Towards a New Architecture for Financial Stability: Seven Principles

In this paper we use insights from organizational economics and financial regulation to study the optimal architecture of supervision. We suggest that the new architecture should revolve around the following principles: (i) banking, securities and insurance supervision should be further integrated; (ii) macro prudential supervisory function must be in the hands of the central bank; (iii) the relation between macro and micro supervisors must be articulated through a management by exception system involving direct authority of the macro supervisor over enforcement and allocation of tasks; (iv) given the difficulty of measuring output on supervisory tasks, the systemic risk supervisor must necessarily be more accountable and less independent than Central Banks are on their monetary task; (v) the supervisory agency cannot rely on high powered incentives to motivate supervisors, and must rely on culture instead; (vi) the supervisor must limit its reliance on self regulation; and (vii) the international system should substitute the current loose, networked structure for a more centralized and hierarchical one.