De la Torre Comments on Till Angels Govern Oct by worldbank

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									             Comments on
Measuring Bank Regulation & Supervision:
          The Policy Messages




           World Bank Workshop
           Sponsored by DECRG-FR
              October 26, 2007


                                   Augusto de la Torre
                                      The World Bank
The main policy prescriptions
 OK: Pursue a regulatory/supervisory policy the emphasizes private
 monitoring – Pillar III
    It works best at boosting banking development, stability, efficiency,
    performance & integrity

 Mixed bag: Avoid direct official oversight, government ownership,
 generous deposit insurance, and restrictive regulations on bank entry
 and activity – de-emphasize Pillar II and even Pillar I
    Most, if not all, these features typically make matters worse
    Stringent capital regulations are not systematically associated with better
    banking sector performance

 Very questionable: Don’t give supervisors power and/or discretion
    Supervisory power is greater where democratic governance is weaker
    Supervisors are manifestations of the type of government/state


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Policy prescriptions – hidden ideological biases

  Failure to take seriously the complementarities and feedback loops
  between supervisory powers & effective private monitoring
     Despite suggestive evidence – supervisory power and emphasis on private
     monitoring often coexist & move in same direction (p. 189)
     False dichotomy when stated in general terms


  Unsupported assumption of a monolithic government
     Supervisory power not significantly correlated with government
     ownership, restrictive regulations, or moral hazard
     Independent, technocratic supervisors need legal protection cum
     accountability to stand up to powerful and well connected bankers




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Policy prescriptions – hidden biases (2)

 Faith that private monitoring arises naturally and that it is sufficient
 overcome misalignment of incentives
    Coexistence of information asymmetry, limited liability and leverage is
    sufficient to encourage imprudent risk taking and looting
        Tripod of capital, monitoring and exit is needed to align incentives
        Without supervisory powers, exit (prompt correction & closure) is a chimera
    Moral hazard obtains even in the absence of generous deposit insurance
        Deposit insurance becomes explicit often endogeneously
    Private monitoring can and does fail miserably – e.g., the sub-prime crisis


 Naïve view of benign private sector
    Adam Smith dictum even stronger when it comes to bankers
    Pro-business not same as pro-market – markets need a smart state and
    policy reforms can’t wait “till angels govern”

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