- Timely and easily accessible and comprehensible disclosure of information

- Equity and debt holders incentivized to oversee financial institutions<sup>27</sup>

- Removal of barriers to competition

James Barth, Gerard Caprio, and Ross Levine are the leading researchers on the effects of banking sector regulations and supervision on financial sector development, including financial depth, stability, and efficiency. They have collected data since the late 1990s and early 2000s from regulatory agencies across the world and compiled a very useful data set on the quantity and quality of regulations and supervision in a large sample of countries.<sup>28</sup> They have frequently published empirical analyses of the regulationsfinancial sector development nexus, and they confirm the insights listed above from Levine (2012). Another important insight from these authors is that for many developing countries, compliance with the Basel II accords—let alone Basel III—should not be a benchmark strategy as it is better for these countries first to develop their legal, information, and incentive systems and then think about specific regulations. The empirical evidence we cite below on the importance of institutions in financial sector development clearly supports this insight.

# **4.1 Financial Depth**

In the finance-growth nexus, academic researchers often approximate the effect of financial depth on growth by using an exogenous increase in financial depth on the order of 10 percentage points or one standard deviation. A crucial question then is how countries can increase their financial depth.<sup>29</sup> This section surveys empirical literature that attempts to answer this important question. In general, the following key factors are found to be associated with financial depth:

- **Regulations and Supervision:** The key insight from the analyses of Barth, Caprio, and Levine is that certain regulations have either negative or no effects on financial deepening. For instance, restrictions on commercial bank activity reduce financial depth, but capital requirements have no significant effect. Although official supervision increases financial depth, this positive effect exists only in countries with a high level of political openness.<sup>30</sup> This result holds only in countries with no government presence in the financial sector. Detragiache, Gupta, and Tressel (2008) complement Barth, Caprio, and Levine (2004, 2012) in that they also find that more stringent regulatory and supervisory requirements<sup>31</sup>

> 27 In other words, as Barth et al. (2009) argue, private supervisory systems are more optimal than official supervisory power, especially in countries with greater voice and accountability.

> 28 These authors collect data on a variety of regulations such as capital and disclosure requirements, and regulations that restrict commercial banks from engaging in securities, insurance, and real estate activities and from mixing with nonfinancial firms.

> 29 As a reminder, financial depth—or, more correctly, intermediation—is often measured by credit from banks to the private sector divided by GDP. A few papers listed in this section look at stock market depth as well.

> 30 One mechanism that comes to mind is that in such countries, the expansion of the official supervisory branch is not subject to corruption.

> 31 In this article, regulations and supervision are measured by accounting, discipline and disclosure, restrictions on banking activities, audit requirements, and deposit insurance.

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