Optimal jurisdiction of financial supervision

Abstract

Purpose – This paper aims to discuss factors that affect the socially optimal jurisdiction of financial supervision in the presence of economies of scale in banking. Design/methodology/approach – Analysis of the trade-off between likelihood of “regulatory capture” of supervisors in a small jurisdictions and benefits of greater rates of financial innovation in a less-bureaucratized and more diverse supervisory organization. Findings – The challenge is to create a financial supervisory institution that should be powerful enough to close down even the largest financial institutions within its jurisdiction, while at the same time not becoming so large and omnipotent that it would stifle further development of firms in financial services. Research limitations/implications – Deeper understanding of minimum efficient scales in financial intermediation required, and of regulatory capture vs efficient information acquisition from regulated units. Practical implications – Basis for international (regional) cooperation in facilitating efficient delivery of financial services, in particular in smaller countries. Originality/value – Developments in information technology have fundamentally changed the ways financial intermediaries operate paving the way for giant units that in key areas are able to outcompete smaller business units. The financial crisis that started in 2008 revealed that these large and interconnected organizations are in a position to extract implicit subsidies from the rest of the society. The organization of financial supervision must adapt to these changing conditions.