Financial Instability in the Era of Deregulation: Examining the Role of Government Oversight

Abstract

This paper investigates the impacts of financial deregulation policies in Pakistan from the 2011s to 2020s on banking sector stability. Deregulation over this period reduced oversight of bank leverage, capital buffers, and lending practices. Using simulated data, quantitative analysis suggests deregulation contributed to increased financial instability. Hypothetical crisis frequency data shows more banking crises after 2020s deregulation compared to the preceding 5 years. Time series models estimate eased capital requirements after 2015 were associated with rising nonperforming loans. Regressions also link reduced supervision strictness to increased bank leverage ratios and declining capital adequacy ratios. These results align with the hypotheses that deregulation encouraged excessive risk-taking among banks, leading to higher instability. The analysis is limited by simulated data constraints. However, it highlights the need to strengthen regulation to prevent systemic crises. Pakistan should reinstate capitalization requirements, improve supervision processes, and align policies with international Basel Accords. Further empirical research using actual Pakistani bank-level data can offer valuable insights to guide policy reforms aimed at balancing financial development with stability.

Keyword: Financial deregulation, Banking regulation, financial stability, Systemic risk, Bank supervision