contributes to development—and how good policy can help guarantee its contribution—has been the focus of a major research effort in recent years. This research has included systematic case-study analyses of the experiences of specific countries, as well as more recent econometric analyses of extensive cross-country data sets. Finance for Growth draws on this research and uses it to develop an integrated view of how financial sector policy can be used to foster growth, maintain stability and bring about poverty reduction.Financial sector development; financial regulation; globalization of finance; finance in developing countries