Does higher political independence for banking regulators and supervisors improve financial stability? Policy makers seem to agree that this is the case. Since the 2008 financial crisis, regulators and supervisors have been granted increased independence from political bodies. One of the main pillars of the Basel Committee’s core principles for effective banking supervision is the independence of supervisors from governments. The International Monetary Fund and the World Bank regularly assess compliance with this principle as part of their Financial Sector Assessment Program. These assessments often flag independence as one of the principles with the lowest compliance.1
The reason why independence can benefit financial stability is straightforward. Elected officials may have incentives to pressure authorities to loosen banking regulations or relax supervision to accommodate credit expansion ahead of elections. In this way, politicians could stimulate short-term growth and boost their electoral prospects. Independent supervisors are insulated from such cycles, allowing them to prioritize long-term financial stability over short-term political gains.
But is regulatory and supervisory independence (RSI) actually associated with a more stable banking system? We investigate this question in a new study (ungated version at this link). Although the benefits of RSI for financial stability are well-established from a theoretical perspective, empirical evidence on this link is scant and has limitations. We address this issue by creating a new index measuring the political independence of bank regulators and supervisors for 98 countries during 1999–2019. The data are freely available at this link.
The index measures the statutory independence of supervisors and regulators based on three aspects: institutional, regulatory, and budgetary. Institutional independence is measured based on the appointment, removal, and term length of the head of the supervising agency. Regulatory independence measures the degree of autonomy in setting technical rules and regulations for the sector it regulates and supervises. Budgetary independence captures how independent the supervisor is in determining its own resources, as politicians could pressure agencies by restricting the resources at their disposal to perform their functions.2 Crucially, this index differs from the traditional central bank independence measure, which focuses on monetary policy. Moreover, in many countries, bank regulation and supervision are delegated to an agency that is separate from the central bank.
The RSI index reveals that there is substantial heterogeneity across countries, with bank supervisors presenting a very high degree of independence and others reporting significantly lower levels (figure 1). We also notice that the independence of regulators and supervisors did not develop at the same pace as central bank independence (figure 2). While central bank independence grew steadily and at a relatively quick pace from the early 2000s, RSI increased more slowly over time and followed a more discontinuous pattern.
