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This dissertation studies a number of topics related to the banking sector regulation. It focuses on the impact of various types of regulation on the banking system stability and also on the implication of some types of regulation for economic dynamic and welfare. In fact, due to numerous market failures present in the banking industry, banks are viewed as fragile. This has led governments to regulate heavily the banking sector, which is nowadays one of the most regulated industries in the world. This dissertation first reviews the theoretical and the empirical literature on the banking system regulation, then uses the Markov-switching model to assess empirically the impact of regulation on the banking system stability, and finally analyzes the growth and welfare effects of banking regulations, such as asset holding restrictions and capital adequacy requirements. More precisely, the first chapter reviews the work already done on the link between banking regulation and the banking sector stability. It brings together and adds structure to the empirical literature on the link between banking regulation and banking system stability. In addition to clarifying the theoretical underpinnings for studying banking regulation, it points to several directions for future empirical research, necessary to fill the gaps in our understanding of the link between banking regulation and stability. It finds that although there are many types of banking regulation, studies focus mainly on a group of regulations such as the capital adequacy requirement, the deposit insurance, and the reserve requirement. The theoretical prediction of the effect of almost each type of regulation on the banking sector stability is mixed. The key reason behind this is the fact that there are many types of market failures in the banking industry. Therefore, a regulatory measure can succeed to cure a given market failure but at the same time help to increase the other market failures. In "The Empirics of Banking Regulation", we assess empirically whether banking regulation is effective at preventing banking crises. We use a monthly index of banking system fragility, which captures almost every source of risk in the banking system, to estimate the effect of regulatory measures (entry restriction, reserve requirement, deposit insurance, and capital adequacy requirement) on banking stability in the context of a Markov-switching model. We apply this method to the Indonesian banking system, which has been subject to several regulatory changes over the last couple of decades and at the same time has experienced a severe systemic crisis. We draw the following findings from this research: (i) entry restriction reduces crisis duration and also the probability of their occurrence; (ii) larger reserve requirements reduce crisis duration, but increase banking instability; (iii) deposit insurance increases banking system stability and reduces crisis duration; (vi) capital adequacy requirement improves stability and reduces the expected duration of banking crises. Finally, in "The Welfare Cost of Banking Regulation", we are motivated by the fact that the Basel Accords promote the adoption of capital adequacy requirements to increase the banking sector's stability. Unfortunately this type of regulation can hamper economic growth by shifting banks' portfolios from more productive risky investment projects toward less productive but safer projects. We introduce banking regulation in an overlapping-generations model of capital accumulation and studies how it affects economic growth, banking sector stability, and welfare. In this model, a banking crisis is the outcome of a productivity shock, which leads some banks to be unable to fulfill their obligations toward lenders. Banking regulation is modeled as a constraint on the maximum share of banks' portfolios that can be allocated to risky assets. This model allows us to evaluate quantitatively the key trade-off inherent to this type of banking regulation, between banking sector stability and economic growth. The model implies an optimal level of regulation which eliminates banking crises. At the same time, regulation is detrimental to growth. We find that the overall effect of the optimal level of regulation on social welfare is positive when the likelihood of a banking crisis is sufficiently high and economic agents are sufficiently risk-averse. We use the model to evaluate whether the proposed Basel Accord regulation might be welfare-improving, given plausible magnitudes for the likelihood of a crisis and agents' risk aversion. Keywords . Markov switching models, overlapping generations models, competitive equilibrium, economic growth, banking stability, banking regulation. JEL Classification . C25, D50, D94, E44, G21, G28.
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