Supranational Supervision: How Much and for Whom?

We argue that the extent to which supervision of banks takes place on the supranational level should be guided by two factors: cross-border externalities from bank failure and heterogeneity in bank failure costs. Based on a simple model, we show that supranational supervision is more likely to be welfare enhancing when externalities are high and country heterogeneity is low. This suggests that different sets of countries (or regions) should differ in the extent to which their regulators cooperate across borders.We apply the insights of our model to discuss optimal supervisory arrangements for different regions of the world and contrast them with existing arrangements and current policy initiatives. We also offer a political economy discussion on the likelihood with which countries delegate supervisory authority to supranational authorities.