Abstract:

In this paper we use insights from organizational economics and financial regulation to study the optimal architecture of supervision. We suggest that the new architecture should revolve around the following principles: (i) banking, securities and insurance supervision should be further integrated; (ii) macro prudential supervisory function must be in the hands of the central bank; (iii) the relation between macro and micro supervisors must be articulated through a management by exception system involving direct authority of the macro supervisor over enforcement and allocation of tasks; (iv) given the difficulty of measuring output on supervisory tasks, the systemic risk supervisor must necessarily be more accountable and less independent than Central Banks are on their monetary task; (v) the supervisory agency cannot rely on high powered incentives to motivate supervisors, and must rely on culture instead; (vi) the supervisor must limit its reliance on self regulation; and (vii) the international system should substitute the current loose, networked structure for a more centralized and hierarchical one.