Who should supervise banks for the banking sector stability?

Abstract

We empirically examine by whom the commercial banks should be supervised for the stability of a banking sector. With a cross-sectional dataset from 78 countries and using a logit estimation model, we find that the probability of the instability of a country’s banking sector reduces if the commercial banks are supervised exclusively by the country’s central bank. This probability is even higher if the central bank can conduct its supervision in a less-corrupt institutional environment. Finally, by carrying out some counter-factual thought experiments, we confirm that banking supervision causes banking sector instability, not vice versa.

Keywords:

• banking supervision
• central bank
• banking crises
• logit model
• corruption

JEL Classification:

• E58
• G32
• G21
• C35

Notes

¹ Gonzaleze-Hermosillo (1996) follows that in a broad sense a bank failure is said to occur when the regulator recognizes the bank as insolvent and decides to liquidate it, or assist in order to keep it in operation. Different instruments are usually followed to assist an ailing bank. These are, for instance, (1) merger or acquisition of the bank with other healthy banks; (2) direct injections of additional capital or other recapitalization schemes; and (3) different restructuring schemes. The restructuring schemes usually include change in bank-management; assisted generalized rescheduling of loan maturities; and removal of banks’ bad loans.