Central bank independence, financial supervision structure and bank soundness: An empirical analysis around the crisis

Abstract

Abstract Over the last fifteen years, many countries introduced reforms into the supervisory architecture of their financial sector. However, there is no evidence on whether specific supervisory arrangements were more successful than others during the crisis. Empirical evidence on the topic is in general scarce and there are reasonable theoretical arguments for and against alternative approaches. Similarly, while the effect of central bank independence on price stability has attracted a lot of attention, our knowledge with regards to its effect on bank soundness remains limited. Using a large sample of commercial banks operating in various countries over the period 2000–2011, this paper investigates whether and how bank soundness is influenced by central bank independence, central bank involvement in prudential regulation, and supervisory unification. We find that central bank independence exercises a positive impact on bank soundness, which in the case of smaller banks is enhanced during the crisis. Supervisory unification and the central bank involvement appear to mitigate the adverse effects of the crisis. The power of the supervisory authorities and bank size also appear to be conditional factors.