This article reviews the literature on political economy of banking regulation. The organization of this paper is based on the two main traditions about regulation, namely the normative or prudential and the positive political economy traditions. Several theoretical elements are extracted from the review of the specialized literature on regulation. The main aspects covered here are the rationale and instruments for banking regulation; the failure of governments in various settings; endogenous regulation and the political economy of banking regulation. The paper also covers a new dimension of banking regulation - as a dialectic process.

The pioneering work of Shaw (1973) and McKinnon (1973) stressed the role of financial deepening in economic development. Financial deepening occurs when the pace of accumulation of financial assets is faster than the accumulation of non-financial wealth (Gonzalez Vega 1976). The success with which funds are mobilized by financial intermediaries and transferred to profitable activities is now widely regarded as a crucial determinant of the pace of economic development (Levine, Loayza and Beck 1998).