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Weekly UpdatesINTRODUCTION
Is the bank-regulatory environment in countries improving and making financial systems more efficient and stable? A decade after the East Asian crisis and the ever-growing importance of developing-country-banking systems, the extent to which progress has been made in regulatory reform commands our attention for several reasons. Those concerned with the fragility of financial systems, whether from a social welfare or a narrower investor's perspective, want to know whether developing countries' financial systems are safer now than in the 1990s, or whether they merely appear safer as a result of the recent generous inflows of foreign capital. Furthermore, those formulating financial-sector policy recommendations including the World Bank (Bank) and the International Monetary Fund (IMF), want to know what to do next in improving the efficacy of financial systems, which presumably necessitates an understanding of what has been accomplished thus far. Indeed, in 1999 the Bank and the IMF started the Financial Sector Assessment Program to assess systematically the status of financial systems in countries and to make recommendations for reform, including in the area of bank regulation. As a result, Bank and Fund officials, among others, want to know the extent to which recommendations were adopted and whether the reforms were beneficial.
Many seem to know what has happened to bank-regulatory reforms in countries and have drawn optimistic conclusions about recent changes perhaps though with some rethinking taking place after the turbulence in credit markets that began in the summer 2007. After all, investors in recent years have been putting their money into emerging market economies at very narrow interest rate spreads. Also, Martin Wolf commented that '... there have been substantial structural improvements in Asian economies, notably in the capitalization and regulation of financial systems' (Financial Times, 23 May, 2007). Still others believe that bank regulation and supervision are now sufficiently effective to warrant more aggressive capital account liberalisation. For example, Ken Rogoff (2007) recently suggested that while IMF recommendations in the 1990s to liberalise more fully capital account transactions might have been premature, now is the time for the IMF, still searching for a new direction for itself, to resume this effort.
Yet, do we actually know what has happened to banking policies in recent years and is there any evidence regarding the consequences of the actions that have been taken? Have changes in the bank-regulatory environment enhanced the creditworthiness of developing countries? Is bank regulation so much better now that one should not expect crises to follow from greater capital account liberalisation? In addition to these important questions about the stability of financial systems, policy makers are also concerned about other features of their financial systems. Will the bank-regulatory framework prescribed by the Basel Committee on Bank Supervision increase access to financial services? Have changes in regulation contributed to financial-sector development and the allocation of capital by banks to those firms most likely to promote growth and reduce poverty? And what about the efficiency of banks, or their corporate governance, and corruption in the lending process itself? These questions regarding the recent changes in the regulatory environment and their effects represent a natural area of inquiry.
More than 10 years ago, a similar set of questions motivated us to start assembling the first cross-country database on bank regulation and supervision. Based on guidance from bank supervisors, financial economists, and our own experiences, we began putting together an extensive survey of bank regulation and supervision. (1) The original survey, Survey I, had 117 country respondents between 1998 and 2000. The first update in 2003, Survey II, characterised the regulatory situation at the end of 2002, and had 152 respondents. Survey III was posted at the Bank website in the summer of 2007 with responses from 142 countries. Survey III is special because barring a postponement in Europe on par with that in the United States; it represents the last look at the world before many countries formally begin implementing Basel II, the revised Capital Accord.
This paper is organised as follows. The next section very briefly reviews the structure of the survey and discusses some issues that arise in the responses to the three surveys. The subsequent section looks at the state of bank regulation around the world in 2006, and importantly how it has changed in the last 10 years. Then the further section turns to a first analysis of the data, asking whether the changes in bank regulation are contributing positively to financial-sector development (and thus we hope to the wider availability of financial services) and to the stability of banking systems around the world. Finally, the last section concludes with lessons for Basel II, and for countries that are grappling with a response to it.
Based on our empirical analysis of what works best in the bank regulation (BCL, 2006) and subsequent changes that have taken place since the late 1990s in the regulatory environment, we see no basis for the view that countries around the world have primarily reformed for the better. While many have followed the Basel guidelines and strengthened capital regulations and empowered supervisory agencies to a greater degree, existing evidence does not suggest that this will improve banking-system stability, enhance the efficiency of intermediation, or reduce corruption in lending. While some countries have reformed their regulations to empower private monitoring, consistent with the third pillar of Basel II, there are many exceptions and even reversals along this dimension. Moreover, many countries intensified restrictions on non-lending activities, which existing evidence suggests hurts banking-system stability, lowers bank development, and reduces the efficiency of financial intermediation.
Our tempered advice continues to be that countries will benefit from an approach to bank regulation that is grounded in what has worked in practice. In our earlier work, we found that an approach that favours private monitoring, limits moral hazard, removes activity restrictions on banks, encourages competition, including competition by foreign banks, and requires or encourages greater diversification appears to work best to foster more stable, more efficient, and less corrupt financial-sector development. Our earlier findings did not support a hurried adoption of the first two pillars of Basel II by developing countries, but rather stressed the value of first developing the legal, information, and incentive systems in which financial systems flourish to the benefit of everyone. Based on the existing evidence, we continue to believe that this approach is the most sensible one for country authorities to pursue. Critically, the data in this new survey provide the raw material for research that should help confirm, refute, or refine this private monitoring view.
THE 2006 SURVEY
The Survey of Bank Regulation and Supervision Around the World assembles and makes available a database to permit international comparisons of various features of the bank-regulatory environment. Current and previous surveys and responses are on the Bank website and the earlier surveys, responses, and indices are available on a CD in BCL (2006). (2) Most questions could be answered 'Yes/No', although in many cases we requested that in case of doubt the authorities attach governing regulations or laws. Some of the questions in the latest version explicitly or implicitly refer to Basel II, such as those enquiring as to the plans for the implementation of Basel II, and if so then the variant of the first pillar to be adopted. Similarly, some of the questions relating to capital, provisioning, and supervision have been modified to keep abreast of current thinking and emerging practice in these areas.
Before turning to the data, an obvious question concerns the accuracy of the responses. The survey was sent to the principal contacts in each country of the Basel Committee on Bank Supervision. Even though these contacts should know the regulatory environment, the survey's scope is such that for any country a number of people usually are involved in its completion, and some or all of the members of this group might change over time, raising the issue of differences in the interpretation of questions over time (in addition to changes in the wording noted above). In order to attain the greatest possible consistency over time, we adopted several approaches: going back to authorities for clarification, where there were notable changes, as well as posting the survey responses on the web, so that the data could be challenged and inconsistencies resolved.
We also searched for instances in which there was a reversal in a country's response to a question across the different surveys, for example, if a component of an index rose from Surveys I to II and then declined from Surveys II to III, or vice versa. Such a change could, though need not, be due to an error in reporting, or possibly a difference in interpretation due to a change in the person or persons replying on behalf of the regulatory agency. With the exception of some of the components of the index on the overall restrictiveness of bank activities, where mostly small reversals occurred in about 20% of the cases, few reversals were seen in the other components. The full results of this analysis are reported in the working paper version of this paper. Again, these reversals are not necessarily an indication of errors, particularly for those questions that require a simple yes or no answer. However, these cases might merit further checking.
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