Impact of Banking Supervision Enhancement on Banking System Structure: Conclusions Delivered by Agent-Based Modelling

The Bank of Russia’s policy for banking sector rehabilitation and clearance of nonviable and malafide banks attracts attention and receives controversial judgments of experts. Our research shows that, in the medium term, such a policy reduces monopolism and raises efficiency of the banking system. Yet, it has an adverse effect on small and medium-sized banks over the short term. All in all, the long-term benefits of proactive supervisory policy might significantly outweigh the short-term negative effects from a temporary increase in banking business concentration. In order to examine the effects of proactive banking sector resolution, we have constructed an agent-based model of the banking sector and calibrated its key variables using Russian banking sector data. On the basis of the model, we compare the short- and long-term effects of two supervisory policies with different degrees of tightness. The results of model simulation show that in the short-term a proactive supervisory policy adversely affects small and medium-sized banks, including those complying with supervisory requirements. Yet, as the banking sector rehabilitates, the benefits from increasing trust in such banks and the banking system in general outweigh the short-term losses. Eventually, the share of small and medium-sized banks in loan and deposit markets turns out to be greater compared to the period prior to the supervisory policy being made stricter. Monopolism in the banking sector decreases and price competition improves. The banking system efficiently creates credit and gets rid of the excessive risk to individual and systemic sustainability, while preserving the average credit risk of projects. At that, financial sustainability of small and medium-sized banks improves