In recent years, market discipline has gained increasingly more attention as an instrument of promoting safe and efficient management in banking. For example, the new capital adequacy proposals by the Basle Committee rely to a much greater degree on market discipline in securing the stability of the banking system. The American Gramm-Leach-Bliley Act on Modernization of Financial Services of 1999 reveals the same trend. However, the country that seems most advanced in the process is New Zealand. Since 1996, discipline by regulation has been extensively replaced by solutions facilitating and enhancing market monitoring and market influence. Unlike most countries, where market discipline is typically perceived as a tool complementary to the traditional prudential provisions, New Zealand has put market discipline at the heart of the system designed to secure the stability of the financial sector.

The paper presents the essence and first effects of the New Zealand market discipline experiment. The first part outlines the history of the country's banking system along with is regulatory framework. The main part deals with the specific solutions implemented in New Zealand to prioritise market discipline in banking supervision policies. This section includes a detailed description of the disclosure requirements and accountability procedures relating to the management of banks. The author then goes on to describe the evolution of the system, covering issues like the proposal that creditors' funds be utilised to refinance banks in distress, or the challenges posed by the new Basle Committee proposals and the consequences of respectively adopting or rejecting them. Part four deals with the weaknesses in the New Zealand banking supervision system. The most important of those include the fact that part of the information on a bank's operations cannot be disclosed. Second, the complicated ownership structure of the industry prevents the new solutions from applying universally throughout the system. Finally, there is concern that a predominantly market-controlled banking sector might be more vulnerable to destabilisation in crisis. In the concluding part, the author seeks to resolve whether the shift towards market discipline possibly challenges the short term stability of the banking system. He analyses the data compiled in the years 1996-2000, illustrating the performance of the banks registered in New Zealand. The findings provide a very bright picture of the situation. The country's banks - in spite of the heavy competition in the domestic market and the narrowing margins on the traditional financial intermediation services - have been able to boost their profitability by expanding the scale of operations and reducing the costs, while maintaining a high-quality loan portfolio. Thus the first five years of the new system do not provide any direct evidence of its destabilising short-run effect.