- The report has relevance to Pakistan
The World Bank recently launched the fifth report under its series of Global Financial Development Report (GFDR), titled ‘Banking regulation and supervision a decade after the global financial crisis’ to reflect upon the decade since the global financial crisis (GFC) of 2007/09. In the words of GFDR 2019/20, ‘This Global Financial Development Report is a crucial contribution to the ongoing policy debate on the role of banking regulation and supervision in ensuring a banking sector that delivers stable and inclusive growth. The report ‘is a product of the staff of The World Bank with external contributions.’
Here, identifying a structural break in policy thinking on the banking and financial sector overall, GFDR 2019/20 highlights, ‘The decade prior to the crisis was characterized by the deregulation of banking sectors in several geographies, especially in advanced economies. The onset of the crisis ushered in a period of intense reregulation of the banking sector, with several initiatives put in motion to address the flaws made so apparent during the crisis.’ Since, it is an interconnected world, especially in terms of financial linkages, the Report is relevant both for developed and developing countries. Hence, there are important lessons for Pakistan’s banking and overall financial sector.
Firstly, the Report highlights that it is important to crowd-in the private sector for not only ‘growth in developing countries, but also as a foundation for the kind of market discipline that can prevent excessive risk-taking…’ This is indeed very important to learn for countries, both developing and developed, that while it is important for making available greater flow of loanable funds, it is more important to not allow banks to create highly risky instruments; a case in point being the crisis in the housing mortgage-related sector, which in turn became one of the contributors to the build-up of the GFC 2007/09.
Among other important highlights are ‘[a] Market discipline may have deteriorated because of bank bailouts that undermined long term incentives for private monitoring… [b] Bank supervision has become stricter, and also more complex. Supervisory capacity has not improved proportionally to match the greater complexity of bank regulations… [where]… in many developing countries, a lack of regulatory independence is also a major impediment to performing effective banking supervision.’
Moreover, as the current government in Pakistan builds momentum towards meeting its target of building five million cost-effective/affordable houses, it needs to be careful not to be tempted to allow or influence banks into venturing into creating risky mortgage instruments. This is all the more important for a developing country like Pakistan not to do, since unlike the developed world, there may not be enough fiscal space to bail out the banking sector in the event of default on mortgage payments. The space of risk-taking is all the more less than the developed world, because of a) high and stubborn inflation likely to influence continuation of a tight monetary stance, which in turn would not allow ease on interest payments, and b) existence of high level of costs and risks associated with prevalence of large information asymmetries, and transaction costs.
Secondly, in order to avoid falling into such risks generally, the Report recommends, ‘The right regulatory and supervisory environment— accompanied by effective financial sector policies— is key to creating a financial system that can attract private capital and align private incentives with the public good.’
Thirdly, at the same time, the latest GFDR points out that while a lot has been written about the impact of GFC 2007/09, ‘and associated changes in bank regulation and supervision from the perspective of advanced countries, there has been less focus on how those changes have affected banking sectors in developing regions.’
Fourthly, the Report highlights that while GFC 2007/09 focused the attention of policy makers on financial stability, there was a deeper focus on not only microprudential policies, but also there was greater inclusion of macroprudential policies, whereby the Report highlights that ‘since the global financial crisis, macroprudential tools have been included in bank supervisors’ toolkits in order to identify and curb the risks posed by individual banks to the overall financial system.’ This has allowed, in turn, both greater regulation of market misconduct, and also promoted greater competition, which ‘constrains monopoly power and allows efficient allocation of resources and intermediation of funds.’
Fifthly, the Report underlines the importance of political economic context for policy formulation dealing with financial sector, and indicates ‘In general, the incentives and accountability of bank supervisors for their decisions and actions will have an important bearing on the effectiveness of regulation and supervision.’
Sixthly, GFDR 2019/20 highlights the centrality of incentives and competition for banking regulation policy, and points out ‘The focus should, however, always remain on the implications of the regulatory changes for incentives and competition. Bank capital regulation, market discipline, and bank supervision are interrelated and may complement or substitute for each other in different contexts.’
Moreover, the Report highlights ‘latest trends in bank regulation and supervision in developing and high income countries.’ Among other things, it is pointed out that ‘a key role of bank capital is to increase the resilience of banks to cope with unexpected losses in their asset portfolios… [where]… worldwide, there has been a trend toward increasing minimum regulatory capital requirements to improve banking system resilience, although, on average, the trend has been more marked for developing countries than high-income ones.’
Among other important highlights are ‘[a] Market discipline may have deteriorated because of bank bailouts that undermined long term incentives for private monitoring… [b] Bank supervision has become stricter, and also more complex. Supervisory capacity has not improved proportionally to match the greater complexity of bank regulations… [where]… in many developing countries, a lack of regulatory independence is also a major impediment to performing effective banking supervision.’
