The Boundaries Of Banking Supervision

Banks are under supervision due to their pivotal function in the nationaleconomy and their unique features. Bank supervision is of particular significanceunder the background of economic system reform in China. However, in more thanone hundred year's banking history, the cycle of "regulation-deregulation -re-regulation" always exists, which testifies to both the importance of supervisionover banks and the inconsistent understanding among regulators over this issue.Theoretically speaking, arguments between effective regulation theory andineffective regulation theory exist. Practically, banking regulatory bodies of variouscountries are wavering between loosening supervision and tightening supervision.This trend is even grievous under new circumstances. Firstly, the prevalence ofhi-tech and novel financial instruments makes it more difficult to conduct accurateand comprehensive bank supervision. Secondly, bank supervision and supervisionover other financial institutions are gradually integrated as a whole. Financialdeepening and financial innovation make the divide between banks and otherfinancial institutions fade away. Pure bank supervision without considering all thesefactors and changes should involve great risks.Under such circumstances, bank supervision should find a balance point betweenloosening and tightening extremes. Cost-benefit analysis, aiming at defining a banksupervision boundary, serves this purpose well. This boundary is the balance pointbetween the cost and benefit of bank supervision. Two conditions are necessary to getsuch a point: determining the supervision cost;determining the supervision benefit. Ifthese two problems are solved, bank supervision boundary could be defined as well.This paper will conduct an in-depth study on the cost and benefit of bank supervision.This paper has three parts. The first part is an introduction of the study. Firstly, itprovides the background of the study and the theoretical and practical significance ofthe study;it then gives a brief summary of relevant theories concerning banksupervision and an introduction of the cost-benefit analysis. Finally, studymethodology, paper structure, innovations and limitations of this paper are providedsuccessively.The main body is composed of four chapters. Chapter One, the groundwork ofthis paper, introduces the concept of bank supervision boundary. The concepts of banksupervision and bank regulation are introduced and distinguished, and the concept ofbank supervision boundary is defined. Features of bank supervision boundary aredescribed to draw the practical boundary and theoretical theory. Costs and benefits ofbank supervision are studied briefly;bank supervision boundary is analyzedaccordingly. At the end of this chapter, a model to define supervision boundary withcost-benefit analysis is introduced.Chapter Two provides a detailed analysis of bank supervision cost. This costcould be divided into direct cost and indirect cost. Direct costs include administrativecost borne by the government and compliance cost borne by banks. Indirect cost couldnot be scaled by cash. It is represented neither by the buildup of governmentexpending, nor by the enhancement of cost borne by people;rather, it is caused by thedecrease of social welfare level. The first two sections of this chapter focus on thesetwo types of cost. The third section gives an introduction of another cost-shift cost,which is peculiar to the current economic reform in China.Chapter Three makes an analysis of the functions of bank supervision. Banksupervision goals, including ultimate goal, practical goal and specific goal, are firstlyintroduced. Through a comparison of financial stability and financial development,financial stability is defined to be the core function of bank supervision. With severalcases of the reforms of state-owned banks, the chief bank supervision function is topromote economic growth through the realization of financial stability. Severalnegative cases show that excessive pursuit of financial development may lead toeconomic crises. Therefore, this chapter discusses the core function of banksupervision, which is undoubtedly the supervision benefit.Chapter Four discussed the supervision balance from the perspectives ofsupervision demand and supervision supply. Supervision supplier is the government,while the demand is the fragility of the overall financial system including banks. Allthe participants in the national economy including government, banks, other financialinstitutions and customers demanding financial services are in need of banksupervision. Short-term rigidity of supply and continual variation of demand for banksupervision make the short-term supervision unbalance natural. In other words,financial stability is not a normal state, which makes it impossible to definesupervision benefit with financial stability. In such a condition, supervision benefitshould be clearly defined: financial sub-stability is also the supervision benefit giventhat the supervision is effective.The conclusion reiterates that the core function of bank supervision is financialstability rather than financial development. The development of banking and financialsystem is the natural result of economic growth;financial stability is one of thepreconditions for economic growth. Financial development, however, will notdefinitely promote economic growth;many other factors are involved. Therefore, theprimary function of bank supervision lies in financial stability. Supervision benefit isjust the realization of its core function, i.e. financial stability. Obviously, in order toevaluate the benefit of bank supervision, we should determine the significance offinancial stability in economic growth.Supply and demand of bank supervision don't match;supervision balance is nota normal state;unbalance is the normal state. That is to say, financial stability is not anormal state. Financial sub-stability, or restricted financial intermediation function, isa normal state. Financial intermediation function restriction rather than deteriorationis also a supervision function. Therefore, financial sub-stability is also the supervisionbenefit. We could determine the significance of financial stability in the economicgrowth so as to evaluate the benefit of bank supervision.