Market Discipline In Banking

The ability of market forces to supervise banking firms has become an important policy problem as banking firms evolve within increasingly global financial markets. The Basel Committee has expressed growing interest in the use of market-related to supplement their traditional methods of supervising banking firms. In 2001 according to the comment of The New Basel Capital Accord, The Committee has put forward that minimum capital standards (Pillar 1) and the supervisory review process (Pillar 2) and market discipline(pillar 3) can promote safety and soundness in banks and financial systems. Market discipline imposes strong incentives on banks to conduct their business in a safe, sound and efficient manner, including an incentive to maintain a strong capital base as a cushion against potential future losses arising from risk exposures. So it is crucial to the safety of bank systems.In the first chapter, the paper introduces the background of writing and reviews the research relative to market discipline. In addition, this chapter points out the structure and research method of the paper.In the second and the third chapter, the paper gives a definition of the market discipline. Market discipline is a process in which the creditors and owners of a bank or other related-beneficiaries will transfer their deposits from an unsound bank to a sound bank or sell their owned equity of unsound bank based on the information disclosure from the bank, the account office, the law office and the credit agencies etc. By doing so, the bank will be forced to run soundly, or it will be drop out of the market. The traditional government supervision shows serious flaws in that its strict and overall regulations subdue the development of banks and this leads to the emergence of market discipline. In addition, the paper elaborate on the content of market discipline. First, some preconditions must be met to maximize the effect of market discipline, including perfect information disclosure, limited safety net, the strict market-dropout policy and good banking environment, etc. Of course, sound macroeconomic circumstance is the first premise of efficient market discipline to achieve its goals by means of actions form a single bank. If the bank system encounters problems, the function of market discipline will fall into trouble. Not surprisingly, as for the government supervision and market discipline, each type of supervision has some comparative advantages, thus it is difficult to choose one system over the other on the basis of the theory alone. Government agents probably have a cost advantage over multiple private analysts, and their access to inside information about firm condition may be superior for two reasons: examiners can force managers to reveal information, and a single government agency does not suffer from free-rider problems associated with many fragmented stakeholders. These government advantages may be partially offset by government constraints which make it difficult to pay competitive market wages. In addition, regulator's incentives to identify and remedy problems promptly have been questioned. When it comes to the discipline of banks, government agents operate under rigid procedural constraints designed to ensure that all regulated institutions are treated fairly. These procedures often slow the imposition of corrective measures, even when problems have been accurately identified. By the contrary, the market is not expected to be fair treated-at least not to the same extent. Market disciplinary forces can therefore take effect rapidly, only if the government safety net does not mute market incentives to act quickly when a problem is first recognized.In the fourth chapter, the paper discusses the practice of market discipline in developed countries and this progress of it promoted by The Basel Committee. The Basel Committee is the most important force to encourage market discipline. In Core Principles for Effective Banking Supervision (SEP, 1997), it is pointed out that effective market discipline is the preconditions for effective banking supervision. An effective system of banking supervision will assign clear responsibilities and objectives to each agency involved in the supervision of banking organizations. Each such agency should possess operational independence and adequate resources. Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place. In Enhancing Bank Transparency (SEP, 1998), this report discusses the role of information in effective market discipline and effective banking supervision. The paper recommends that banks, in their financial reports and other disclosures to the public, provide timely information which facilitates market participants' assessment of them. It identifies the following six broad categories of information, each of which should be addressed in clear terms and appropriate detail to help achieve a satisfactory level of bank transparency: financial performance, financial position, risk management strategies and practices, risk exposures accounting policies, and basic business, management and corporate governance information. In New Basel Capital Accord, it identifies that market discipline is one of three pillars to protect the stability of banks. Market discipline has the potential to reinforce minimum capital standards (Pillar 1) and the supervisory review process (Pillar 2), and thus promote safety and soundness in banks and financial systems. Market discipline imposes strong incentives on banks to conduct their business in a safe, sound and efficient manner, including an incentive to maintain a strong capital base as a cushion against potential future losses arising from risk exposures. NEW ZEALAND is the first country to enforce the market discipline in regulating the banks. AMERICA and SINGAPORE are also good patterns of market discipline. These countries make some progress in practice but at the same time incur some criticisms, so there are still some points deserving further discussion.The fifth chapter and the sixth chapter are difficult to deal in the whole paper because there are few materials on market discipline at present in China and it is an arduous work to enhance the overall effect of market discipline in Chinese banking supervision. However, the construction of market discipline mechanism is an issue that must be confronted regardless of arduous difficulties in our country. The government supervision and the interior management of banks have many defects which create preconditions for the market discipline. So we must create conditions actively in order to avoid exterior costs stemmed from the action of market discipline. We need to deepen the reformation of commercial banks, establish the perfect corporate governance and information disclosure system in banks. And we also need to abolish the potential deposit insured system, persist on the principle of limited safety net, strict the market-dropout policy and establish the credit agency system.The main contribution of this paper is that it first elaborates on the relation among the government supervision, market discipline and the interior management. It also puts forward the viewpoints about the discussion of the practice of market discipline and furthermore provides some valuable areas in the forthcoming discussion.