Article

Market Discipline in Bank Supervision

Mark J. Flannery

in The Oxford Handbook of Banking

Published in print January 2012 | ISBN: 9780199640935
Published online September 2012 | | DOI: http://dx.doi.org/10.1093/oxfordhb/9780199640935.013.0015

Series: Oxford Handbooks in Finance

Market Discipline in Bank Supervision

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This article describes research that suggests that bank securities' prices (including stock, bonds, and CDSs) can be used to improve government supervisory processes. The second section defines the concept of market discipline and explains the importance of its two main components: market monitoring of firm value and market influence over a firm's behaviour. The third section explains how the view of banking firms as unusually ‘opaque’ may create a need for government regulation, and discusses whether banks are truly opaque. The evidence on investors' ability to monitor bank condition accurately is described in the fourth section, which concludes that bond yields do reflect bank risks, and that depositors withdraw funds when a bank's riskiness increases. The fifth section discusses some of the practical issues related to the use of market information and proposes the best way to incorporate market assessments into the supervisory process. The sixth section evaluates the concept of market discipline in light of the financial crisis that began in August 2007.

Keywords: bank securities prices; market discipline; financial regulation; bank condition; bond yields; bank risks

Article.  11055 words. 

Subjects: Economics ; Financial Markets ; Public Economics

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