# _Regulatory_

If the content of the law may be less important than the fact that it is enforced, an argument can be made that the opposite is true for prudential regulation. Practitioners of regulation typically see the regulators as disinterested technocrats for whom the only requirements are adequate legal powers and sufficient skilled resources. However, the wider perspective of the economic analyst points to self-serving or politically biased regulatory performance. And the informational and skill requirements for the effective pursuit of some regulatory strategies is simply beyond reach in most countries, with the result that the damaging side-effects of regulatory capture and rent-seeking may be incurred without any compensating gain in stability. The World Bank’s extensive survey of regulatory practice in 107 countries (a second wave has recently been conducted) allows the impact of regulatory style on financial stability and financial development to be assessed quantitatively. Barth, Caprio and Levine (BCL 2002) et al find that the regulatory choices made on some three dozen different dimensions tend to cluster into one of two styles, which they term the “grabbing hand” and the “helping hand”. The interventionist “grabbing hand” approach relies heavily on discretionary official supervision of bank activities; the “helping hand” approach empowers market discipline by, for example, ensuring information disclosure, and removing discretion that could turn into excessive forbearance. Perhaps unsurprisingly (given the loaded terminology) they proceed to show that helping hand policies work better for promoting bank development, performance and stability—at least in the sense of limiting the frequency of systemic banking failures and reducing non-performing loans. But the less discretionary approach may come at a cost in terms of amplifying short-term fluctuations, as shown in evidence presented by Caprio and Honohan (2002).

# _Ownership (government and foreign)_

A third infrastructural characteristic (overlapping to be sure with the regulatory classification above) relates to ownership. If government decides to take a large ownership share in the banking system, or to exclude foreign-owned banks systematically from a large share in the system, will financial sector performance improve or diminish? A growing literature has studied these issues with generally market-friendly findings. The cross-country findings by La Porta et al (2000), showing that a higher degree of state ownership was associated with lower financial sector development, lower growth and lower productivity, and a higher risk of crises have been confirmed by several subsequent studies (including Barth et al 2003).

The case of foreign ownership is more highly contested, given the widely observed tendency for the typical foreign-owned bank to lend to larger firms, and the fear that their commitment to the host country might be limited, with the result that they might have a greater tendency to exit in a downturn. However, data-based findings (surveyed by Clarke et al. 2002<sup>25</sup> ), suggest that these concerns are over-done and that entry of foreign banks tends to improve the efficiency and stability of the financial system. Even small

> 25 See also Levine (2002) confirming in a striking way the favorable impact of foreign banks on bank spreads.  More widely, the role of competition in improving performance but potentially adding to vulnerability is examined in the papers presented at a World Bank conference in Washington DC in April 2003, see http://www.worldbank.org/research/interest/confs/bank_concentration.htm.

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