Bank Regulatory Policies Research Articles

Impact of banking regulation on risk and efficiency in Islamic banking

PurposeThis paper aims to examine whether bank regulation, supervision and monitoring enhance or impede technical efficiency and risk‐taking behaviour of Islamic banks across the globe.Design/methodology/approachTechnical efficiency scores are calculated using the data envelopment analysis (DEA) model while simultaneity between banks' supervision and regulation on risk and efficiency estimates are calculated using the seemingly unrelated regression (SUR) approach.FindingsThe author's results suggest that regulations and strict monitoring of banking operation, and higher supervisory power of the authorities, increase the technical efficiency for Islamic banks. The opposite effect is observed in the case of risk‐taking behaviour of Islamic banks, with higher restrictions resulting in a reduction in risk taking of Islamic banks.Research limitations/implicationsThe Basel II & Basel III guidelines suggested that stricter regulations and supervision could hamper banking efficiency. The existence of a powerful supervisory body could also lead to the inefficiency of banks. The DEA scores from this paper suggest that this may not necessarily be the case, especially as Islamic banks appear to be technically efficient in stricter regulatory conditions.Originality/valueA message that emerges from this analysis is that there is a strong link between Islamic bank technical efficiency and risk‐taking behaviour with the Central Bank regulatory and supervisory policies. It is also conclusive that the Islamic banking system works well within a stricter regulatory environment.

Bank Regulation and Supervision in 180 Countries from 1999 to 2011

In this paper and the associated online database, we provide new data and measures of bank regulatory and supervisory policies in 180 countries from 1999 to 2011. The data include and the measures are based upon responses to hundreds of questions, including information on permissible bank activities, capital requirements, the powers of official supervisory agencies, information disclosure requirements, external governance mechanisms, deposit insurance, barriers to entry, and loan provisioning. The dataset also provides information on the organization of regulatory agencies and the size, structure, and performance of banking systems. Since the underlying surveys are large and complex, we construct summary indices of key bank regulatory and supervisory policies to facilitate cross-country comparisons and analyses of changes in banking policies over time.

Bank regulation and supervision in 180 countries from 1999 to 2011

PurposeThe purpose of this paper is to discuss and provide new data and measures of bank regulatory and supervisory policies in 180 countries from 1999 to 2011.Design/methodology/approachThe authors' approach is based upon the quantification of hundreds of questions, including information on permissible bank activities, capital requirements, the powers of official supervisory agencies, information disclosure requirements, external governance mechanisms, deposit insurance, barriers to entry, and loan provisioning, to form indices of key bank regulatory and supervisory policies.FindingsIt is found that the regulation and supervision of banks varies widely across countries in many different dimensions. Furthermore, there has not been a convergence in bank regulatory regimes over the past decade despite the worst global financial crisis since the Great Depression.Research limitations/implicationsThe data are based on survey responses and this requires that the answers be accurate. To better ensure this is the case, several checks were made to ensure greater accuracy in all the answers. Using this database one can perform various statistical analyses in attempt to determine which bank regulatory regimes work best to promote well‐functioning banking systems.Originality/valueThe authors' data and measures are new and unique so as enable policy makers and researchers to examine cross‐country comparisons and analyses of changes in banking policies over time.

Bank Regulations and Income Inequality: Empirical Evidence

This paper provides cross-country evidence that variations in bank regulatory policies result in differences in income distribution. In particular, the overall liberalization of banking systems decreases the Gini coefficient and the Theil index significantly. However, this effect fades away for countries with low levels of economic and institutional development and for market-based economies. Among the different liberalization policies, the most significant negative effect on inequality is that of credit controls, which also seem to have a lasting effect on the Gini coefficient. Banking supervision and the abolition of interest rate controls also have a negative yet short-run impact on income inequality. A notable finding is that liberalization of securities markets increases income inequality substantially and over a long time span, suggesting that securitization widens the distribution of income. We contend that these findings have new implications for the effects of bank regulations, besides those related to their impact on financial stability. Keywords: Bank regulations; Income inequality; Cross-country panel data; Instrumental variables; Panel VAR JEL classification: G28; O15; O16

The Perceived Guarantee of Bank-Affiliated Money Market Funds

Excerpts from letters to the Federal Reserve Board and other federal banking regulators concerning the growing investor perception that banking organizations are effectively guaranteeing their affiliated money market funds. The letters show how bank regulatory policies are fostering this perception and address moral hazard and other concerns. The letters provide supporting data and suggest steps banking regulators can take to avoid the perception of a guarantee. A recommendation by the ABA Task Force on Regulatory Reform is appended.

The Pros and Cons of Regulating Corporate Reporting: A Critical Review of the Arguments

In this paper, we distil essential insights about the regulation of financial reporting from the academic literature. The key objective is to synthesize extant theory to provide a basis for evaluating implications of pressures on the regulation of financial accounting following the recent financial crisis. We succinctly lay out arguments put forth both for and against the regulation of corporate disclosure and standard setting. We then examine current developments suggesting that accounting standard setting is at risk of becoming entangled in a web of political forces with potentially significant consequences. The crisis has brought into sharp focus the reality that the regulation of corporate reporting is just one piece of a larger regulatory configuration, and that forces are at play that would subjugate accounting standard setting to broader regulatory demands. Recent actions by the European Commission relating to IFRS 9 and proposed legislation in the U.S. Congress to create a systemic risk council serve to illustrate this point. We conclude by discussing in detail the recent fair value debate as a case study of the way in which bank regulatory policy and accounting standard decisions were jointly determined as a potentially socially optimal means to mitigate the effects of the financial crisis.

Bank concentration, competition, and crises: First results

Motivated by public policy debates about bank consolidation and conflicting theoretical predictions about the relationship between bank concentration, bank competition and banking system fragility, this paper studies the impact of national bank concentration, bank regulations, and national institutions on the likelihood of a country suffering a systemic banking crisis. Using data on 69 countries from 1980 to 1997, we find that crises are less likely in economies with more concentrated banking systems even after controlling for differences in commercial bank regulatory policies, national institutions affecting competition, macroeconomic conditions, and shocks to the economy. Furthermore, the data indicate that regulatory policies and institutions that thwart competition are associated with greater banking system fragility.

THIS ARTICLE HAS BEEN RETRACTED A Framework for Market Discipline in Bank Regulatory Design

Abstract: Given current debates on the future direction of regulatory design, the first objective of this paper is to contextualise the issues surrounding bank market discipline. Accordingly, the paper raises awareness of the current key themes within incentive‐based regulatory design and analyses the theory underlying market discipline. This leads to the creation of a theoretical framework of market discipline, which provides a powerful tool for understanding the conditions necessary for effective market discipline and for assessing the findings of market discipline‐related empirical research. The second objective is to emphasise the suitability of the theoretical framework for debates on contemporary market discipline and aiding future bank regulatory policy design, in particular, how to incorporate suitable, incentive mechanisms in international banking regulation.

The Basel Capital Accords and International Mortgage Markets: A Survey of the Literature

This paper surveys the literature on the impacts of the Basel Capital Accords on banking market profitability, competitiveness, structure and risk‐taking. Special emphasis is applied to the evolution of mortgage markets throughout the world over almost two decades of international bank regulatory policies.

The Evolution Of Bank Resolution Policies In Japan: Evidence From Market Equity Values

AbstractWe examine the evidence in equity markets concerning bank regulatory policies in Japan from 1995 to 1999. Our results support the presence of information‐based contagion in Japanese equity markets. When the failure of a bank of certain regulatory status was announced, it adversely affected excess returns on banks with equal or lower levels of regulatory protection. Market participants therefore initially behaved as if only second regional and smaller banks would be allowed to fail. As the situation deteriorated, however, banks that traditionally enjoyed greater regulatory protection were also perceived to lose their too‐big‐to‐fail status.

A model of the monetary sector with and without binding capital requirements

Bank equity is exogenous in the standard deposit-and-loan-expansion multiplier model, so that model is inappropriate for analyzing the interaction between monetary and bank regulatory policies. This paper examines the effect of a binding capital requirement on the loan expansion process. We evaluate how the conflict between the monetary and regulatory authorities evolves when bank equity adjusts to a binding capital requirement. We find that capital requirements are not innocuous for monetary policy. Nevertheless, the monetary authority can assert control over the loan expansion process in the long run, although multiplier values will differ considerably from those in the standard multiplier model.

The business cycle in a globalising new economy: Implications for bank regulation and monetary policy

This paper examines the implications for bank regulatory and monetary policy of the business cycle; the nature of which is being transformed by the forces of globalisation and the communication and information technology revolution. Asset price fluctuations and overinvestment appear to have become more common, and ‘cheap money’ has been a causal factor. More risk‐related ‘Basel’ bank capital adequacy requirements, combined with more rigorous bad loan provisioning policies and ‘marking to market’ will result in bank regulation amplifying cycles. Hence, monetary policy must be closely coordinated with bank regulation policy to attenuate the cycle and the impact of asset price fluctuations.

The Information Content of Bank Exam Ratings and Subordinated Debt Prices

An important question for bank regulatory policy is whether supervisory examinations of large commercial banking firms - institutions that are already actively followed by many investors and their private sector agents - produce useful information that is not already reflected in market prices. We investigate this question using a new research methodology and a unique data set of national bank exam ratings and subordinated debt risk spreads for their parent holding companies. We find that government exams do produce significant new information that is value-relevant to financial markets; that debenture prices do not fully reflect this new information until several quarters after an exam; and that on net markets price the likely regulatory actions implied by this new information. These results have implications for the balance of market vs. regulatory discipline at large banking firms, and for proposals to make subordinated debt issues mandatory for these firms.

The Pitfalls in Inferring Risk from Financial Market Data

This paper examines two qualitative rules of thumb, frequently invoked in discussions of bank regulatory policy. The first, that equity holders prefer more risk to less, derives from a result in option pricing theory, that an option's value increases monotonically with the riskiness of the underlying asset. This result is shown to depend on very restrictive assumptions regarding the underlying asset's return distribution and the type of option being considered. These restrictive assumptions do not generally obtain in practice. The second rule of thumb is that bondholders' and deposit insurers' interests are aligned. The paper shows that, in fact, their interests can diverge in the sense that bondholders and deposit insurers will not necessarily agree on the relative riskiness of different banks or bank portfolios. The conclusion of this paper is that rules of thumb can be misleading. Furthermore, the concept of risk is shown to be model and agent specific.

The impact of contingent liability on commercial bank risk taking

From 1863–1935, regulators imposed contingent liability on bank shareholders to discourage risk taking. Using data from 1900 to 1915, I find that banks subject to stricter liability rules have lower equity and asset volatility, hold a lower proportion of risky assets, and are less likely to increase their investment in risky assets when their net worth declines, consistent with the hypothesis that stricter liability discourages commercial bank risk taking. These findings provide lessons for current bank regulatory policy and show that the shape of the residual claimant's payoff function has a significant impact on managerial incentives and firm performance.

Subordinated debt prices and forward-looking estimates of bank asset volatility

We have estimated the forward-looking bank asset volatility using market prices of bank equity and subordinated debt. This is in contrast to estimation procedures which rely on historical stock price volatilities. Important for bank regulatory policy, we find that, during 1987–1988, a time of financial stress in the banking industry, most bank asset volatility estimates based on contemporaneous market information were on average 40% higher than historically-based readings. Our results suggest that elevated asset volatilities would require higher risk-based capital standards to protect the deposit guarantor.

Deposit Insurance: Problems and Solutions

The author briefly described the current plan for a risk-premium structure of deposit insurance and considers some potential operational problems with it. He also reflect on the role of risk-based premiums in the context of the broader themes of the current debate over bank regulatory policy.

Production costs for consolidated multibank holding companies compared to one-bank organizational forms

Economies of scale and scope for consolidated multibank holding companies (MBHCs) are examined with a translog cost function and are compared with one-bank holding companies (OBHCs) and independent banks. Empirical results indicate that costs curves are generally U-shaped for independent banks and OBHCs but are relatively flat for MBHCs. This evidence implies that banking organizations should prefer the MBHC to one-bank forms at higher output levels. Implications for bank regulatory policy and interstate banking are discussed.

Bank loan-loss provisions and the income-smoothing hypothesis: An empirical analysis, 1976–1984

This article tests an income-smoothing hypothesis for a sample of 106 large bank holding companies for the period 1976 to 1984. Our focus is on the behavior of the provision for loan losses as a function of bank income and alternative measures of business conditions likely to affect loan portfolio risk-taking or quality. Using an econometric model with pooled time-series, cross-sectional data, we find evidence of income-smoothing behavior over our test period. Our dummy-variable models indicate that regional banking companies tend to engage in income smoothing more than money-center banks. Alternative motivations for income-smoothing behavior, which include bank regulatory policy, risk management, agency theory, and compensation policy, are explored and their policy implications considered.

The emergence and regulation of contingent commitment banking

In but a relatively few years banking has changed considerably. Now it is very much a business of making contingent promises or commitments; and even just a decade ago it was not. Recognizing change is apparently easier, though, than accounting for it. Or than not worrying about it. In this paper, an attempt is made to account for the change from traditional to contingent commitment banking, an attempt which must, however, be regarded as less than brilliantly successful. And responding to the concern that has been expressed by, among others, Federal Reserve officials, it is argued that even if banking keeps on changing until the last vestige of the traditional has disappeared, the Federal Reserve need not in the end be less effective as the U.S. monetary authority than it is at present. There is also a concern, shared by some Federal Reserve officials, that if change persists, then, unless bank regulatory policy is altered appropriately, financial stability will be increasingly threatened. That could be, but as is argued in the paper it is far from obvious that more capital (and/or a risk-adjusted capital requirement) will make bank failures rarer than they otherwise would be.