Latin American Banks, Market Discipline and Official Regulation: Completing the Circle
31 Pages Posted: 3 May 2005
Date Written: April 2005
The banking literature on market discipline has stressed that depositors punish banks that take greater risks by demanding higher interest rates or withdrawing funds. We extend these results to a true cross-country analysis for 13 countries in Latin America. However, on splitting the sample, we also find that market discipline is only strong in countries with higher Basel Core Principles of Banking Supervision (BCP) compliance. In contrast to previous analyses, we also estimate a system comprising of equations for the interest rate, changes in deposits and bank risk that allows us to investigate not only whether depositors punish higher risk banks but also how banks respond. We find that private banks do respond to market discipline but the result is driven by high BCP-compliant countries. We suggest that official regulation and market discipline are complements and that while rules on disclosure, transparency and other tools to enhance market discipline should be stressed traditional supervision should also be enhanced.
Keywords: Market Discipline, Prudential Regulation, Banking
JEL Classification: G20, G21, G38
Suggested Citation: Suggested Citation