Policy Lessons for Prudential Regulation in Developing Countries

Abstract

This article draws together the regulatory policy lessons arising from the Finance and Development Research Programme's project on prudential regulation and supervision of the financial sector in low-income countries. The policy recommendations include: bringing regulations, such as loan provisioning rules, into line with international standards, where this has not already been done; tightening bank licensing procedures and raising minimum capital requirements; introducing 'prompt corrective action rules'; providing the regulators with an unambiguous mandate to protect deposits and the stability of the financial system; enhancing the regulators' independence from political interference in operational issues but making them more accountable ex-post; introducing risk-based supervision; and limiting deposit insurance to small deposits only.Recent experience in emerging markets has demonstrated how costly financial crises can be -for the economy, government budgets and general living standards -and this has stimulated interest in improving financial sector regulation and supervision. This article analyses the lessons for regulatory policy generated by the Finance and Development Research Programme's project on prudential regulation and supervision of the financial sector in low-income countries. The objective of this project is to identify feasible policy reforms which can strengthen the prudential regulation of financial systems in countries where the institutional environment is often not conducive to effective prudential regulation. The empirical research undertaken by this project includes case studies of three low-income African countries and Bangladesh, and a study of regulatory failures in the East Asian countries hit by financial crisis in 1997/8. The objective of prudential regulation is to safeguard the stability of the financial system and to protect deposits. Hence its main focus is on the safety and soundness of the banking system and of non-bank financial institutions (NBFIs) which take deposits.The institutional impediments to effective prudential regulation include weak accounting standards and a shortage of qualified accountants, the poor quality of financial information available to regulators and the market, acute shortages of the specialist professional skills needed for financial regulation, poor pay in the public service, the politicisation of regulatory processes (which reflects the politicisation of public administration in general) and the difficulty in enforcing bureaucratic and legal regulations, which also stems in part from political interference in the regulatory process. Because financial systems in low-income countries are typically very small, effective prudential regulation is also impeded because it cannot take advantage of the * Research Associate, Institute for Development Policy and Management, University of Manchester, UK.

Corporate Governance of Banks in Developing Economies: concepts and issues

“…The main objective of prudential regulation is to safeguard the stability of the financial system and to protect deposits. However, the prudential reforms already implemented in developing countries have not been effective in preventing banking crises, and a question remains as to how pru-dential systems can be strengthened to make them more effective (Brownbridge, 2002).…”

Time to Simplify Banking Supervision—An Evidence-Based Study on PCA Framework in India

“…This study showed that US banks displaying risk of insolvency escaped PCA as they are not considered undercapitalized based on the existing risk-based capital. Brownbridge (2002) studied policy lessons for prudential regulation in developing countries. The study recommended, including prompt corrective action rules, providing regulators with an unambiguous mandate to protect deposits and the financial system's stability.…”

“…Research interests around PCA have their origin in 1991 with the implementation of the Federal Deposit Insurance Corporation (FDIC) Improvement Act (FDICIA). Studies revolved around bank recovery efforts (Dahl and Spivey 1995;Garcia 1995), revised solvency measures (Jones and King 1995), depositor protection, insurance (Brownbridge 2002;Sumathy and Venkatachalam 2019;Schich 2008;Gulati 2020), and regulator forbearance, effectiveness (Garcia 2010;Kagade 2015). Extant research also suggests modifications in the PCA framework through continuous improvement in the regulatory capital ratios (Jones and King 1995), inclusion of new tailored triggers, alternative, and additional triggers (Svoronos 2018;Cole and White 2017;Council, Financial Stability Oversight 2011), and revamping prudential regulation (Loveland 2016).…”