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Bank regulation and the network paradigm : policy implications for developing and transition economies

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Author Info

  • Honohan, Patrick
  • Vittas, Dimitri

Abstract

Current issues in banking policy range from the need to construct basic institutions and incentive structures in transition economies, to the challenges posed by the increasingly complex interactions involved in contemporary banking. The authors of this report outline the basic regulatory framework needed to reduce bank failures, as shown by recent experience. Theoreticians note that banking increasingly displays network characteristics that may call for corrective action but make policy intervention ineffective or counterproductive. Networks are susceptible to externalities, redundancy, (ensuring that flows cannot be obstructed by blocking just one path), and a tendency to adapt to disturbances in a complex manner. Regulation is justified, but the complexity of the network makes successful interventions hard to design. Supervision has a role, and the authors outline the basic regulatory measures needed, but the blurring of boundaries between banking and the rest of the financial network has placed an upper bound on the effectiveness of supervision. The authors conclude that although bank failures--mitigated by deposit insurance to protect small savers--must be put up with in designing banking policy, the social cost of bank failure is not as high as is sometimes thought.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1631.

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Date of creation: 31 Aug 1996
Date of revision:
Handle: RePEc:wbk:wbrwps:1631

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Related research

Keywords: Payment Systems&Infrastructure; Economic Theory&Research; Banks&Banking Reform; Financial Intermediation; Financial Crisis Management&Restructuring; Banks&Banking Reform; Financial Intermediation; Financial Crisis Management&Restructuring; Economic Theory&Research; Environmental Economics&Policies;

References

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Citations

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Cited by:
  1. Patrick Honohan, 1998. "Diagnosing Banking System Failures in Developing Countries," Papers WP093, Economic and Social Research Institute (ESRI).
  2. A.W.A. Boot & S. Dezelan & T.T. Milbourn, 2000. "Regulation and the Evolution of the Financial Services Industry," DNB Staff Reports (discontinued) 50, Netherlands Central Bank.
  3. Vittas, Dimitri, 1998. "The role of non-bank financial intermediaries (with particular reference to Egypt)," Policy Research Working Paper Series 1892, The World Bank.

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