Prudential regulation and banking supervision : building an institutional framework for Banks

Economic deregulation and financial liberalization are important for a country to develop a viable and robust financial system. But deregulation will remove the protections previously afforded the banking system. Increased competition, a changing price structure, new market entrants and other factors will increase the risks banks assume and the instability of the financial system. So, the government's goal to ensure the stability of the financial system is of paramount importance. Prudential regulation and supervision are designed to remove or lessen the threat of systemic instability. In addition, the safety and soundness of the banking system must be supported by an adequate legal framework governing a bank's contractual relationship with its customers. Satisfactory accounting and auditing standards are also crucial to ensure that financial statements reflect each financial institution's condition. Different countries have adopted different models of bank regulation and supervision. Organizational approaches also vary from country to country. However, no model will be effective if significant political interference is permitted. The primary line of defense against banking insolvency and financial system distress is the quality of management within the banks themselves. Therefore, efforts to strengthen the financial system must also focus on strengthening management through a process of institutional development.