Measuring the quality of banking regulation and supervision and its relevance for inflation in transition countries

Abstract

Bank regulation and supervision is essential to maintain confidence and stability in the financial system. The contribution of this study is twofold: primarily, we develop a technique to measure the quality of bank regulation and supervision by identifying the techniques and tools that should exist in a banking law. Secondly, using this measurement criteria, we form an index of banking regulation and supervision (RS) in a manner that allows systematic comparisons. We then use this index to document and quantify the cross-sectional and over time variation in the quality of RS in transition economies. This empirical findings support our hypothesis that regulation and supervision is negatively associated with inflation; and good regulation and supervision along with a high level of legal central bank independence and liberalization has a significant effect on price stability. Results not only confirm the studies of Cukierman, Webb and Neyapti (1999) and Melo, Denizer and Gelb (1996), but also modifies them by incorporating an additional institutional dimension.