2.

7 Theoretical Framework
The theoretical framework of this dissertation delves into the intricate
relationship between regulatory strictness and financial stability, with a
particular emphasis on the Thai financial system. Regulatory strictness,

characterized by the rigor and enforcement of financial oversight, is

critical in ensuring market discipline and mitigating risks associated with
moral hazard, asymmetric information, and systemic vulnerabilities.
Figure X presents the theoretical framework underpinning this study,
articulating the anticipated pathways through which regulatory strictness
may impact financial stability. This visual diagram guides the relationships
and constructs that will be examined in detail throughout this chapter.
The framework presented in this research considers 'Regulatory
Strictness' as the primary independent variable influencing key financial
concepts. These concepts include 'Market Discipline,' 'Moral Hazard and
Asymmetric Information,' and 'Systemic Risk and Too-Big-To-Fail.' These
mechanisms represent how regulations can affect practices within
financial institutions and, ultimately, their stability.
The framework suggests that these mechanisms interact with broader
economic factors such as 'Monetary Economics' (the role of monetary
policy) and 'Institutional Economics' (how institutional characteristics such
as size, type, and age influence economic behavior). Additionally, the
'Macroeconomic Environment' including indicators like GDP growth and
inflation, directly affects financial stability.
Furthermore, the outcomes of regulatory influences (called 'Financial
Regulation Impacts') are connected to 'Risk Management Practices.' It is
these risk management practices that are thought to have a direct effect
on 'Financial Stability,' which is the central outcome of interest in this
research. External economic conditions and institutional characteristics
also moderate this effect.
Here is the list of Theoretical Framework Theories:
1. Financial Regulation Theories
i. Market Discipline
Drawing on the theory of market discipline, the
framework posits that transparent market operations allow
well-informed market participants to make better decisions,
potentially reducing the need for stringent regulations. The
 hypothesis is that a well-informed market is a self-correcting
entity, and the framework will explore how transparency can
substitute for regulatory strictness in promoting financial
stability.
ii. Moral Hazard and Asymmetric Information
The framework incorporates the theory of moral hazard
and asymmetric information to examine the behavior of
insured institutions. It hypothesizes that these institutions
may engage in riskier behavior without appropriate regulatory
mechanisms as they do not bear the full consequences of
their actions. The dissertation will investigate how regulatory
strictness can mitigate these risks within the Thai banking
sector.
iii. Systemic Risk and Too-Big-To-Fail
The too-big-to-fail theory suggests that the failure of
large institutions can lead to cascading effects on the broader
economy, necessitating stringent oversight and regulation.
The framework will assess how the regulatory environment in
Thailand addresses the systemic risk and whether it
effectively prevents economic fallout from the potential
failure of large, interconnected banks.
2. Risk Management Theories
i. Portfolio Theory
 The framework will use portfolio theory to guide the
analysis of how banks manage risk through diversification and
the influence of regulatory strictness on risk-taking behaviors
across different asset classes. It will evaluate if stringent
regulations prompt Thai banks to diversify their portfolios to
mitigate risk.
ii. Capital Adequacy Theory
According to capital adequacy theory, higher capital
reserves are critical for absorbing losses. The framework will
explore whether stringent capital requirements are correlated
with excellent financial stability in the Thai banking system. It
will analyze how these requirements impact the overall
resilience of financial institutions during economic downturns.
3. Economic Stability Theories
i. Monetary Economics
The framework will use monetary economics to
understand the interplay between monetary policy and
financial regulations. It will examine how the regulatory
environment interacts with monetary policy tools to
influence bank behaviors, such as lending practices and
interest rate risk management.
ii. Institutional Economics
 Institutional economics will provide insights into how
governance structures and regulations of financial institutions
affect economic outcomes. The framework will analyze the
differential responses of SFIs, commercial banks, and shadow
banks to regulatory strictness, considering how institutional
characteristics shape these responses.
The theoretical framework suggests a multi-layered approach to
understanding financial stability, integrating the direct effects of regulatory
strictness with the mediating roles of market discipline and risk
management practices while also considering the broader economic and
institutional context.
In the following sections, each element of this framework will be
explored in depth. We will examine how regulatory strictness can
influence market behavior and institutional responses, and how these
contribute to the financial system's overall stability. This exploration will
include a review of relevant literature, theories, and models that support
the constructs and relationships depicted in the framework.

I. Heterogeneity in Regulatory Impact

Regulatory effects differ based on an institution's size, role, and
systemic importance. This study aims to explore this heterogeneity
within Thailand's financial sector. It posits that SFIs and shadow
banks might respond differently to regulatory pressures than
commercial banks due to their varying operational goals and
 regulatory frameworks. This part of the study uses panel data
regression to analyze the dynamic relationship between regulation
and stability, highlighting potential shifts in activities and responses
to regulatory changes.

II. Adaptive Risk Management Strategies

Financial institutions' ability to adjust their risk management in
response to regulatory changes is crucial for stability. This section
examines how portfolio and capital adequacy theories influence
financial institutions' risk management strategies, particularly under
varying regulatory conditions. It extends previous research, like
Ashraf et al. (2016), to the Thai context, employing quantitative
analysis to observe evolving strategies.

III.Regulatory Arbitrage and the Shadow Banking System

This section addresses the risk of regulatory arbitrage,
particularly in Thailand's less-regulated shadow banking system. It
investigates how increased regulations in traditional banking might
shift activities to shadow banking, using qualitative and quantitative
analyses to understand this phenomenon's impact on financial
stability.

IV. Contextual Specificity in the Thai Financial System

The research emphasizes the importance of understanding
Thailand's unique regulatory, economic, and institutional context.
This section outlines how the diversity of Thailand's financial system
 necessitates a nuanced approach to regulation and how the study's
methodology is tailored to capture these specific dynamics.

V. Panel Data Regression Analysis

Panel data regression analysis is used to understand the time-
varying effects of regulatory strictness on financial stability. This
section explains the method's advantages, including its ability to
capture temporal changes and control for individual-specific
characteristics, offering a comprehensive view of the regulatory
landscape's impact.

VI. Policy Implications and Systemic Stability

The final section links the research findings to broader policy
implications. It discusses how the insights can guide Thai
policymakers in balancing regulations to maintain financial stability
without hindering growth. The findings also have broader
implications for systemic stability and regulatory strategies in
emerging economies, potentially offering insights applicable beyond
Thailand.

VII. Hypotheses Development

1. Stringent regulatory environments may enhance financial
stability by promoting cautious risk management but could also
potentially constrain growth and profitability.
2. SFIs, given their distinct mandates, might react to regulatory
changes differently from commercial banks.
3. The response of the shadow banking sector to increased
regulatory stringency could highlight significant gaps in current
regulations due to its inherently less regulated nature.
4. Non-bank financial institutions, with their unique risk profiles
and operational models, may respond to regulatory strictness
in ways distinct from traditional banks, potentially affecting
various aspects of financial performance and stability.