Skip to main content
Log in

Do exchange rate regimes affect the role of central banks as banking supervisors?

  • Published:
European Journal of Law and Economics Aims and scope Submit manuscript

Abstract

We investigate the effect that exchange rate regimes have on the degree of central bank involvement in banking supervision. Using both de jure and de facto exchange rate regimes, we find that, conditional on several other factors affecting supervisory power allocation, policymakers are more willing to delegate this task to central banks when the latter are pegging their currency to some kind of parity. This evidence is confirmed when instrumental variables are added, in order to account for possible endogeneity. Results suggest that exchange rate regime features can mitigate the trade offs that political authorities face in evaluating the possibility of assigning supervision to monetary authorities.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. See Goodhart and Schoenmaker (1995), Arnone and Gambini (2007), Masciandaro (2007), and Hussain (2009) for some comprehensive reviews of the literature. The reviews also consider the topic from the perspective of monetary policy effectiveness, where, again, it is not a general and definitive answer to the question regarding under which conditions a central banker who cares about financial stability is better positioned to pursue monetary policy goals. On this issue—as well as on the related consequences on central bank governance—see also Crockett (2010), Papademos (2010), Svensson (2010) and Woodford (2011).

  2. Gersbach (2011) claims that macro prudential supervision should be outside the central bank responsibilities, in order to avoid time inconsistency in pursuing the monetary policy goals.

  3. Such a possibility has been recently and deeply analyzed in the literature (Barth et al. 2004; Djankov et al. 2002; Quintyn and Taylor 2002; Boyer and Ponce 2011).

  4. Few recent empirical works have tried to shed light on this aspect by providing evidence of policymakers’ preferences for a particular regime over another (Masciandaro 2006, 2007; Dalla Pellegrina and Masciandaro 2008). It has been observed, in particular, that political and institutional features, such as the presence of “grabbing hand” policymakers—typically measured by countries’ corruption scores—are significant factors affecting supervisory architectures.

  5. Although hidden pegs are typical of developing countries, there are recent examples of central banks in developed countries announcing a free-floating regime while in fact engaging in repeated purchases on foreign-currency market (Bank of Israel, Annual Report, 2009).

  6. We will account for elements which may divert the policymaker’s interests from those of the society in the empirical section.

  7. One can imagine that C(Y) encompasses the potential cost of bailouts, inflation, etc., which are associated to the use of monetary policy as a solution to supervisory failures.

  8. We assimilate incentives to assigning supervisory powers.

  9. For details on the construction of the CBSS index, see Masciandaro et al. (2011).

  10. Since we are only focusing on the banking sector, we do not use an index of concentration of the overall supervisory structure as in Masciandaro (2006, 2007) and Masciandaro and Quintyn (2009a).

  11. As identified by the IMF staff. See IMF (2006) for details on the de facto exchange rate regimes classification.

  12. In order to control for possible simultaneity in the choice of both supervisory and exchange rate regimes, we take the lagged value of the main dependent variables (see Table 10 in the “Appendix” for details). We will discuss more extensively endogeneity issues in the remainder.

  13. The IMF classification puts crawling bands and crawling pegs into two different categories. However, due to the scarce number of countries in our sample following these regimes, we have merged them in a single category.

  14. Data on population are collected at five points in time, 1996, 1998, 2000, 2002, and 2004, respectively, and then averaged. Similarly to what explained in a previous note, we seek to avoid simultaneous determination of the variables by lagging all independent ones. Furthermore, the reason why we average (where possible) on a number of years is that of getting rid of the cyclicality of some of these variables.

  15. GDP per capita is calculated at five points in time, 1996, 1998, 2000, 2002, and 2004, respectively, and then averaged.

  16. The idea to insert a measure of good governance in an empirical assessment of the choice of the supervisory model has been employed in several previous studies. See, among others, Dalla Pellegrina and Masciandaro (2008), and Masciandaro (2006, 2007).

  17. Central bank independence is a more general concept of discretion in the conduct of monetary policy since it also involves elements related to political autonomy. This information seemed, however, the most reliable proxy of the degree of discretion as intended here.

  18. Detailed criteria used to construct the GMT index are reported in Table 10 of the “Appendix”.

  19. The reason behind using latitude is to check if there is an ‘endowment effect’, i.e. if it’s true that countries closer to the Equator tend to be more inhospitable because of climate conditions, and therefore less favorable to the development of competitive financial markets (Beck et al. 2000).

  20. For the characteristics of economic, banking, and financial sectors, central bank independence, and the level of corruption, the percentage of countries having above sample averages are reported.

  21. Note that this evidence may turn out from the fact that distributions are affected by selection bias.

  22. Managed floating, in particular, has also been included in the set of pegging regime dummies. In fact, according to our view, it entails operating to some extent on liquidity, so as to maintain the required external equilibrium.

  23. This in part refutes the results of Poirson (2001) on the determinants of de facto exchange regimes and the preference for more flexibility. We will discuss the differences between de jure and de facto options in the remainder.

  24. These last results can be related to the fact that these two groups include mainly small and emerging economies, where it is more likely that banks are foreign-owned.

  25. Technically, free floating is omitted in order to avoid the dummy variable trap. We do the same with other sets of covariates expressed in the form of dummy variables with the exception of continental fixed-effects, where we exclude two dummies (Oceania and Africa) instead of one, due to the low number of observations included in each category.

  26. See next section for a more accurate treatment of endogeneity.

  27. We do not take into explicit consideration causality between the dependent variable and these covariates since its presence are not likely to boost the significance of the main relationship at stake, but rather to decrease it, so that the safest outcome is provided by our estimates.

  28. We also estimated specifications of (4) and (5) where measures of exchange rate tightness have been interacted with the central bank independence index but obtained no significant outcome concerning the interaction term. This may suggest that policymakers are perhaps correctly balancing considerations regarding monetary policy discretion and exchange rate tightness, thus undertaking the optimizing choice in terms of supervisory power assignment.

  29. In the empirical section we use these variables in logs since it plausible that their growth rate rather than their level to induce a shift towards a different regime.

  30. The test rejects the null hypothesis at 10% level in the specification in column (5).

References

  • Alesina, A., & Tabellini, G. (2003). Bureaucrats or politicians? Part II: Multiple policy task. Discussion paper no. 2009, Harvard Institute of Economic Research, Harvard University, MA. Bank of Israel, annual report, 2009.

  • Apinis, M., Bodzioch, M., Csongradi, E., Filipova, T., Foit, Z., Kotkas J., et al. (2010). The role of national central banks in banking supervision in selected central and eastern European countries. Legal working paper series, no. 11.

  • Arnone, M., & Gambini, A. (2007). Architecture of supervisory authorities and banking supervision. In D. Masciandaro & M. Quintyn (Eds.), Designing financial supervision institutions: Independence, accountability and governance. Cheltenham: Edward Elgar.

    Google Scholar 

  • Arnone, M., Laurens, B. J., Segalotto, J.-F., & Sommer, M. (2007). Central bank autonomy: Lessons from global trends. IMF working paper no. 07/88, International Monetary Fund.

  • Barth, J. R., Caprio, G. J., & Levine, R. (2004). Bank supervision and regulation: What works best? Journal of Financial Intermediation, 117(13), 205–248.

    Article  Google Scholar 

  • Bean, C. (2011). Central banking then and now. Sir Leslie Melville Lecture, Australian National University, Canberra, mimeo.

  • Beck, T., Demirgüç-Kunt, A., & Levine, R. (2000). A new database on financial development and structure. World Bank Economic Review, 14, 597–605.

    Article  Google Scholar 

  • Bernanke, B. (2007). Central banking and banking supervision in the United States. Allied Social Sciences Association, annual meeting, Chicago, mimeo.

  • Bernanke, B. (2011). The effect of the great recession on central bank doctrine and practice. Board of Governors of the Federal Reserve System, mimeo.

  • Blanchard, O., Dell’Ariccia, G., & Mauro, P. (2010). Rethinking macroeconomic policy. IMF working paper series, WP 10.

  • Blinder, A. (2010). How central should the central bank be. Journal of Economic Literature, 48(1), 123–133.

    Article  Google Scholar 

  • Bordo, M. (2011). Long term perspectives on central banking. In A. Berg et al. (Eds.), What is a useful central bank? Norges Banks occasional papers, no. 42.

  • Borio, C. (2007). Monetary and prudential policies at the crossroads? New challenges in the new century. BIS working papers, no. 216.

  • Borio, C. (2011). Central banking post—Crisis: What compass for uncharted waters? BIS working papers, no. 353.

  • Boyer, P. C., & Ponce, J. (2011). Central banks and banking supervision reform. In S. Eijffinger & D. Masciandaro (Eds.), The handbook of central banking, financial regulation and supervision after the crisis. Cheltenham: Edward Elgar.

    Google Scholar 

  • Cagliarini, A., Kent, C., & Stevens, G. (2010). Fifty years of monetary policy: What have we learned? In C. Kent, M. Robson (Eds.), 50th Anniversary symposium, conference volume. Reserve Bank of Australia.

  • Calvo, G. A., & Reinhart, C. M. (2002). Fear of floating. The Quarterly Journal of Economics, 117(2), 379–408.

    Article  Google Scholar 

  • Committee on International Economic and Policy Reform. (2011). Rethinking central banking. Washington, DC: Brookings Institute.

    Google Scholar 

  • Crockett, A. (2010). Central bank governance under new mandates. BIS papers, no. 55.

  • Cukierman, A. (2008). Central bank independence and monetary policymaking institutions: Past, present and future. European Journal of Political Economy, 24, 722–736.

    Article  Google Scholar 

  • Dalla Pellegrina, L., & Masciandaro, D. (2008). Politicians, central banks, and the shape of financial supervision architectures. Journal of Financial Regulation and Compliance, 16(4), 290–317.

    Article  Google Scholar 

  • Dalla Pellegrina, L., Masciandaro, D., & Pansini, R. V. (2011). New advantages of tying one’s hands: Financial supervision, monetary policy and central bank independence. In S. Eijffinger & D. Masciandaro (Eds.), Handbook of central banking, financial regulation and supervision after the crisis. Cheltenham: Edward Elgar.

    Google Scholar 

  • Djankov, S., La Porta, R., Lopez-de Silanes, F., & Shleifer, A. (2002). The regulation of entry. Quarterly Journal of Economics, 117(1), 1–37.

    Article  Google Scholar 

  • Eichengreen, B., & Dincer, N. (2011). Who should supervise? The structure of bank supervision and the performance of the financial system. NBER working paper series, no. 17401.

  • Eichengreen, B., & Razo-Garcia, R. (2011). How realiable are de facto exchange rate regime classification? NBER working paper series, no. 17318.

  • Ferguson, R. (2000). Alternative approaches to financial supervision and regulation. Journal of Financial Services Research, 17(1), 297–303.

    Google Scholar 

  • Gerlach, S. (2010). Are the golden years of central banking over? Monetary policy after the crisis. 38th Economic conference, Austrian National Bank, Vienna, mimeo.

  • Gerlach, S., Giovannini, A., Tille, C., & Vinals, J. (2009). Are the golden days of banking over? The crisis and the challenges. Geneva reports on the World Economy, no. 10.

  • Gersbach, H. (2011). A framework for two macro policy instruments: Money and banking combined. CEPR Policy Insight, no. 58.

  • Goodhart, C. (2001). The organizational structure of banking supervision. FSI occasional paper series, no. 1.

  • Goodhart, C. (2010). The changing role of central banks. BIS working papers, no. 326.

  • Goodhart, C., & Schoenmaker, D. (1995). Should the functions of monetary policy and banking supervision be separated? Oxford Economic Papers, 47, 539–560.

    Google Scholar 

  • Grilli, V., Masciandaro, D., & Tabellini, G. (1991). Political and monetary institutions and public financial policies in the industrial countries. Economic Policy, 13, 341–376.

    Article  Google Scholar 

  • Hausmann, R., Gavin, M., Pages-Serra, C., & Stein, E. (1999). Financial turmoil and the choice of exchange rate regime. In E. F. Arias & R. Hausmann (Eds.), Wanted: World financial stability. Washington, DC: Interamerican Development Bank.

    Google Scholar 

  • Hausmann, R., Panizza, U., & Stein, E. (2000). Why do countries float the way they float? Inter-American Development Bank, Research Department, Working paper no. 418.

  • Hermings, R. J., & Carmassi, J. (2008). The structure of cross-sector financial supervision. Financial Markets, Institutions and Instruments, 17(1), 51–76.

    Article  Google Scholar 

  • Holmstrom, B., & Milgrom, P. (1991). Multitask principal–agent analyses: Incentive contracts, asset ownership, and job design. Journal of Law Economics and Organization, 7, 24–52.

    Article  Google Scholar 

  • Hussain, B. (2009). Integrated financial supervision and its implications for banking sector stability. Stern School of Business, New York University, mimeo.

  • International Monetary Fund. (2006). Annual report on exchange arrangements and exchange restrictions. Washington, DC: International Monetary Fund.

    Google Scholar 

  • Ioannidou, V. P. (2005). Does monetary policy affect the central bank’s role in bank supervision? Journal of Financial Intermediation, 14, 58–85.

    Article  Google Scholar 

  • Ito, T. (2010). Monetary policy and financial stability: Is inflation targeting passè? ADB economics working paper series, no. 206, Asian Development Bank, Manila.

  • Kaufman, H. (2000). On money and markets. New York: McGraw-Hill.

    Google Scholar 

  • Kaufmann, D. (2004). Corruption, governance and security: Challenges for the rich countries and the world. Washington, DC: The World Bank Institute.

    Google Scholar 

  • Kaufmann, D., Kraay, A., & Mastruzzi, M. (2003). Governance matters III: Governance indicators 1996–2002. Policy research working paper series, no. 3106. Washington, DC: The World Bank.

  • Klomp, J., & de Haan, J. (2009). Central bank independence and financial instability. Journal of Financial Stability, 5(4), 321–338.

    Article  Google Scholar 

  • Kremers, J., Schoenmaker, D., & Wierts, P. (2003). Financial supervision in Europe (pp. 160–175). Cheltenham: Edward Elgar.

  • La Porta, R., Lopez de Silanes, F., Shleifer, A., & Vishny, R. W. (1997). Legal determinants of external finance. Journal of Finance, 52(3), 1131–1150.

    Article  Google Scholar 

  • Lamfalussy, A. (2010). The future of central banking under post—Crisis mandates. BIS papers, no. 55.

  • Levy-Yeyati, E., & Sturzenegger, F. (2005). Classifying exchange rate regimes: Deeds vs. words. European Economic Review, 49(6), 1603–1635.

    Article  Google Scholar 

  • Masciandaro, D. (1995). Designing a central bank: Social player, monetary agent or banking agent? Open Economies Review, 6, 399–410.

    Article  Google Scholar 

  • Masciandaro, D. (2006). E Pluribus Unum? Authorities design in financial supervision: Trends and determinants. Open Economies Review, 17(1), 73–102.

    Article  Google Scholar 

  • Masciandaro, D. (2007). Divide et Impera: Financial supervision unification and central bank fragmentation effect. European Journal of Political Economy, 23(2), 285–315.

    Article  Google Scholar 

  • Masciandaro, D., Pansini, R. V., & Quintyn, M. (2011). The economic crisis: Did financial supervision matter? IMF working paper series, no. 261, Washington, DC: International Monetary Fund.

  • Masciandaro, D., &, Quintyn, M. (2008). Helping hand or grabbing hand? Politicians, supervisory regime, financial structure and market view. North American Journal of Economics and Finance, 19, 153–174.

  • Masciandaro, D., & Quintyn, M. (2009a). After the big bang and before the next one? Reforming the financial supervision architecture and the role of the central bank. A review of worldwide trends, causes and effects (1998–2008), Bocconi University, “Paolo Baffi” Centre research paper series no. 2009-37.

  • Masciandaro, D., & Quintyn, M. (2009b). Reforming financial supervision and the role of the central banks: A review of global trends, causes and effects (1998–2008). CEPR Policy Insight, Centre for Economic Policy Research, no. 30.

  • Mussa, M. (1986). Nominal exchange rate regimes and the behaviour of real exchange rates: Evidence and implications. Carnegie-Rochester Conference Series on Public Policy, 25(1), 117–214.

    Article  Google Scholar 

  • Nier, E. W. (2009). Financial stability frameworks and the role of central banks: Lessons from the crisis. IMF working paper series, no. 70, Washington, DC: International Monetary Fund.

  • Nier, E. W., Osinski, J., Jacome, L. I., & Madrid, P. (2011). Towards effective macroprudential policy frameworks: An assessment of stylized institutional models. IMF working paper series, no. 250, Washington, DC: International Monetary Fund.

  • Oritani, Y. (2010). Public governance of central banks: An approach from new institutional economics. BIS working papers, Bank for International Settlements, no. 299.

  • Padoa Schioppa, T. (2003). Financial supervision: Inside or outside the central banks?

  • Papademos, L. (2010). Central bank mandates and governance arrangements. BIS papers, no. 55.

  • Pauli, R. (2000). Payments remain fundamental for banks and central banks. Bank of Finland discussion papers, no. 6/2000.

  • Peek, J., Rosengren, E., & Tootell, G. (1998). Does the Federal Reserve have an informational advantage? You can Bank on it. Federal Reserve Bank of Boston, working paper no. 98/2.

  • Peek, J., Rosengren, E., & Tootell, G. (1999). Is bank supervision central to central banking. Quarterly Journal of Economics, 114, 629–653.

    Article  Google Scholar 

  • Poirson, H. (2001). How do countries choose their exchange rate regime? IMF working paper no. 01/46.

  • Quintyn, M., & Taylor, M. (2002). Regulatory and supervisory independence and financial stability. IMF working paper 02/46.

  • Sincler, P. J. N. (2000). Central banks and financial stability, Bank of England. Quarterly Review, 377–391.

  • Svensson, L. (2010). Inflation targeting after the financial crisis, challenges to central banking. Reserve Bank of India conference, mimeo.

  • Taylor, J. (2010). Macroeconomic lessons from the great deviation. 25th NBER macro annual meeting, mimeo.

  • Toniolo, G. (2011). What is a useful central bank? Lessons from interwar years. In A. Berg et al. (Eds.), What is a useful central bank? Norges Banks occasional papers, no. 42.

  • Tuya, J., & Zamalloa, L. (1994). Issues on placing banking supervision in the central bank. In: T. Balino, & C. Cottarelli (Eds.), Framework for monetary stability. Washington, DC: International Monetary Fund.

  • Ugolini, S. (2011). What do we really know about the long term evolution of central banking. Working paper series, no. 15, Norges Bank.

  • Woodford, M. (2011). Inflation targeting and financial stability, the future of central banking. EIEF conference, Rome, mimeo.

  • World Bank. (2007). World Development Indicators 2006. Washington, DC: The World Bank.

    Google Scholar 

  • World Trade Organization. (2007). International trade statistics 2007. Geneva: World Trade Organization.

    Google Scholar 

Download references

Acknowledgments

We thank Sharon Hannes, and all participants to the European Association of Law and Economics Meeting, Paris, 2010, for precious suggestions. We also thank the Paolo Baffi Centre at Bocconi University for financial support.

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to L. Dalla Pellegrina.

Appendix

Appendix

See Tables 10, 11 and 12.

Table 10 Variables description and data sources
Table 11 Central bank as banking supervisor and Exchange rate regimes
Table 12 Exchange rate arrangements and supervisory powers: treatment regression

Rights and permissions

Reprints and permissions

About this article

Cite this article

Dalla Pellegrina, L., Masciandaro, D. & Pansini, R.V. Do exchange rate regimes affect the role of central banks as banking supervisors?. Eur J Law Econ 38, 279–315 (2014). https://doi.org/10.1007/s10657-012-9317-4

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10657-012-9317-4

Keywords

JEL Classification

Navigation