Do depositors discipline the banking sector? Evidence from an emerging economy

Abstract

Purpose Market discipline is an important part of financial regulation, under Basel II and III. This paper aims to provide evidence on market discipline in Pakistan. Specifically, the authors have analyzed the impact of CAMEL variables on costs of funds and deposit switching. Design/methodology/approach This study has used panel data related to different banking and macroeconomic variables. The sample period is 2004–2017 so it has covered the changing regulations that became binding for banks under Basel II and III. Quarterly data has been collected from the financial disclosure of publicly listed banks. The total number of banks in the sample is 26. Among these, 24 are publicly listed. Foreign banks have not been included because their activities in Pakistan are quite limited. Findings It has been found that efficiency, liquidity, asset quality and capital adequacy are negatively related to costs of funds for banks. Capital adequacy, liquidity and profitability are negatively related to deposit switching. Research limitations/implications These results indicate the presence of market discipline and have generated valuable implications for bank managers and regulators. Originality/value In this study, the case of Pakistan is interesting. The country has experienced financial liberalization that sought to avoid government intervention and encourage a more “market-based” approach. This change in the system was made more pronounced by the privatization of nationalized banks, improvement in the market structure, reduction in barriers to entry and consolidation of smaller banks. As a result, the banking system has emerged as an important source of financing and it provides us motivation to look deeper into depositor discipline in banking sector.