Apanard P. Prabha

Market Discipline for Financial Institutions and Markets for Information

This study analyzes the causes of the market discipline failure in the recent financial crisis. We argue that the most important market failure of informativeness was that large financial institutions had the incentive to remain opaque strategically so that outside investors could not assess their solvency. We also discuss how different debt-based and equity-based financial instruments provide more or less timely information by illustrating the behavior of different financial instruments (e.g., stock price indexes, credit default swaps and subordinated debt) around events associated with insolvency of some financial institutions during the 2007-2009 financial crisis. Our paper concludes by laying out four “informativeness principles” for regulators and policy makers to follow with the objective to strengthen the incentives of market participants to acquire, analyze, disclose and signal information.

What Makes High Credit Growth Harmful? Evidence from Banking Crises

Rapid credit growth seems to precede many episodes of banking crises in both advanced and emerging market economies including the recent global financial crisis of 2007-09. All episodes of high credit growth are not followed by crisis, however. We argue that credit growth is more likely to lead to a banking crisis if the financial system is characterized by fragility caused by distortions or imbalances in the system. The indicators of potential fragility we point to in this paper are high leverage, financial liberalization, a high rate of capital inflows (e.g. bank loans) from abroad, surges in asset prices, the existence of explicit or implicit protection of banks’ creditors, and weak supervision of banks’ risk-taking. We test the hypotheses that these factors interact with high credit growth to increase the likelihood of a banking crisis. The empirical work is based on data for 77 countries for the period 1973-2009. The results show that in advanced economies relatively high credit growth over several years increases the likelihood of a banking crisis and that this effect is strengthened by high leverage, weak capital regulation and supervision, and cumulative asset price inflation. These results are robust with respect to inclusion of the recent crisis period. The other financial fragility indicators have independent effects on the likelihood of banking crisis but the significance of effects vary across specifications, types of countries and time period.

Interest Groups and Bank Regulation

It is clear that the organization and operation of political and institutional systems shape bank regulations. Political and institutional systems are also important because they can limit the degree to which narrowly-focused interest groups can unduly influence policy choices. This paper presents illustrative results supporting this position. Specifically, evidence is provided indicating that political and institutional characteristics exist in countries that will determine the degree to which special interest groups will be able to exert undue influence on government leaders and regulatory officials to favor narrow special interests rather than the broader public interests.