06 September 2019

Bank of England: Supervisory governance, capture and non-performing loans

This paper compares the impact of three supervisory governance models — supervision by the central bank, by an agency or by both of them — on bank non-performing loans. It finds that supervisory governance per se does not significantly affect non-performing loans. However, it also finds that, where the risk of capture is high, shared supervision is associated with a significant reduction in non-performing loans

The institutional setting of microprudential banking supervision has acquired new relevance in light of the recent financial crisis and the reforms that followed it. While the literature provided a number of theoretical arguments both in favour and against the allocation of such responsibility to central banks, little attention has been paid to the institutional environment in which supervision is conducted. This comes at a time when shared supervision between central banks and agency is increasingly spreading, as with the establishment of the Single Supervisory Mechanism in the European Union, where the ECB supervises with a number of national agencies.

This paper has shown that this lack of attention might be unjustified. On the one hand, it found that analysing the impact of supervisory governance by looking solely at the distinction between central banks and supervising agencies may be misleading. Central bank supervision and shared supervision are the only models of supervisory governance significantly correlated with NPLs, suggesting that the effectiveness of governance may depend from factors other than the nature of the institution. Therefore, the inclusion of shared supervision provides an explanation to the contrasting evidence provided in existing works on supervisory governance.

Nevertheless, when controlling for year fixed effects, the significance of central bank supervision vanishes, leaving shared supervision as the only (weakly) significant governance model. On the other hand, it showed that shared supervision is the only governance arrangement able to affect NPLs, but only if interacted with the risk of supervisory capture of a country. NPLs are in fact significantly lower in those countries where supervision is shared between the central bank and an agency, and where the risk of capture is high.

In conclusion, this paper suggests that reforms in supervisory governance could have an impact only depending on the institutional setting in which they are implemented. Institutional factors, such as the risk of capture in a country, are in fact able to influence the effectiveness of supervisory governance in keeping the banking system stable. If policy-makers want to address reforms in the governance of banking supervision, they should be aware that the success of their efforts will be conditional on the existing political economy setting in which the reform is undertaken.

Full working paper on Bank of England

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