1. A Retrospective on Bank Regulation and Supervision Around the World James R. Barth Penny Prabha Auburn University and Milken Institute Milken Institute Capital Flows and Financial Liberalization Annual CEMP-CIEPS FORUM March 13, 2014 Arlington, Virginia 1

2. Motivation: More Frequent (and Severe) Banking Crises Worldwide Sources: Reinhart and Rogoff (2008), Milken Institute. 2

3. Motivation: Frequency of Recent Banking Crises 1970 - 2011 Source: Laeven, Valencia (2012). 3

4. Motivation: Cost of Banking Crises 2007 - 2011 4 Source: Laeven, Valencia (2012). CountryStart of crisis Date when systemic Extensive liquidity support Significant guarantees on liabilities Significant restructuring costs Significant asset purchases Significant nationalizations Austria2008 vvv v Belgium2008 vvv v Denmark20082009vv v Germany20082009vv v Greece20082009vvv Iceland2008 vvv v Ireland20082009vvvvv Kazakhstan20082010v v v Latvia2008 vv v Luxembourg2008 vvv v Mongolia20082009vvv v Netherlands2008 vvv v Nigeria20092011vvvvv Spain20082011vvv Ukraine20082009v v v United Kingdom20072008vvvvv United States20072008vvvvv

5. Motivation: Cost of Banking Crises Banking Crises Outcomes, 1970-2011 5 Source: Laeven, Valencia (2012). Country Output loss Increase in debt Monetary expansion Fiscal costsDuration Peak liquidity SupportPeak NPLs Medians In percent of GDP In percent of financial system assets In years In percent of deposits and foreign liabilities In percent of total loans All23.012.11.76.812.72.020.19.625.0 Advanced32.921.48.33.82.13.011.55.74.0 Emerging26.09.11.310.021.42.022.311.130.0 Developing1.610.91.210.018.31.022.612.337.5

6. Motivation: U.S. History of Crises More Regulators with More Power 6

7. Bank Regulation and Supervision Matter  Fed Chairman Ben Bernanke said, “stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates.”  Measuring bank regulation and supervision around the world is hard.  Yet, as Lord Kelvin said, “[I]f you cannot measure it, you cannot improve it.” 7

8. Countries Participating in the World Bank Surveys 8

9. Countries and Questions in the World Bank Surveys  Survey I (1999): 118 countries and 180 questions  Survey II (2003): 151 countries and 275 questions  Survey III (2006): 143 countries and 300 questions  Survey IV (2011): 143 countries and 270 questions  Surveys I-IV: 84 countries 9

10. Data and Indexes  The dataset includes information on: the organization of national banking authorities, the details of financial regulation and supervision, and the size and structure of the banking systems.  About 50 indexes of policies are constructed to measure: capital requirements, ownership restrictions, deposit insurance generosity, allowable activities, among other regulatory and supervisory policies. 10

11. Aggregating the Data: the Art and Science of Forming Indexes IndexComponent Bank activity regulationsThe degree to which national regulatory authorities allow banks to engage in securities, insurance, real estate activities Financial conglomerateThe extent to which banks may own and control non-financial firms Competition regulationWhether foreign banks may own or compete with domestic banks Capital regulationThe extent of regulatory requirements regarding the amount of capital banks must hold and whether the source of funds that count Official supervisory actionRestructuring authority, insolvency declaration, forbearance Official supervisory structure The degree to which the supervisory authority is independent from political influence, political lobbying from banks Private monitoringAudit, credit rating, explicit deposit insurance scheme, bank accounting Deposit insurance schemeDeposit insurance fund authority, size of deposit insurance fund, moral hazard Market structureConcentration of deposits and assets in five largest banks, foreign and government banks External governanceExternal audits, financial statement transparency, accounting standards 11

12. Dataset for Surveys I-IV James Barth  http://business.auburn.edu/~barthjr/Web%20Dataset.htm http://business.auburn.edu/~barthjr/Web%20Dataset.htm Jerry Caprio  http://econ.williams.edu/people/gcaprio http://econ.williams.edu/people/gcaprio Ross Levine  http://faculty.haas.berkeley.edu/ross_levine/Regulation.htm http://faculty.haas.berkeley.edu/ross_levine/Regulation.htm 12

13. Bank Assets / GDP Ratio 13

14. Differences in Total Assets of Big U.S. Banks Due to Differences in the Accounting Treatment of Derivatives Q2 2012 Sources: BankScope, Bloomberg, annual reports, and Milken Institute. 14

15. Total Bank Assets / GDP 15

16. Percentage of Assets Accounted for by 5 Largest Banks 16

17. Percentage of Total Bank Assets Government Owned 17

18. Percentage of Total Bank Assets Foreign Owned 18

19. Regulatory Restrictions on Bank Activities and the Mixing of Banking and Commerce 19

20. New Survey IV Information: Bank Supervisory Criteria for Assessing Systemic Risk Number of Countries Reporting Yes for Each Factor 20

21. New Survey IV Information: Statutory Corporate Tax Rate on Domestic Bank Income 21

22. Convergence  We attempt to assess whether bank regulatory and supervisory practices have converged across countries.  One way to do so is to calculate the normalized standard deviation in Survey I and Survey IV for each index.  Another way is to assess the number of countries that are x% different from the median value, where x equals 10%, 25%, 30%, and 50%. 22

23. Was There a Convergence or Divergence in Regulation and Supervision Overtime? (Number of Countries with Index Values Different From the Median by At Least 10, 25, 30 or 50 Percent) 23 Total number of countries Range Median Normalized Standard Deviation 10%25%30%50% Survey I Survey IV Survey I Survey IV Survey I Survey IV Survey I Survey IV Survey I Survey IV Survey I Survey IV Overall restrictions on bank activities 1053—12770.30290.2851849053513425137 Entry into Banking Requirements 1350—8880.13050.05913720414120 Bank capital regulations1080—10670.30510.234690815141431323 Official supervisory powers 1320—1411 0.22350.226558362871641 Private monitoring920—12880.18240.18436863484710 External governance330—1912150.17160.107311 303000

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