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Technological Improvements Crucial To Greater Transparency In Banking Supervision

Direct government supervision of banks may actually drive corruption in some countries, study suggests.

Traditional approaches to government supervision of banks may actually hurt development and lead to greater corruption in lending in some countries, according to research by Brown University (Providence, R.I.) Professor of Economics Ross Levine. Based on new data from more than 2,500 financial services firms across 37 countries, Levine and his coresearchers assessed how different supervisory policies impact banks' ability to raise capital.

The researchers found considerable evidence that supervisory and regulatory practices that focus on transparency and public disclosure of information improve the efficiency and integrity of bank lending when countries have effective legal systems, which could have implications on banks' IT infrastructures. "Improvements in information technology are absolutely key because they provide an inexpensive mechanism for disseminating information and facilitating comparisons," Levine says. "IT innovations ... should transform bank regulation and supervision."

After assembling the first international database on banking policies, Levine and his coauthors assessed which policies promote sound banking, judged in terms of stability, bank development, efficiency, corruption in lending and corporate governance of banks. They compared countries that choose a hands-on approach (such as Argentina, Bolivia and Nigeria), in which the government owns much of the banking industry and creates a powerful supervisory agency that directly oversees banks, to countries that rely substantially less on direct government control and put greater emphasis on forcing banks to disclose accurate information to the public (including the U.S., the U.K., Canada, Australia and Korea).

According to the research, powerful supervisory agencies with the authority to directly monitor and discipline banks do not improve bank operations; rather, powerful supervisory agencies tend to lower the integrity of bank lending. Further, bank supervisory strategies that focus on forcing accurate information disclosure and not distorting the incentives of private creditors to monitor banks enhance the efficiency of banks and reduce corruption in lending.

"Sunlight is the best disinfectant," Levine says. "Transparency helps stop corruption."

Basel Bad for Business?

Based on the findings, Levine asserts that 90 percent of the countries that are mandating Basel II regulations could face negative outcomes, including China, India and Russia. "Basel II will tend to encourage the creation of more-powerful bank supervisors in many countries that do not have the political system to oversee supervisory agencies effectively. This will tend to reduce the efficiency of banks, since [it] may work to limit competition," Levine contends. "This will also tend to increase corruption in lending, as the entrepreneurs without political connections or ties to supervisors may find it difficult to access banking credit."

"This is not a laissez-faire finding," the report concludes. "This result suggests that active bank supervision can help ease information costs and improve the integrity of bank lending. Just as clearly, however, the results highlight the importance of theories that emphasize political and regulatory capture and suggest that powerful supervisory agencies too frequently do not act in the best interests of society."

Levine first questioned bank supervision policies as an economist with the World Bank from 1990 to 1997. "But there was no evidence that any universal set of best practices are appropriate for promoting sound banking in countries as different as the United States, Nigeria, Russia, China and Argentina," he relates.

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