The Role of Market Discipline in Ensuring the Soundness and Stability of the Banking Sector

Abstract

This study examines market discipline in the banking sector, an issue central to the sector's soundness and stability. It investigates the role of market discipline in mitigating systemic banking risk. The analysis addresses supervisory authorities' need for market discipline, the concept and operation of market discipline in banking, and the complementarity between market discipline and official supervision in strengthening banking sector stability. The findings indicate that market discipline provides strong signals that supervisory authorities can incorporate into early-warning models, enabling timely corrective action. Market discipline also exerts direct pressure on bank managers to take corrective measures. It therefore complements official supervision and contributes to banking sector stability.