The Microeconomic Effects of Different Approaches to Bank Supervision

A large body of evidence finds that cross-country differences in banking sector development influences national rates of economic growth. To assess which policies enhance the functioning of banks, this paper evaluates two broad government approaches to bank supervision: official supervision, and private sector monitoring. The microeconomic evidence is inconsistent with the official supervisory approach to bank supervision and regulation and broadly consistent with the private monitoring view. The data do not suggest that strengthening the ability of official supervisors to directly monitor and discipline banks improves bank efficiency or the integrity of bank-firm relations. Rather, the data indicate that empowering official supervisors tends to increase the degree to which the corruption of bank officials curtails firm growth. The results empirically verify the private monitoring approach. Empowering private monitoring of banks tends to enhance the efficiency of intermediation and enhance the integrity of bank-firm relations. While confirming the private monitoring view, the data strongly reject the official supervisory approach to bank supervision.