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The Empirics of Banking Regulation

  • Fulbert Tchana Tchana

This paper empirically assesses whether banking regulation is effective at preventing banking crises. We use a monthly index of banking system fragility, which captures almost every source of risk in the banking system, to estimate the effect of regulatory measures (entry restriction, reserve requirement, deposit insurance, and capital adequacy requirement) on banking stability in the context of a Markov-switching model. Our methodology is less prone to selection and simultaneity bias which are common in this type of study. We apply this method to the Indonesian banking system, which has been subject to several regulatory changes over the last couple of decades, and at the same time, has experienced a severe systemic crisis. We draw the following findings from this research : (i) entry restriction reduces crisis duration as well as the probability of such an occurrence; (ii) larger reserve requirements reduce crisis duration, but increase banking instability; (iii) deposit insurance increases banking system stability and reduces crisis duration; (vi) capital adequacy requirement improves stability and reduces the expected duration of banking crises. Finally, we find that previous studies present a negative simultaneity bias for deposit insurance and a negative selection bias for capital adequacy requirement.

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Paper provided by Economic Research Southern Africa in its series Working Papers with number 128.

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Date of creation: 2009
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Handle: RePEc:rza:wpaper:128
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  1. Kim, Daesik & Santomero, Anthony M, 1988. " Risk in Banking and Capital Regulation," Journal of Finance, American Finance Association, vol. 43(5), pages 1219-33, December.
  2. Blum, Jurg, 1999. "Do capital adequacy requirements reduce risks in banking?," Journal of Banking & Finance, Elsevier, vol. 23(5), pages 755-771, May.
  3. Morrison, Alan & White, Lucy, 2004. "Crises and Capital Requirements in Banking," CEPR Discussion Papers 4364, C.E.P.R. Discussion Papers.
  4. repec:ebl:ecbull:v:28:y:2002:i:6:p:a0 is not listed on IDEAS
  5. Alan D. Morrison & Lucy White, 2005. "Crises and Capital Requirements in Banking," American Economic Review, American Economic Association, vol. 95(5), pages 1548-1572, December.
  6. Barry Eichengreen & Andrew K. Rose & Charles Wyplosz, 1994. "Speculative Attacks on Pegged Exchange Rates: An Empirical Exploration with Special Reference to the European Monetary System," NBER Working Papers 4898, National Bureau of Economic Research, Inc.
  7. Demirguc-Kunt, Asli & Detragiache, Enrica, 1999. "Does deposit insurance increase banking system stability ? An empirical investigation," Policy Research Working Paper Series 2247, The World Bank.
  8. Tai-kuang Ho, 2004. "How Useful are Regime-Switching Models in Banking Crises Identification?," Econometric Society 2004 Far Eastern Meetings 764, Econometric Society.
  9. Demirguc-Kunt, Asli & Kane, Edward J. & Laeven, Luc, 2006. "Determinants of deposit-insurance adoption and design," Policy Research Working Paper Series 3849, The World Bank.
  10. Eichengreen, Barry & Rose, Andrew K & Wyplosz, Charles, 1996. "Contagious Currency Crises," CEPR Discussion Papers 1453, C.E.P.R. Discussion Papers.
  11. Kibritcioglu, Aykut, 2002. "Excessive Risk-Taking, Banking Sector Fragility, and Banking Crises," Working Papers 02-0114, University of Illinois at Urbana-Champaign, College of Business.
  12. Poonam Gupta & Asli Demirgüç-Kunt & Enrica Detragiache, 2000. "Inside the Crisis; An Empirical Analysis of Banking Systems in Distress," IMF Working Papers 00/156, International Monetary Fund.
  13. Filardo, Andrew J. & Gordon, Stephen F., 1998. "Business cycle durations," Journal of Econometrics, Elsevier, vol. 85(1), pages 99-123, July.
  14. Garcia, Rene, 1998. "Asymptotic Null Distribution of the Likelihood Ratio Test in Markov Switching Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 763-88, August.
  15. Franklin Allen & Douglas Gale, 2003. "Financial Intermediaries and Markets," Center for Financial Institutions Working Papers 00-44, Wharton School Center for Financial Institutions, University of Pennsylvania.
  16. Maddala, G.S., 1986. "Disequilibrium, self-selection, and switching models," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 3, chapter 28, pages 1633-1688 Elsevier.
  17. Coe, Patrick J, 2002. "Financial Crisis and the Great Depression: A Regime Switching Approach," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 76-93, February.
  18. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
  19. Marc Klau & John Hawkins, 2000. "Measuring potential vulnerabilities in emerging market economies," BIS Working Papers 91, Bank for International Settlements.
  20. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  21. Fulbert Tchana Tchana, 2009. "Regulation and Banking Stability: A Survey of Empirical Studies," Working Papers 136, Economic Research Southern Africa.
  22. Filardo, Andrew J, 1994. "Business-Cycle Phases and Their Transitional Dynamics," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(3), pages 299-308, July.
  23. Scott E. Hein & Jonathan D. Stewart, 2002. "Reserve requirements: A modern perspective," Economic Review, Federal Reserve Bank of Atlanta, issue Q4, pages 41-52.
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