How and when exercising financial supervision can enhance central bank's independence

Abstract

According to the current literature concentrating monetary policy and supervisory policy functions in the central bank weakens the anti-inflationary credibility of this institution. In this paper we show that, if central banks behave as political players, exercising banking supervision can allow these institutions to gain the support of commercial banks and therefore to enhance their independence from political pressures and their credibility. However, the use of central banks' supervisory powers to strengthen the banking industry's support, may lead to an inefficient regulation of the banking sector. Therefore there may be a trade-off between giving central banks' supervisory authority and banking efficient regulation.