Market Discipline - Introduction


Since 1990's there is an increase of interest among policymakers and academics for enhancing the environment for market discipline. The reason being: Financial engineering and technological improvements enabled financial intermediaries to be involved in overly complex and advanced financial operations. These activities become more and more costly to monitor and supervise from the regulatory agency perspective. This is precisely why regulators support the idea of including market discipline as another channel to complement regulatory policies. In a study reported to the Congress in 1983 by the FDIC, the challenge to the possibility of restructuring financial markets is stressed quite nicely:

"We must seek new ways, in the absence of rigid government controls on competition, to limit destructive competition and excessive risk-taking. There are only two alternatives. We can promulgate countless new regulations governing every aspect of bank behaviour and hire thousands of additional examiners to enforce them. This approach would undercut the benefits sought through deregulation, would favour the unregulated at the expense of the regulated, and would ultimately fail. The FDIC much prefers the other alternative: seeking ways to impose a greater degree of marketplace discipline on the system to replace outmoded government controls". (page:3)

Therefore, making the relevant financial data publicly available in a timely fashion will, supposedly, help investors to better evaluate bank condition by themselves and as such this will relieve the pressure of regulators and put it on the shoulders of the market investors and depositors.

The right amount of information release is essential. With too little information, there is no discipline. Too much information, on the other hand, may cause a bank run which might have devastating consequences. A timely, balanced amount of information is critical for the desired results.

At the Conference of Bank Structure and Competition on May 8, 2003, the then FED Chairman Alan Greenspan noted that transparency is not the same as disclosure. Relevant data shall be disclosed in a timely fashion for enhanced transparency:

"Transparency challenges market participants not only to provide information, but also to place that information in a context that makes it meaningful."

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