Politicians and Financial Supervision Unification Outside the Central Bank: An Update of Theory and Evidence

Abstract

An increasing number of countries show a trend towards a certain degree of consolidation of powers in financial supervision, which has resulted in the establishment of unified regulators, that are different from the national central banks. By contrast a high involvement of the central bank in supervision seems to be correlated with a multi - authorities regime (central bank fragmentation effect). This paper, using a simple application of a general common agency game, sheds light on which conditions the politicians prefer when implementing a unified sector supervision outside the central bank. From a theoretical point of view the quality of public sector governance plays a crucial role in determining the supervision unification. Focusing on the behaviour of the "good" policymaker (helping hand type), it will prefer a unified financial authority that is different from the central bank if the correspondent welfare gains - linked to at least one of the three effects: moral hazard, conflict of interest, bureaucracy - are considered higher respect to the information losses. The "bad" policymaker (grabbing hand type) will choose the single financial authority if the financial industry likes it, and the central bank is not a captured one. On the other hand, the paper tests the model, confirming the robustness of the institutional position of the central bank in explaining the recent trend in supervision consolidation, with an empirical analysis performed with ordered functions on an updated dataset.

Keywords: Financial Supervision, Central Banks, Political Economy

JEL Classification: G18, G28, E58