The central banker as prudential supervisor: Does independence matter?

We study whether central bank independence (CBI) and monetary policy arrangements can jointly influence the likelihood of policymakers assigning banking supervision to central banks. Our empirical analysis shows that, assuming a benevolent government, a higher degree of central bank operational (economic) independence is associated with a lower probability of supervisory powers being entrusted to the monetary authority. We interpret this result as deriving from governments’ fear of the risk of excessively discretionary monetary policy. However, there is evidence that – conditional on operational independence – central banks are more involved in supervision when they pursue tighter monetary policy goals (a specific aspect of political independence). Our interpretation is that the latter may represent a commitment to mitigate central banks’ discretion in the monetization of financial distress. Our study suggests that CBI can be relevant, not only for its alleged effects on macroeconomic variables, but also in influencing policymakers’ decisions on the allocation of banking supervisory powers.

► Can the central bank independence (CBI) influence the likelihood of policymakers assigning banking supervision to central banks? ► The cross country empirical analysis disentangles the effects of two different kind of CBI: economic and political independence. ► A higher degree of economic independence is associated with a lower probability of supervisory powers being entrusted to the central bank. ► Central banks are more involved in supervision when they are more politically independent.