Rethinking Bank Regulation: Till Angels Govern.

• Author: Anderson, Robert E.
• Position: Book review

Rethinking Bank Regulation: Till Angels Govern James R. Barth, Gerard Caprio Jr., and Ross Levine Cambridge: Cambridge University Press, 2006, 428 pp.

When experts recommend economic policies for developing countries, they often fail to take into account the inability of weak governments to implement those policies. An important exception is Rethinking Bank Regulation: Till Angels Govern by three academic economists with a long history of research on banking.

With support from the World Bank, the authors have assembled a database on bank regulation and supervision in over 150 countries. Based on statistical analysis of this data, the authors conclude that the development of banking systems--especially in countries with weak political institutions--will be helped the most by private monitoring of the financial health of banks rather than by conventional government regulation and supervision.

The database includes the official policies for bank regulation and supervision in each country. One weakness, however, is that no effort is made to determine whether the actual regulation follows these policies. With help from the World Bank or International Monetary Fund, it is easy for a developing country to adopt the most sophisticated policies. But implementing them successfully is far more difficult.

Using this database, the authors attempt to determine what type of regulation works best. They use various indicators of how well a country's banking system is performing. As a measure of the size and importance of the banking system, the indicator used is the amount of credit issued by banks to private-sector firms relative to gross domestic product. As a measure of the stability of the banking system, the indicator is whether or not the country has experienced a large-scale banking crisis over the period 1988-99. Other indicators include whether banks are efficiently managed as measured by net interest margin and overhead costs, and the degree of corruption in bank lending as measured by surveys of private-sector businessmen.

I reached similar conclusions about banks in my book just Get Out of the Way: How Government Can Help Business in Poor Countries (Cato Institute, 2004). Conventional government regulation of banks is likely to backfire because the regulators are frequently incompetent or corrupt. Instead of serving the public interest, regulators often end up serving the banking industry and its political supporters.

The most compelling...