Bank Regulation, Macroeconomic Management, and Monetary Incentives in OECD Economies

Abstract

This paper argues that banks operating in systems where monetary and regulatory authority are unified in a central bank expect and receive preferential monetary policies, and so act less prudently than do banks in non-unified systems. These incentives arise when the natural tension between counter-cyclical monetary policy and pro-cyclical regulatory policy is resolved in ways that benefit the banking sector. I test the hypothesis using time series cross-sectional and multilevel models that exploit two types of policy interventions -accession to the European monetary union, and reassignment of domestic regulatory authority -within OECD countries from 1992-2007, the period during which the international Basel accords harmonized key aspects of national regulatory standards. The results strongly support the claim that there is a relationship between prudential behaviors of banks and the location of regulatory and