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The World Bank Research Observer Advance Access originally published online on August 5, 2006
The World Bank Research Observer 2006 21(2):179-206; doi:10.1093/wbro/lkl002
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Right arrow O16 - Financial Markets; Saving and Capital Investment
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© The Author 2006. Published by Oxford University Press on behalf of the International Bank for Reconstruction and Development / THE WORLD BANK. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org.

Banking and Regulation in Emerging Markets: The Role of External Discipline

Xavier Vives

Xavier Vives is Professor of Economics and Finance at IESE Business School, University of Navarra, Barcelona, and Research Professor at Institució Catalana de Recerca i Estudis Avançats-Universitat Pompeu Fabra (UPF); his email address is xvives{at}iese.edu.

This article reviews the main issues of regulating and supervising banks in emerging markets with a view toward evaluating the long-run options. Particular attention is paid to Latin America and East Asia. These economies face a severe policy commitment problem that leads to excessive bailouts and potential devaluation of claims of foreign investors. This exacerbates moral hazard and makes a case for importing external discipline (for example, acquiring foreign short-term debt). However, external discipline may come at the cost of excessive liquidation of entrepreneurial projects. The article reviews the tradeoffs imposed by external discipline and examines various proposed arrangements, such as narrow banking, foreign banks and foreign regulation, and the potential role for an international agency or international lender of last resort.


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