Compliance with Basel Norms by Banks in Philippines

Abstract

Strong regulation and supervision plays an essential part in ensuring a safe and sound banking system. To curb bank fragility and improve crisis management, many countries are in the process of strengthening their regulatory and supervisory systems, a complicated and costly process for many developing countries where human resources are scarce and other supporting institutions are weak. What type of regulations and supervisory practices are most effective in ensuring bank soundness? This is the question that we have addressed in this study. Using bank-level investor ratings for 39 countries, we study whether compliance with Basel Core Principles (BCPs), the standard of best practices in bank supervision, is associated with bank soundness. BCP compliance assessments, carried out under the auspices of the World Bank and IMF Financial Sector Assessment Program, provide a unique source of information about the quality of bank supervision and regulation around the world. An important aspect of our study is the attempt to differentiate among different elements of the regulatory framework, to help prioritize reform efforts. We find a significant and positive relationship between compliance with information provision and bank soundness, which is robust to controlling broad indexes of institutional quality, macroeconomic variables, sovereign ratings, as well as reverse causality. Specifically, countries which require their banks to report regularly and accurately their financial data to regulators and market participants have more highly rated banks, as timely disclosure of high quality information strengthens monitoring by regulators and markets alike. Our results also suggest that countries aiming to upgrade banking regulation and supervision should consider giving priority to information provision over other elements of the Core Principles. Because information provision is a necessary condition for effective discipline, this policy recommendation is consistent with the approach to regulation and supervision recommended by Barth, Caprio, and Levine (2006), who stress the importance of mechanisms to empower market discipline and are sceptical of structures that assign too much power to regulators.