Supervisory Incentives in a Banking Union
IMF Working Papers, September 15, 2016
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- Supervisory Incentives in a Banking Union
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Bibliographic details
- Authors: Elena Carletti, Giovanni Dell'Ariccia, Robert Marquez
- Published: September 15, 2016
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475536751.001
Summary
- The paper analyzes supervisor behavior when a centralized agency has full authority over bank decisions but depends on local supervisors to collect necessary information.
- This institutional arrangement creates a principal-agent problem between the central and local supervisors when their objective functions differ.
- Information collection under this design may be inferior to that under fully independent local supervisors or under centralized information collection.
- Inferior information collection may increase risk-taking by regulated banks.
- A “tougher” central supervisor may raise regulatory standards.
- The net effect of centralization on bank risk taking depends on the balance between weaker information collection and tougher regulatory standards.
Key findings
- Principal-agent frictions arise when central and local supervisors have different objective functions.
- Decentralized information collection by local supervisors, when combined with centralized decision authority, can lead to lower-quality information relative to alternatives.
- Lower-quality information can increase regulated banks’ risk-taking incentives.
- Centralization can also lead to stricter regulatory standards if the central supervisor is “tougher,” which can counteract increased bank risk-taking.
Policy implications and considerations
- Assess the trade-off between centralized decision-making and the quality of information collection by local supervisors.
- Consider mechanisms to align objectives between central and local supervisors to mitigate principal-agent problems.
- Evaluate whether centralized supervision should be paired with reforms to ensure information quality (e.g., incentives, reporting standards, monitoring of local supervisors).
- Recognize that centralization’s net impact on bank risk depends on the relative strength of improved regulatory standards versus degraded information collection.
Scope and topics
- Subject areas: Balance of payments, Bank supervision, Banking, Commercial banks, Distressed institutions, Financial institutions, Financial regulation and supervision, Financial services, Investment banking, Portfolio investment.
- Keywords: bank risk taking, Bank supervision, capitalized bank, Centralized bank supervision, Commercial banks, Distressed institutions, Europe, Global, Investment banking, investment portfolio, limited liability, optimal portfolio, portfolio choice, Portfolio investment, portfolio quality, price bank risk, reaction function, WP.