Financial Sector Assessment a handbook, Chapter 4 Assessing Financial Structure and Financial Development, imf and World Bank, August 2005

Development Obstacles Imposed by Unwarranted Prudential 
Regulation
Supervision and regulation have important implications for the effectiveness of interme-
diation and access to financial services, in addition to their roles in fostering stability. 
Entry regulation and uneven supervisory practices across different groups of financial 
institutions (either by type or ownership) can hamper competitiveness and, thus, effec-
tiveness. Different regulatory and supervisory standards across different financial institu-
tions that offer similar products and compete directly with each other can negatively 
affect competitiveness. Heavy regulation of branch openings (as already mentioned) or 
other delivery channels can limit access to financial services. For example, prudential 
policies should avoid undue reliance on tools that are likely to disadvantage small and 
new firms (such as excessive mandatory collateralization requirements for bank loans). 
Supervision and regulation also impose transaction costs on financial institutions and, 
ultimately, on the users. The benefit of regulation and supervision in terms of promoting 
soundness and stability must be balanced with the costs that they may impose in terms of 
efficiency and access. Given the high fixed-cost component of financial supervision, that 
balance is especially important for small financial systems and for components of finan-
cial systems that are made up of small institutions, such as the cooperative movement or 
microfinance.
4.7
From Finding Facts to Creating Policies
Once the data gathering and analysis have been conducted (as outlined in sections 4.2 
through 4.6), policies and reforms must be identified and prioritized. The task of policy 
formulation consists of distilling those findings into an overview of the principal strategic 
issues and development gaps—specifically in terms of the functions that finance is sup-
posed to perform—and of opportunities. The reforms needed to enhance development of 
the financial system typically fall under the headings of (a) infrastructural strengthening, 
(b) policy corrections to reduce unintended side effects of regulatory or tax policies, or
(c) governance reform. Those reforms must be prioritized and synthesized.

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Financial Sector Assessment: A Handbook