Some Lessons for Regulation from Recent Bank Crises

This paper summarises eight main causal factors in recent banking crises:

• Volatility in the macro-economy;
• The inheritance of structural weaknesses in the economy;
• Bad banking practices;
• Hazardous incentive structures and moral hazard within the financial system;
• Ineffective financial regulation;
• Weak monitoring and supervision by official agencies;
• The absence of effective market discipline against hazardous bank behaviour due partly to the lack of transparency and disclosure of relevant information;
• Structurally unsound corporate governance mechanisms within banks.

Outlines characteristics of a stable financial system, such as:

• Regulation;
• Incentive structures for all the major players including regulators and supervisors;
• Monitoring and supervision;
• Official intervention in the event of bank distress;
• The role of market discipline;
• Corporate governance guidelines.

Denotes five key criteria of a regulatory regime:

• The extent to which it generates appropriate incentives for banks' owners and managers;
• Whether it generates correct pricing of absolute and relative risk of bank loans;
• Whether it minimizes existing and new moral hazards;
• The extent to which sufficient differentiation is made between institutions based on overall portfolio risks;
• The impact on competitive conditions and whether it is neutral between different competing firms.

[Author's abstract]