The Impact of Regulatory and Supervisory Structures on Bank Risk and Efficiency: Evidence from Dual Banking System

Abstract

James Madison once said “If men were angels, no government would be necessary”. Madison’s view has direct implications for efficient bank supervisory and strong regulatory strategies. On the onset of 2007-08 subprime crisis banking system across the globe were left exposed to financial tsunami due to over-expansion and excessive risk concentrations. This incident should provide regulators wake up call to further develop and strengthen the regulatory system with new and strict monitoring mechanism. In the given context, this paper will investigates the linkages between bank regulatory and supervisory structures associated with Basel III’s pillars and various aspects of banks’ efficiency and risk. The analysis will be focussed on dual banking system over the period 2006-2010. Our results suggest that regulations and strict monitoring of banking operation, and higher supervisory power of the authorities, increase the technical efficiency for Islamic banks but decreases convention banks efficiency. We observe the opposite effect in the case of restrictions on bank activities, with higher restrictions having a reduction in risk taking of Islamic banks while increasing the risk taking of conventional banks. Results also indicate that Islamic banks are better prepared towards the implementation of Basel III guidelines compared to their conventional counterparts.