Commentaries | Dec 14,2019
December 19 , 2020
By Howard Davies ( The first chairman of the United Kingdom’s Financial Services Authority. )
The benefits of central bank independence are accepted by almost everyone nowadays. And there is growing evidence that financial regulation works best – boosting the stability of the banking system – when regulators and supervisors have similar independence, writes Howard Davies, the first chairman of the United Kingdom’s Financial Services Authority.
There is a vast academic literature on central bank independence, and central bank governors address the topic at every opportunity. Most of the academic papers, and all of the governors, argue that a high degree of independence is associated with low inflation and monetary stability.
Some of these academic studies question the direction of causation, asking whether countries with highly inflation-averse populations – Germany being the most obvious example – are inclined to favor robust independence. But there is wide support for the general proposition that taking politicians out of the process of setting interest rates is associated with lower and more stable inflation. There is much evidence that, previously, the electoral cycle influenced interest-rate decisions, with damaging consequences.
Much less attention has been paid to the independence of financial regulators and, especially, banking supervisors. Many of the latter are of course part of central banks, but by no means all of them are.
Around a third of countries with significant banking systems operate with supervisors outside the central bank. That is true of Sweden, Japan, and Australia, for example. And in some cases, different independence regimes apply to monetary policy and supervision, even where both are brigaded within the central bank.
The question of how independent bank supervisors are is of more than theoretical interest. Regulatory and supervisory independence is one of the Basel Committee on Banking Supervision’s core principles. Yet according to the International Monetary Fund, it is the one with the lowest level of compliance across the countries the Fund reviews.
Banking supervisors’ perceived lack of independence in some Eurozone countries was one of the reasons for establishing the European Union’s banking union. There is evidence that banks with direct political involvement were subject to indulgent supervision and performed especially poorly in the 2008 global financial crisis. Their bad debts were higher than might have been expected.
More recently, there have been questions about the closeness of German supervisors to the country’s finance ministry. After the accounting scandal that brought about the insolvency of the payment processing and financial services firm Wirecard, the European Securities and Markets Authority pointed to “a heightened risk of influence by the Ministry of Finance given the frequency and detail of reporting” in the Wirecard case.
Against this background, the Bank of England has produced timely new research on the link between regulatory independence and financial stability. The authors construct a novel index of independence that resembles the indices used in the monetary policy arena, but with differences in some areas.
The BOE paper incorporates the procedures for appointing the head of the regulator: Is there a degree of independence in the process? How long is the head’s term? How easy is it to dismiss him or her?
The authors also look at the supervisor’s ability to impose regulations without political approval, and at the budget process. Some can fund themselves through a power to levy fees on regulated firms; others need to go cap in hand to the government or legislature for money, creating the possibility of political lobbying by banks to starve the regulator of funds.
Having constructed the index, the authors then examine whether supervisory independence is positively correlated with financial stability. Compared to monetary stability, financial stability is a slippery concept. We tend to discover all too painfully when it is absent, but attempts to develop indices of its presence have proven to be difficult. Many explain the last crisis very well but are somewhat less useful for predicting the next one.
As a proxy for financial stability, the BOE authors choose the level of non-performing loans in the banking system. It is not a perfect measure, perhaps, but it has the benefit of being available, on a broadly comparable basis, across a range of countries and for a meaningful number of years.
Mapping the two datasets against each other produces strong conclusions. There has been a steady increase in supervisory independence over the last two decades. And, in the authors’ words, “reforms that bring greater regulatory and supervisory independence are associated with lower non-performing loans in banks’ balance sheets [and] … overall, our results show that increasing the independence of regulators and supervisors is beneficial for financial stability.”
Furthermore, they produce evidence that the tougher oversight associated with independent supervisors does not adversely affect the efficiency or profitability of the banking system. One might reasonably be concerned that tighter supervision might impose costly constraints, yet that does not seem to be the case. Bank efficiency, defined as the cost-to-income ratio, tends to improve when supervisors are made more independent. And there is no negative impact on banks’ bottom line.
So what is not to like? Are we in “free lunch” territory?
Not quite. There is one drawback, which may give politicians pause. The relationship between independence and the quantity of bank lending is negative. In other words, if independent supervisors are more rigorous, banks tend to lend a little less. The scale of the effect is not dramatic, but it is negative and it is significant.
It is possible that this effect is transitional and would fade as more disciplined supervision is maintained. Moreover, the lending that has not taken place might have been to non-viable companies or over-extended consumers. It is not obvious that such lending is especially beneficial to growth and productivity.
In the public domain at least, regulatory and supervisory independence has not acquired the reputation of central bank independence. It does not have its own well-used acronym, like CBI. When RSI is used, it typically refers to repetitive strain injury. The BOE research adds up to a strong case for changing that.
PUBLISHED ON Dec 19,2020 [ VOL 21 , NO 1077]
Commentaries | Dec 14,2019
Fortune News | Sep 11,2020
Fortune News | Apr 09,2022
Fortune News | Jan 30,2021
Fortune News | Mar 17,2021
Fortune News | Apr 22,2022
Fortune News | Aug 14,2022
Viewpoints | Sep 06,2020
Agenda | Oct 30,2021
Radar | May 21,2022
Photo Gallery | 54732 Views | May 06,2019
Fortune News | 47192 Views | Jul 18,2020
Photo Gallery | 46561 Views | Apr 26,2019
Fortune News | 46201 Views | Sep 01,2021
Commentaries | Aug 13,2022
Life Matters | Aug 13,2022
My Opinion | Aug 13,2022
Sunday with Eden | Aug 13,2022
Agenda | Aug 14,2022
Editorial | Aug 14,2022
July 2 , 2022 . By RUTH TAYE
On a rainy afternoon last week, a coffee processing facility in the capital's Akaki-Qality District was abuzz with activ...
November 27 , 2021
Against my will, I have witnessed the most terrible defeat of reason and the most sa...
November 13 , 2021
Plans and reality do not always gel. They rarely do in a fast-moving world. Every act...
October 16 , 2021 . By HAWI DADHI
Residing in a country with no capital market, an organised marketplace for trading se...
Leaders of the National Election Board are in a charm offensive mood, of a sort. Last week, they organised a rare tour for members of the me...
When the country’s most senior diplomats and envoys return back to their posts after two-week debriefings, they leave behind a point or tw...
August 14 , 2022
The call for lofty ideals such as national dialogue and consensus has been as old as...
August 6 , 2022
Few initiatives by the administration of Prime Minister Abiy Ahmed (PhD) have been pu...
July 30 , 2022
Ethiopia’s banking industry is not merely underdeveloped. It has historically regre...
July 23 , 2022
The flip side of a government spending plan is financing. Behind the campaign promise...
PM Abiy Ahmed (PhD) at a Gala Dinner Called for the Awarding of the Félix Houphouët-Boigny Peace Prize
May 6 , 2019
Having studied psychology, I am fascinated by how our thoughts shape our lives. I am also interested in mental health and try my best to cre...
August 14 , 2022 . By RAHEL BOGALE
Federal authorities approved submissions by the Addis Abeba University (AAU) administ...
August 13 , 2022 . By BERSABEH GEBRE
The federal government is imposing a new tax, hoping to generate an additional 22 bil...
August 15 , 2022
Agricultural authorities have backpedalled on a decision to raise the minimum price t...
August 13 , 2022 . By ELSHADAY HAGOS
Transport authorities have introduced unique license plates to vehicles owned by indi...
Or see contact page