helping hand or grabbing hand?: politicians, supervision regime, financial structure and market view

North American Journal of Economics and Finance 19 (2008) 153–173

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North American Journal ofEconomics and Finance

Helping hand or grabbing hand?Politicians, supervision regime, financialstructure and market view�

Donato Masciandaroa,∗, Marc Quintynb

a Bocconi University, Italyb International Monetary Fund, United States

a r t i c l e i n f o

Article history:Received 2 August 2007Received in revised form 23 December 2007Accepted 11 February 2008Available online 18 March 2008

JEL classification:G18G28E58

Keywords:Financial supervisionPolitical economyGrabbing handBanking concentrationMarket view

a b s t r a c t

Almost all the literature on the evolution of the financial supervisionarchitecture stresses the importance of financial market character-istics in determining the recent trend toward more unification. Butin the real world it is not always clear to what extent market fea-tures matter. We present two complementary approaches to gaininsights in the above relationship, focusing on the political costand benefit analysis. First, a cross-country study tests two alter-native theories—the helping hand and the grabbing hand view ofgovernment—to determine the impact of the market structure onthe supervisory setting. Our evidence seems more consistent withthe grabbing hand view, considering the degree of banking con-centration a proxy of the capture risk and presuming the marketdemonstrates a preference for consolidation of supervisory pow-ers. Second, the results of a survey among financial CEOs in Italyconfirm a market preference for a more consolidated supervisoryregime but reveal only weak consistency between the views of thepolicymakers and those of the market operators.

© 2008 Elsevier Inc. All rights reserved.

1. Introduction

In recent years many countries have made drastic changes to the architecture of financial supervi-sion, and more countries are contemplating modifications. The current restructuring wave is making

� The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or itsmanagement.

∗ Corresponding author. Tel.: +39 02 58365310; fax: +39 02 58365343.E-mail address: [email protected] (D. Masciandaro).

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154 D. Masciandaro, M. Quintyn / North American Journal of Economics and Finance 19 (2008) 153–173

the supervisory landscape less uniform than in the past. In several countries the architecture stillreflects the classic model, with separate agencies for banking, securities and insurance supervision.However, an increasing number of countries show a trend towards consolidation of supervisory pow-ers, which in some cases has culminated in the establishment of a unified regulator, either inside oroutside the central bank.1

These changes in the supervisory architecture are taking place against the backdrop of fundamen-tal changes in the financial markets. The financial industry is changing its conventional face, with ablurring of the traditional boundaries between banking, securities and insurance, and the formationof large conglomerates. The natural question that follows from a confrontation of these trends is: in agiven country, is there any relationship between the shape of the supervisory regime and the evolvingfeatures of its financial industry?

As a matter of fact, the authorities in the first eye-catching examples of this trend—the UnitedKingdom and Australia—explicitly justified the supervisory reorganization by referring to the changesin their financial industries along the lines indicated above.2 In other cases, such as South Africa,supervisory unification was seen as premature because the authorities did not see any clear trends ofblurring of boundaries, or formation of conglomerates. Hence it was decided that bank supervisionwould remain with the Reserve Bank of South Africa and that supervision of all other subsectors wouldbe unified in another, new agency (Bezuidenhout, 2004).

This last example notwithstanding (and there are a few more), there has been a tendency inrecent years among policy makers to allude to developments in their financial markets to justifya consolidation of supervisory powers. More generally, the idea that supervisory consolidation andunification is (in part) in response to the blurring and conglomeration trends in the financial sec-tor has become common place in overview studies devoted to the recent evolution in supervisorydesign.3

However, against this widespread “belief” stands the finding that there is a general lack of theoreticalunderpinning and empirical evidence to corroborate the view that the structure of the financial marketsplays a decisive role in shaping a country’s supervisory structure. The only empirical papers on thetopic, Masciandaro (2006, 2007), find that when policymakers choose the supervision model, theyactually seem to neglect some specific features of their financial markets (basically bank based versusmarket based setting). So the question regarding the importance of market features for the designof the supervisory structure remains broadly unanswered and this paper will explore the empiricallinkages further.

A second, related and equally relevant question in this debate, relates to the views of the supervisedentities themselves on the supervisory architecture, and the extent to which these views are taken intoaccount in the decision-making process. Systematic and empirical evidence in this domain too is ratherscarce. Westrup (2007) is one of the few sources on the topic. He reports for instance that in Germany,at least one part of the financial sector representatives (represented in the Bunderverband DeutscherBanken, BdB) were in favor of a unified model outside the Bundesbank, and with a weaker degreeof independence. This is one of the clearest examples of views expressed by the market at the timeof a reform. Moreover, these views seem to have had an impact on the final decision. For the UnitedKingdom, in contrast, his research finds no evidence of explicit views expressed by the market actorsat the time of the reforms. The Wallis Commission in Australia reports prior consultation with thefinancial sector on the reforms of the supervisory framework (Commonwealth of Australia, 1996).Beyond this, almost anecdotal, evidence we have little information on views from the market, and ontheir potential impact on the decision-making process in individual countries.

1 For surveys of recent developments see, among others, De Luna Martinez and Rose (2003), Masciandaro (2005), and Cihakand Podpiera (2007).

2 See among others, for the U.K. Briault (1999) and Davis (2004), and for Australia, Commonwealth of Australia (1996). Yearsbefore the current wave of supervisory restructuring started, the Nordic countries (Denmark, Norway and Sweden) had alreadyestablished a unified supervisor. The high degree of concentration of their financial systems was also mentioned as a mainreason for this reform (see among others, Taylor and Fleming (1999).

3 See, for example, Taylor and Fleming (1999) and the case studies collected in Masciandaro (2005).

D. Masciandaro, M. Quintyn / North American Journal of Economics and Finance 19 (2008) 153–173 155

This paper offers two complementary contributions to the debate about the importance of the“market factor” in reshaping supervisory architectures. By “market factor” we understand hereafter thetwo elements referred to above: the structure of the markets and the views of the market participants(financial institutions).4 In the first part of the paper we take a political-economy view to explore theimpact of market structure on the supervisory architecture. Since a purely economic view—representedin the selection of the “banks-versus-market” variable in Masciandaro (2006, 2007)—does not seemto yield clear results, we explore this issue from a political-economic point of view. From a theoreticalpoint of view, at least two alternative theories can be formulated to explain the relationship betweenthe structure of the markets and the supervisory architecture—the helping hand view (HHV) of govern-ment and the grabbing hand view (GHV).5 The main difference between the two is in whose intereststhe government is working.

Under HHV, the policymaker’s choices are motivated by improving general welfare. Therefore, it ispossible to claim that their efforts to reform the supervisory structure aim at improving the efficiencyof overall resource allocation, and that the market features are an important factor to be taken intoconsideration. According to the GHV approach, the policymakers are motivated by the aim to pleasethe interest of specific, well-defined voters. In our case, the financial industry may be considereda highly organized and powerful interest group. The financial industry is likely to be a smaller andmore coherent group than the consumers of their services, and therefore politically better organized.The policymaker, in defining the supervisory setting, is likely to be influenced by the market view ofsupervision, if this increases the probability of his/her re-election. Therefore the market view becomesthe crucial variable in determining the shape of the supervisory regime if we use the grabbing handapproach. This theoretical approach is further discussed in our paper and empirically tested in a cross-country setting.

The second part of the paper starts from the view that the opinion of the market participantsregarding the supervisory architecture is also an important aspect to study. Understanding the marketpreferences can be useful to predict either the effectiveness and/or the likelihood of a supervisoryregime. Again, this issue has not been addressed systematically in the literature. So here we presentand analyze the results of a survey, held in 2006 among CEOs of Italian financial institutions, abouttheir preferences and beliefs on supervisory structure and regulatory governance and their views onthe political decision-making process.

This paper is structured as follows. Sections 2 and 3 disentangle the two opposite theories (HHVand GVH) on the determinants of emerging supervisory structures with special attention for the role ofthe market factor in the decision-making process. Section 2 discusses the background to our analysisin the context of the HHV versus GHV hypotheses, and Section 3 reports on our empirical tests. InSection 4 we discuss the survey on market views. Section 5 brings the main conclusions together.

2. Do markets matter in designing financial supervision architectures? Helping hand viewversus grabbing hand view

Do the features of financial markets matter in determining the shape of the supervisory regime?The relevance of this question is of a recent date. Until roughly 15 years ago, the issue of supervisoryarchitecture was considered irrelevant. First of all, the fact that only banking systems were consideredneeding supervision made several of the current organizational questions meaningless. In such a con-text, the supervisory design was either considered deterministic (i.e., it is an exogenous variable), oraccidental (i.e., it is a completely random variable).6

The situation has changed. The changes in the financial markets, resulting in the growing systemicimportance of insurance, securities and pension fund sectors have made supervision of all segmentsof the financial system important, and raise the issue as to whether the newly emerging financial

4 Depositors and clients of other financial institutions are of course also market participants in the broader sense of the word,but we will limit ourselves to the narrower definition and we will refer to “depositors” when we discuss them explicitly.

5 The helping hand view goes back to Pigou (1938) and the grabbing hand view was first elaborated by Shleifer and Vishny(1998).

6 For an historical perspective, see the discussion in Goodhart (2007) and Capie (2007).


supervisory structures are endogenous, i.e., designed in response to these developments and otherfactors.

Our starting point to answer the above question is based on three crucial hypotheses. First of all,we claim that gains and losses of a supervisory model7 are variables calculated by the policymaker incharge, who decides to maintain or reform the supervisory regime.8 Second, the decisions of policy-makers, whatever their own specific goals are, will likely be influenced by structural variables—suchas the features of the financial markets—that may vary from country to country. We wish to test thehypothesis that in every country, given the structural endowment, these variables can determine,ceteris paribus, the gains or losses policymakers expect from a specific supervisory regime. The super-visory regime is the dependent variable. Finally, economic agents have no information on the truepreferences of the policymaker: the latter’s optimal degree of financial supervision concentration is ahidden variable.9

The crucial element in considering the policymaker’s objective as a factor in the design of thesupervisory architecture is the identification of his/her preferences. The first approach to identifyingthe policymaker’s function could be the so-called narrative approach, in which official documents andstatements are interpreted to gauge the choices of policymakers.10 One drawback of this approach isthat there is often substantial room for differences between the pronouncements of policymakers andtheir actual preferences.

The second approach, which we intend to follow here, is to consider the actual choices of poli-cymakers in determining the level of financial supervision concentration (factual approach). At eachpoint in time, we observe the policymaker’s decision to maintain or reform the financial supervisionarchitecture. In other words, we consider that policymakers are faced with discrete choices. Accordingto the factual approach, we can investigate if the features of the financial markets play any role indetermining the actual shape of the supervisory architecture. By taking a political economy view, wecan test the hypothesis that politicians may wish to use reform (or status quo) to gain or keep influencethrough the supervisory process.11

The relevant players in our theoretical framework are the policymakers, the community and thefinancial constituency. First of all, we focus our attention on the behavior of the policymakers. Wewill explore two alternative views—the helping hand view of government and the grabbing handview—which share a common premise: the policymakers are politicians, i.e., they are “career con-cerned” agents, motivated by the goal of pleasing the voters in order to win the elections.12 The maindifference concerns which voters—general interest versus vested interest—they are trying to please.

Consequently the second relevant player is the community, i.e. the citizens. Market economiesare committed to financial stability in order to maximize long term welfare. Given the high costs interms of resource misallocation, informational losses and taxpayer bailouts that financial instabilitycan cause, citizens have an interest in the soundness of the financial and banking system and preferto avoid generalized unexpected negative shocks in the financial industry. In the banking sector, thegeneralized unexpected negative shocks have a precise name – systemic crises – and a well definedclass whose interests would be adversely affected by the emergence of such a shock: the public in the

7 For an analysis of pros and cons of alternative models of supervision see, among others, Arnone and Gambino (2007), Cihakand Podpiera (2007), Di Giorgio and Di Noia (2007). See also Section 5 below.

8 The importance of the policymakers’ preferences in explaining how supervisory settings come about can be tackled indifferent ways. For example, the political economy of financial regulation can be analyzed as the outcomes of conflicts whichare linked to inclusive and exclusive processes. See Mooslechner, Schubert, and Weber (2006) and in particular Lutz (2006).

9 By financial supervision concentration we refer to the degree of integration or consolidation of the supervisory function.At one end of the spectrum are those countries that have several sector-specific supervisory agencies; at the other end of thespectrum are the countries that have established a unified supervisor. See Section 3 for more details.

10 The narrative approach has been used in, for instance, Westrup (2007).11 For instance, a majority of commentators agree that the government’s decision to establish a unified regulator in Poland

in 2006 was mainly meant to curb the central bank’s power and to regain some government influence over financial sectordevelopments. See for instance remarks and citations in Dow Jones Commodities Service (September 14, 2006), Agence FrancePress (September 29, 2006), and Associated Press Newswires (October 3, 2006).

12 Alesina and Tabellini (2003) stressed that the lines of accountability represent the main difference between politicians andbureaucrats: politicians are held accountable at the elections, while bureaucrats are accountable to their professional peers orto the public at large.


form of depositors and/or taxpayers. The citizens like a supervisory architecture effective in minimizingthe risks of financial instability.

In terms of a contracting approach, the delegation of the task to the policymakers creates a contractbetween them and depositors/taxpayers. The terms of this contract are that in establishing a supervi-sory regime, the policymaker acts as an agent on behalf of depositors/taxpayers whose preference isfor long-run stability in the financial system. The peculiarity of this contract is that the effectivenessof the supervisory design is observable only ex post, but not contractible ex ante. If the level of effec-tiveness cannot be defined ex ante – the optimal level of financial stability so far is not defined in theliterature – the policymaker cannot be rewarded directly through an explicit and verifiable contract.The policymaker can be rewarded based only on observed ex post performances of the chosen supervi-sory regime. Masciandaro, Quintyn, and Taylor (2007) and Quintyn (2007) broadly discuss how, otherthings being equal, the degree of discretion of the policymaker in building up a supervisory regimeis greater, compared to other institutional designs (for example, to implement a monetary regimecharacterized by an independent central bank aimed to pursue monetary stability).

However, merely delegating the specialized task to the policymakers will not produce automaticallythe social optimal outcome if these same policymakers are subject to “capture”. A strand in the litera-ture, which derives from Stigler (1971), stresses that every regulator is likely to be captured by privateinterests in the sense that a policymaker which is supposed to be acting in the public interest can bedominated by vested interests of the existing incumbents in the industry that it oversees. In publicchoice theory, regulatory capture arises from the fact that vested interests have a concentrated stakein the outcomes of policy decisions, thus ensuring that they will find means—direct or indirect—tocapture decision makers. In the case of the supervisory setting, industry capture can influence thepolicymakers, who will design the regime consistent with the preferences of the financial industry.Therefore the third relevant player is the financial community.

In a policy game in which the incumbent policymaker may please two different constituencies, wecan identify two different types of government.

2.1. Helping hand view

In general, the “helping hand” (HH) policymaker – i.e., a government that aims to maximize socialwelfare – wishes to correct or prevent market imperfections.13 In the case of designing the financialsupervision regime, the HH policymaker can choose to maintain or reform the degree of supervisoryconcentration in order to improve the overall efficiency in resource allocation, and therefore he/shehas to take into account the structure of the financial system.

The crucial stylized fact in this regard is the blurring of boundaries in the financial industry whichis leading to an increasing integration of the banking, securities and insurance markets, as well as theirrespective products and instruments. The blurring effect has caused two interdependent phenomena:(i) the emergence of financial conglomerates, which is likely to produce important changes in thenature and dimensions of the individual intermediaries, as well as in the degree of unification of thebanking and financial industry; and (ii) growing securitization of the traditional forms of bankingactivity and the proliferation of sophisticated ways of bundling, repackaging and trading risks, whichweakens the classic distinction between equity, debt and loans, and is bringing changes in the natureand dimensions of the financial markets.

The HH policymaker recognizes that the supervisory architecture was created for a structure of thefinancial system that is no longer consistent with these structural changes. The supervisory boundariesno longer reflect the actual features of the financial industry. The question of the institutional settingof supervision becomes a policy issue. In particular, the HH policymaker wonders if a unificationin supervision has to follow the blurring trends in the markets. In other words, should supervisory

13 Pigou (1938). Although the helping hand view was identified by Pigou as the government’s way to address market imper-fections and enhance social welfare, it has been pointed out that this view of the government can also lead to excesses. Barth,Caprio, and Levine (2004) point out that the helping hand view can stimulate the introduction of regulations that in fact chokefinancial sector development, such as entry restrictions and limits on activities.


activities be integrated, through the establishment of a single financial regulator? In general, the HHpolicymaker will find advantages and disadvantages in the establishment of a unified financial sectorsupervisor.14

Potential benefits of unification include a more efficient and effective control of financial con-glomerates and financial markets in a state of flux. By providing more effective supervision the HHpolicymaker would please the financial consumers—i.e., the citizens—by contributing to the exis-tence of a stable financial environment in the hopes of increasing the probability of winning futureelections.

The views expressed by the market participants on the optimal structure of supervision couldbecome an important factor in the discussion on improving efficiency and effectiveness of financialsupervision. From the point of view of the market participants a unified supervisor could solve prob-lems of duplication, overlap and inconsistency in controls and reporting requirements, and regulatorygaps. It could also increase the possibility of having a level playing field, characterized by competitiveneutrality. In other words a unified supervision could mean a decrease in the expected compliancecosts. If the market participants like more concentrated supervision, a closer alignment between gen-eral interest (effective supervision) and specific (market participants) interest (efficient supervision)is more likely to occur. Therefore, the HH policymaker can be sensitive to the market view.

2.2. Grabbing hand view

The “grabbing hand” (GH) policymaker is also an elected politician, for which he/she has to pleasethe voters. But now we consider the case of lobbies, that can influence the policymaker’s choices. In con-trast with the HH policymaker, the GH government would tend to give benefits only to a small but wellorganized interest group. The GH policymaker is captured by a specific interest group, whose supportis considered fundamental for (re)election.15 We can suppose that, while the common voters can influ-ence the policymaker only through elections, the vested interest group can influence the policymakerthrough explicit or implicit contributions, important enough to increase the chances of winning theelections. In this case the preferences of the interested group would become the fundamental variablein explaining the policy choices.

Faced with the issue of (re)shaping the architecture of financial supervision, the GH policymaker canbe influenced by the market features, but – more importantly – he/she will most likely be sensitive tothe preferences of the market participants. The demand by the financial industry for more consolidatedsupervision can be a disguised form of capture. Capture is more likely to occur: (i) the greater the levelof concentration in the financial industry is; and (ii) the more the number of supervisory authoritiesdecreases. In these circumstances, if premises (i) and (ii) together hold, the establishment of a singlefinancial authority can become an institutional deficiency from a social welfare point of view, andundermine effectiveness and efficiency of supervision.

Let us summarize the main findings. How important is the market factor – i.e. the structure of thefinancial markets and the views of the market participants – in explaining the trend toward moreintegrated supervision? We imagined the design of the financial supervision regime as a delegationproblem, where the incumbent policymaker – the agent – in order to maximize his/her probabilitiesof re-election can choose to please the citizens (HH type), or the financial industry (GH type). The HHpolicymaker can consider the market factor just one element to take in consideration, while for theGH policymaker the market factor is the crucial variable in the decision-making process. We discussedunder which conditions each type of policymaker can choose a more integrated supervisory regime.Now can we disentangle the effect of different type of policymakers on the relationship between thefinancial supervision unification and the market factor? Let us focus in the following section on therole of the market structure.

14 Abrams and Taylor (2002), Arnone and Gambino (2007), Cihak and Podpiera (2007).15 We use the terminology of the regulatory capture theory – Stigler (1971) – to describe a situation where both policymaker

and industry pursue their own benefits, rather than social welfare.


3. Does the market structure matter?

To assess empirically the role of the market structure in determining the degree of concentration inthe financial supervision architecture from the perspective of these two alternative views, we estimatea model of the probability of different regime decisions as a function of a set of exogenous structuralvariables.

To that effect, we use the approach introduced in Masciandaro (2006, 2007). Weaving a cross-country perspective into an empirical analysis consistent with this discrete choice process involvesclaiming the existence of unobservable policymaker utilities Uij, where each Uij is the utility receivedby the ith national policymaker from the jth level of supervision consolidation. Since the utility Uij isunobservable, we represent it as a random quantity, assuming that it is composed of a systematic partU and a random error term ε. Furthermore, we claim that the utilities Uij are a function of the attributesof the alternative institutional level of supervision consolidation and the structural characteristics ofthe policymaker’s country.

By combining the two hypotheses, we have a random utility framework for the unobservable super-vision consolidation variable. As usual, we assume that the errors εij are independent for each nationalpolicymaker and institutional alternative, and normally distributed. The independence assumptionimplies that the utility derived by one national policymaker is not related to the utility derivedby a policymaker in any another country, and that the utility that a policymaker derives from thechoice of a given level of financial consolidation is not related to the utility provided by the otheralternative.

Therefore, supervisory regimes can be viewed as resulting from an unobserved variable: the optimaldegree of financial supervision consolidation, consistent with the policymaker’s utility. Each regimecorresponds to a specific range of the optimal financial supervision consolidation, with higher discretevalues of a given index corresponding to a higher range of financial unification values. We use theIndex of Financial Authorities Concentration (FAC) proposed in Masciandaro (2004).

This index was created through an analysis of which, and how many, authorities in the 88 coun-tries examined are in charge of supervising the three traditional sectors of financial activity: banking,securities markets and insurance.16 The country sample depends on the availability of institutionaldata.17

To transform the qualitative information into quantitative indicators, we assigned a numerical valueto each type of regime, in order to highlight the number of the agencies involved. The rationale by whichwe assigned the values considers simply the concept of unification of supervisory powers: the greaterthe unification, the higher the index value.

The index was built on the following scale: 7 = single authority for all three sectors (total numberof supervisors = 1); 5 = single authority for the banking sector and securities markets (total numberof supervisors = 2); 3 = single authority for the insurance sector and the securities markets, or for theinsurance sector and the banking sector (total number of supervisors = 2); 1 = specialized authority foreach sector (total number of supervisors = 3).

We assigned a value of 5 to the single supervisor for the banking sector and securities marketsbecause of the predominant importance of banking intermediation and securities markets over insur-ance in every national financial industry. It also interesting to note that, in the group of integratedsupervisory agency countries, there seems to be a higher degree of integration between banking andsecurities supervision than between banking and insurance supervision1; therefore, the degree ofconcentration of powers, ceteris paribus, is greater. These observations do not, however, weigh anotherqualitative characteristic: there are countries in which one sector is supervised by more than oneauthority. It is likely that the degree of concentration rises when there are two authorities in a given

16 Sources: for all countries, official documents and websites of the central banks and the other financial authorities. Theinformation is updated to 2006. See Table 1.

17 In the empirical analysis we do not include nine very small countries and territories (Bahrain, Bermuda, Cayman Islands,Gibraltar, Hong Kong Maldives, Netherlands Antilles, Singapore and United Arab Emirates) with a single financial authority inorder to avoid an evident bias in the empirical analysis.


sector, one of which has other powers in a second sector. On the other hand, the degree of concen-tration falls when there are two authorities in a given sector, neither of which has other powers ina second sector. It would therefore seem advisable to include these aspects in evaluating the variousnational supervisory structures by modifying the index as follows: adding 1 if there is at least one sec-tor in the country with two authorities, and one of these authorities is also responsible for at least oneother sector; subtracting 1 if there is at least one sector in the country with two authorities assignedto supervision, but neither of these authorities has responsibility for another sector; 0 elsewhere.

There are five qualitative characteristics of supervisory regimes that we decided not to considerin constructing this index. Firstly, we do not consider the legal nature – public or private – of thesupervisory agencies nor their relationship to the political system (degree of independence, level ofaccountability18). Secondly, at least in each industrial country, there is an authority to protect com-petition and the market, with duties that include the financial sector. Since it is common to all thestructures, we decided not to take into account the antitrust powers in constructing the index. Besideswe do not consider who is involved in the management of the deposit insurance schemes. In gen-eral, we consider only supervision of the three traditional sectors (banking, securities and insurancemarkets). Finally, financial authorities may perform different functions in the regulatory and the super-visory area. At this first stage of the institutional analysis, we prefer to consider only the number ofthe agencies involved in the supervisory activities.

Since the FAC Index is a qualitative ordinal variable, the estimation of a model for such a depen-dent variable necessitates the use of a specific technique. Our qualitative dependent variable can beclassified into more than two categories, given that the FAC Index is a multinomial variable. But theFAC Index is also an ordinal variable, given that it reflects a ranking. Then the ordered model is anappropriate estimator, given the ordered nature of the policymaker’s alternative.

Let y be the policymaker’s ordered choices taking on the values (0, 1, 2, . . ., 7). The ordered modelfor y, conditional on a set of K explanatory variables x, can be derived from a latent variable model.In order to test this relationship, let us assume that the unobserved variable, the optimal degree offinancial supervision consolidation y*, is determined by:

y∗ = ˇ′x + ε

where ε is a random disturbance uncorrelated with the regressors, and ˇ is a 1 × K regressors’ vector.The latent variable y* is unobserved. What is observed is the choice of each national policymaker

to maintain or to reform the financial supervisory architecture. This choice is summarized in thevalue of the FAC Index, which represents the threshold value. For the dependent variable we haveseven threshold values. Estimation proceeds by maximum likelihood, assuming that ε is normallydistributed across country observations, and the mean and variance of ε are normalized to zero andone. This model can be estimated with an ordered model.

On the basis of this framework, we can analyze the role of the market features in the determinationof the supervisory architecture. In spite of the contrast between both views, they remain difficult todisentangle from an empirical point of view, among others because it is not easy to find empiricalvariables that consistently and unambiguously represent each of these two approaches.

3.1. Review of existing evidence

We start this section by recalling the results from the model developed in Masciandaro (2006, 2007).The model identified six potential determinants of the financial supervision regime. The determinantsand their proxies are described on Table 1. First, the probability that a country will move toward a moreconcentrated form of supervision may depend on the overall size of the nation, highlighting a smallcountry effect: whatever the policymaker type, with relatively few people the expertise in financialsupervision is likely to be in short supply, and concentration is more likely to occur (economic factor:its proxy is the gross national product).

18 On these issues, see Quintyn and Taylor (2003) and Hupkes, Quintyn, and Taylor (2005).


Table 1Data sources

Variable Symbol Definition Data sources

Financial Authorities Concentration Index FAC Section 3 see also Masciandaro (2007) forfurther details

(4)

Central Bank as Financial Authority Index CBFA Section 3 see also Masciandaro (2007) forfurther details

(4)

Good governance Gov The index is built using all the indicatorsproposed by Kaufmann et al. (2003). Averagevalues 1996, 1998, 2000, 2002, 2004

(5)

GDP GDP GDP. Average values: 1996, 1998, 2000, 2002,2004

(6)

Market versus banked systems MVB Market versus bank-based countries. Dummyvariable computed using different banking andfinancial variables: see Beck, Demirguc-Kunt, &Levine (2000) for further details. Averagevalues 1996, 1998, 2000, 2002, 2004

(6) and (1)

Conglomeration n/a The variable is derived from the databasecontained in Caprio–Levine and corresponds totheir question 2.4

(3)

Concentration n/a The variable is constructed as the percentage oftotal deposits held by the five largest banks inthe country. The variable is derived fromquestion 2.6.2 of the new database constructedby Caprio–Levine

(2)

European Union EU Dummy that signals whether a given country isa member of the European Union or not

(7)

OECD OECD Dummy that signals whether a given country isa member of the OECD or not

(7)

Reform Year Reform Year of the last reform of the supervisionarchitectures

(4)

Common Law, Civil Law Com, Civ Legal origin of countries. See Beck,Demirguc-Kunt and Levine (2001) for details

(7)

(1) Bankscope; (2) Beck et al. (2000); (3) “How countries supervise their banks, insurances and securities markets 2006”, CentralBanking Publications Ltd., UK. Central Banks Websites. Richmond Law & Tax, Ldt. 2005; (4) Kaufmann et al. (2003); (5) WorldDevelopment Indicators, World Bank; (6) World FactBook, CIA.

Second, the choice of the policymaker regarding how many institutions are to be involved in super-vision seems to be related to the traditional role played by the central bank in the supervisory process(central bank factor: its proxy is the central bank involvement in supervision). To measure the impor-tance of the role the central bank plays in the various national supervisory regimes, we use the indexof the central bank’s involvement in financial supervision: the Central Bank as Financial AuthorityIndex (CBFA) (Table 1). For each country, and given the three traditional financial sectors (banking,securities and insurance), the CBFA Index is equal to: 1 if the central bank is not assigned the mainresponsibility for banking supervision; 2 if the central bank has the main (or sole) responsibility forbanking supervision; 3 if the central bank has responsibility in any two out of the three sectors; 4 if thecentral bank has responsibility in all three sectors. In evaluating the role of the central bank in bankingsupervision, we considered the fact that, whatever the supervision regime, the monetary authorityhas responsibility in pursuing macro financial stability. Therefore the relative role of the central bankis the rule of thumb: we assigned a greater value (2 instead of 1) if the central bank is the sole or themain authority responsible for banking supervision.

It is interesting to note that in general the present degree of the central bank involvement hasbeen established in the years before, and then confirmed in subsequent reforms. For each countrywe compare the year in which the present degree of central bank involvement in supervision wasestablished (i.e. definition of the CBFA Index), with the year of the most recent reform of the supervisoryarchitecture (i.e. definition of the FAC Index). Given data of 88 national reforms of the supervisoryarchitecture, the central bank involvement was confirmed in 67 cases (76%), decreased in 16 cases(18%), increased only in 5 cases (6%).


Third, the quality of the political environment could be important in determining the policymaker’schoice (political factor; its proxy is the level of good governance), as well as the legal system (legal factor;its proxies are Common Law and Civil Law), the geographical location (geographical factor; its proxyis Europe), or the membership in international organization (international factor: its proxy is OECD).Finally, the policymaker can choose to maintain or change the degree of supervisory unification inresponse to the structure of the financial system (market factor). The market factor is captured byusing the classic comparison between the equity dominance model (or market-based regime) and thebank dominance model (or bank-based regime).

The sample was made of 88 countries belonging to all continents. Most of the data have beencollected using World Bank Surveys and public Official documents (see Table 1).

The results of the estimates showed that the probability that a country will move toward a sin-gle authority model is higher: (i) the smaller the size of the economy (small country effect)19;(ii) the lesser the central bank is involved in supervision before the reform (path dependenceeffect); and (iii) when the jurisdiction operates under the Civil Law—particularly if the legal frame-work is characterized by German and Scandinavian roots (law effect).20 The market factor does notmatter.

3.2. New evidence

This section attempts to further the analysis of the role of the market factor by testing three innova-tions to the basic model. First the original database of the general model is updated by calculating thelevel of the structural macro variables: gross domestic product and good governance.21 Tables 2 and 3show the logit and probit estimates of the basic equation with the new database. The results confirmthe robustness of two main determinants: the institutional factor and the law factor. The market factoris still not significant.

Second, since we are studying general trends among policymakers in reforming supervision, ratherthan a specific trend in consolidation, we can ask ourselves if there is some kind of “bandwagoneffect” at work among the policymakers. The policymaker in a given country implements a reformof the supervisory framework, because policymakers in other countries did or are doing the samething, in other words, because it is becoming fashionable. To test the bandwagon effect, we constructa new variable: for each country, we compute the year in which the last reform in supervision wasimplemented (Reform Year). The hypothesis is that, with a bandwagon effect, recent reforms are likelyto correspond to higher level of consolidation.22 Table 4 shows that the new variable is not significant.This finding seems to confirm an activism on the part of the policymakers in reforming the supervisoryarchitecture, rather than a simple mimicking of the establishment of a single regulatory authority inother countries. So, while there might be some form of demonstration effect—reforming because othersare reforming—it is certainly not clear from the above finding that the model of complete integrationis being copied because it seems fashionable.

The third step addresses the question as to which type of policymaker is in action. To take intoaccount the predictions of both the HH and the GH types, we have to identify new indicators, giventhat, under this perspective, the above “market oriented versus bank oriented” variable alone is notsufficient to discriminate between the two views.

19 This finding is consistent with the so-called small open economy-argument for unification of the supervisory functions. Theargument was first developed by Taylor and Fleming (1999) in their analysis of the Scandinavian experience with supervisoryintegration in the late 1980s and early 1990s. The argument has later been used by other countries to justify the establishmentof a unified supervision (for examples, see contributions in Masciandaro (2005)).

20 On the law and finance approach see La Porta et al. So far the testing of the legal origins effect produced mixed results inthe empirical works. In Masciandaro (2006) the legal origin effect disappeared when different classifications of legal origins areused while in Masciandaro, 2007, with a different sample size, the legal origin effect holds using the alternative classifications.

21 Masciandaro (2006, 2007) used for each of the two variables the mean of four years: 1996, 1998, 2000, 2002. Here wecompute the mean by adding a fifth value: 2004. The source is the same: World Bank.

22 We acknowledge that the Reform Year variable is a fairly imperfect proxy for a possible bandwagon effect. The best way tocalculate this effect would be the construction of an index of the change in each country in the level of supervision consolidationbefore and after the last reform.


Table 2Choice of supervisory unification – ordered logit estimation: basic model with new data

Dependent variable: FAC index

(a) (b) (c) (d) (e)

CBFA Index −0.750** −0.681** −0.738** −0.725** −0.769**−0.29 −0.3 −0.31 −0.31 −0.32

GDP −0.00022 −0.00029 −0.00028 −0.0003 −0.0003−0.00016 −0.00019 −0.00018 −0.00019 −0.0002

Common Law 0.974 0.505 0.719 0.753 0.636−0.62 −0.65 −0.7 −0.7 −0.71

Civil Law 1.577*** 1.315** 1.369*** 1.370*** 1.394***−0.51 −0.51 −0.52 −0.52 −0.52

Good Governance 0.850*** 0.673** 0.565 0.573−0.26 −0.34 −0.41 −0.4

EU 0.492 0.406 0.553−0.6 −0.62 −0.64

OECD 0.328 0.104−0.69 −0.73

Markets vs Banks 0.469−0.52

Number of observations: 88; standard errors in parentheses; *significant at 10%; **significant at 5%; ***significant at 1%.

The HH policymaker, in order to increase the efficiency in resource allocation, will address thetwo most striking financial sector phenomena: the formation of conglomerates and securitization offinancial products. However, the role of market trends in influencing the policymaker’s decisions isnot unequivocal, given that – as we highlighted above – the optimal model of supervision is still tobe discovered, and ex-ante a more consolidated supervisory setting can produce either advantages ordisadvantages. Therefore, given the market structure, the expected sign of a relationship between the

Table 3Choice of supervisory unification – ordered probit estimation: basic model with new data


(a) (b) (c) (d) (e)

CBFA Index −0.373** −0.331** −0.354** −0.350** −0.354**−0.16 −0.16 −0.16 −0.16 −0.16

GDP −0.00014 −0.000180* −0.000174* −0.000181* −0.000181*−9.2E−05 −9.3E−05 −9.3E−05 −9.6E−05 −9.6E−05

Common Law 0.426 0.145 0.265 0.273 0.223−0.34 −0.36 −0.38 −0.38 −0.39

Civil Law 0.853*** 0.697** 0.747** 0.743** 0.752**−0.29 −0.29 −0.3 −0.3 −0.3

Good Governance 0.545*** 0.436** 0.397* 0.405*−0.15 −0.19 −0.23 −0.23

EU 0.308 0.278 0.321−0.34 −0.36 −0.36

OECD 0.121 0.0353−0.39 −0.42

Markets vs Banks 0.186−0.3



Table 4Choice of supervisory unification – ordered logit and probit estimation: bandwagon effect


Logit Probit

CBFA Index −0.721** (−0.31) −0.349** (−0.16)GDP −0.0003 (−0.00019) −0.000181* (−9.6E−05)Common Law 0.753 (−0.7) 0.274 (−0.38)Civil Law 1.355** (−0.53) 0.736** (−0.31)Good governance 0.566 (−0.41) 0.398* (−0.23)EU 0.427 (−0.64) 0.288 (−0.37)OECD 0.322 (−0.69) 0.118 (−0.39)Reform Year −0.00157 (−0.012) −0.00088 (−0.007)


degree of supervision concentration and a proxy of the new financial trends is undetermined – i.e., canbe positive or negative – and remains an empirical question. At the same time, the HH policymaker isby definition immune with respect to any risks of capture.

The GH policymaker will be sensitive to the preferences of the market participants, irrespective ofthe actual trends in the financial markets. As we already noted, the demand of the financial industryfor more consolidated supervision can hide a risk of capture. Provided that the market participantslike a unified supervisory model, and given the market structure, the expected sign of a relationshipbetween the degree of supervision concentration and a proxy of the capture risk is positive.

Thus, the predictions of the theory regarding the two types of policymakers are different, althougha degree of ambiguity cannot be eliminated. Given the policymakers’ opposite profiles, we can first testthe effect of an indicator of market trends: the conglomeration effect. The relationship between thesupervisory unification and the conglomeration effect (Conglomeration) is more likely to be significantif the policymaker is a HH type.

Secondly, we can test the consequences of a proxy of the capture risk: the degree of consolidationin the financial industry. The relationship between supervisory unification and the degree of concen-tration of the financial system (Concentration) is more likely to be significant if the policymaker is aGH type. In addition, provided that the market participants prefer a unified supervisory model, theexpected sign of the relationship is positive. That the two measures of the market factor are different,at least in our sample, is confirmed by their low positive correlation coefficient (0.0519). Due to lim-ited data availability on these two variables, the size of the original country sample is reduced from88 countries to 51 countries for the conglomeration effect.

The results are reported in Tables 5 and 6. Table 5 shows that the conglomeration effect is notsignificant. In addition, the overall specification looses significance. In contrast, the results in Table 6signal that the concentration effect is always positive and significant. Furthermore, the relevance ofthe institutional factor and the law factor are confirmed in this specification.

Table 5Choice of supervisory unification – ordered logit and probit estimation: conglomeration effect


Logit Probit

CBFA Index −0.533 (−0.43) −0.234 (−0.22)GDP −0.00025 (−0.0002) −0.00015 (−0.00011)Common Law 0.892 (−1) 0.334 (−0.54)Civil Law 1.408* (−0.78) 0.802* (−0.45)Good governance 0.894 (−0.59) 0.677** (−0.34)EU 0.92 (−0.97) 0.437 (−0.52)OECD −0.536 (−0.84) −0.331 (−0.46)Conglomeration Effect 0.0092 (−0.0077) 0.00631 (−0.0046)



Table 6Choice of supervisory unification – ordered logit and probit estimation: concentration effect


Logit Probit

CBFA Index −0.689** (−0.32) (−0.16)GDP −0.00021 (−0.0002) −0.00013 (−0.0001)Common Law 0.806 (−0.7) 0.345 (−0.39)Civil Law 1.487*** (−0.53) 0.824*** (−0.31)Good governance 0.51 (−0.4) 0.36 (−0.23)EU 0.351 (−0.63) 0.258 (−0.36)OECD 0.397 (−0.69) 0.169 (−0.39)Concentration effect 2.141* (−1.22) 1.341* (−0.72)


Table 7Choice of supervisory unification – ordered logit and probit estimation: alternative indicator

Dependent variable: FAC two index

Logit Probit

CBFA Index −1.484*** (−0.41) −0.711*** (−0.19)GDP 8.02E−05 (−0.00017) 0.000039 (−0.00011)Common Law 1.327 (−0.81) 0.772* (−0.46)Civil Law 1.198* (−0.62) 0.718** (−0.36)Good governance 0.185 (−0.44) 0.169 (−0.25)EU 1.07 (−0.68) 0.601 (−0.39)OECD 0.47 (−0.74) 0.289 (−0.42)Concentration effect 2.816** (−1.43) 1.600* (−0.83)

Number of observations: 88; standard errors in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%.

Tables 7 and 8 report on a number of robustness tests, which test different definitions of thedependent variable. First of all, we eliminated the weights attributed to the banking and financialsupervisory responsibility with respect to the insurance sector supervision.23 The concentration effectholds, as well as the institutional effect and the law effect (Table 7). Secondly we tested a more radicalhypothesis: each policymaker simply decides between the two extreme regimes of supervision, singleauthority (complete centralization) versus multi-authority (decentralization). The dependent variablebecame a dummy, to be estimated using simple logit and probit. Again the concentration effect andthe institutional effect are significant, and the geographical effect becomes relevant again (Table 8).

Finally we consider the issue of causality. Let us highlight that the tests examine the supervisorystructure at time t (year 2006), analyzing if a set of structural variables defined at t − 1 is relevant inexplaining the supervisory shape. The dependent variable is obviously lagged compared to the law,geographical and international factors, and in the above section we also showed that the institutionalfactor (central bank involvement in supervision) is in general established at t − 1.

The other two control variables—the economic factor and the political factor—were defined as aver-age values in the period 1996–2004. The same methodology was used for the banking concentrationvariable, the only relevant proxy of the market factor. In general, the way the explanatory variableswere constructed minimized the risks of reverse causality.

Focusing on these three contemporary independent variables, the political factor can influence themarket factor. Therefore we controlled for an interaction effect between the governance variable andthe concentration variable: both the institutional factor and the law factor remain significant, whilethe market factor is significant only in the probit test (Table 9), without any role for interaction. We

23 We used an index (FAC Two) according to the following scale: 5 = single authority for all three sectors (total number ofsupervisors = 1); 3 = single authority for two sectors (total number of supervisors = 2); 1 = specialized authorities for each sector(total number of supervisors = at least 3). The correlation between FAC and FAC Two is 0.92.


Table 8Choice of single financial authority – logit and probit estimation

Dependent variable: binary index

Logit Probit

CBFA Index −1.989*** (−0.69) −0.969*** (−0.31)GDP 0.00027 (−0.00025) 0.000122 (−0.00015)Common Law 0.845 (−1.39) 0.721 (−0.79)Civil Law 1.005 (−0.96) 0.652 (−0.56)Good governance 0.121 (−0.68) 0.0458 (−0.39)EU 2.225** (−0.95) 1.324** (−0.55)OECD 0.859 (−1) 0.545 (−0.58)Concentration effect 3.969* (−2.3) 2.127* (−1.29)Constant −3.440* (−2.05) −2.182* (−1.12)


Table 9Choice of supervisory unification – ordered logit and probit estimation: interaction effects


Logit Probit

CBFA Index −0.694** (−0.32) −0.338** (−0.16)GDP −0.0002 (−0.00019) −0.00012 (−0.0001)Common Law 0.841 (−0.71) 0.346 (−0.39)Civil Law 1.478*** (−0.53) 0.817*** (−0.31)Good governance 0.0305 (−1.01) 0.224 (−0.61)EU 0.391 (−0.64) 0.263 (−0.36)OECD 0.428 (−0.7) 0.18 (−0.4)Concentration effect 1.875 (−1.33) 1.280* (−0.76)Interaction effect (good governance × concentration effect) 0.681 (−1.32) 0.194 (−0.8)


Table 10Choice of supervisory unification – ordered logit and probit estimation: interaction effects


Logit Probit

CBFA Index −0.613* (−0.32) −0.311* (−0.16)GDP −0.00113* (−0.00061) −0.000655* (−0.00038)Common Law 0.835 (−0.71) 0.349 (−0.39)Civil Law 1.438*** (−0.53) 0.781** (−0.31)Good governance 0.563 (−0.41) 0.396* (−0.23)EU 0.217 (−0.64) 0.182 (−0.36)OECD 0.338 (−0.69) 0.129 (−0.39)Concentration effect 1.925 (−1.23) 1.231* (−0.73)Interaction effect (GDP × concentration effect) 0.00234 (−0.0015) 0.00137 (−0.00094)


obtained similar results, controlling for the possible interaction effect produced by the scale factor(Table 10).

Finally, we considered the fact that the governance variable is a composite one, summarizing sixdifferent indices: voice and accountability, political stability, government effectiveness, regulatoryquality, rule of law, control of corruption.24 Therefore, instead of the overall governance variable, weused each index as control variable. Consistent with previous findings, the institutional factor, the lawfactor and the market factor remain significant, but none of the governance indices is significant (withthe exception of just one case: a weak positive relationship with political stability in the probit test).

24 See Kaufmann, Kraay, and Mastruzzi (2003).


In conclusion, the new result from the empirical work in this paper is that the behavior of poli-cymakers in reforming supervisory structures is more consistent with the GHV than the HHV, if oneassumes that the degree of banking concentration is a reliable proxy for the political influence exertedby the financial industry, and presuming a market preference toward supervisory consolidation. Moreresearch is certainly needed to arrive at more robust conclusions. The key here is to identify betterproxies for the market features that are considered relevant in the politicians’ decision-making process.

4. Case study: the market view in Italy

Information on the views of the market participants regarding the desirable supervisory architec-ture and its governance structure is not generally and systematically available. Thus far, researchershave to rely more on anecdotal evidence. As indicated earlier, Westrup (2007) reports that in Germany,at least one part of the financial sector representatives (represented in the Bunderverband DeutscherBanken, BdB) were in favor of a unified model outside the Bundesbank. For the United Kingdom, incontrast, he finds no evidence of explicit views expressed by the market actors at the time of thereforms. The Wallis Commission in Australia also consulted with the financial sector on the reformsof the supervisory framework (Commonwealth of Australia, 1996).

In this section we will analyze the market view on supervision architecture and regulatory gov-ernance in the case of Italy. The analysis is based on a survey conducted among Italian financialbusinessmen regarding the supervisory structure and its governance. As such it is one of the firstattempts to map the views, preferences and beliefs of the sector in a systematic way, and can provideus with a number of additional insights into the dynamics of the evolving debate regarding supervisorystructures and their governance.

The Italian situation is particularly interesting, with a bank-based financial system, which has gonethrough a rapid consolidation in recent years and which is governed by a highly decentralized super-visory model, with five authorities. This model was confirmed by the Italian Parliament in December2005, but more recently the Center-Left Government started discussing a reform aimed at introducinga twin-peak regime and revisiting the governance model.25

Thus, we are observing a consolidation process in the markets which will perhaps be accompaniedby a consolidation in the supervisory architecture. We wonder if in a more concentrated financialindustry the market participants have clear preferences on the level of the supervisory consolidationand on the degree of independence and accountability of the supervisors. The identification of themarket view can be useful to analyze the choices of the policymakers, in order to test the chain betweenthe financial structure, the market view and the political preferences.

4.1. Italy’s financial system structure

The Italian financial industry is a typical bank-based system. We acknowledge that often an arbitraryjudgement is made to decide whether a country’s financial industry is bank-based or market-based.Among the many indicators of the financial structure that have been proposed in the literature,26 weuse the ratio of the market capitalization of stocks to the gross domestic product. While this measure isintuitively simple and appealing, it remains an imperfect benchmark. However this ratio is sufficient toshow that Italy still has underdeveloped securities markets. In the overall country sample, Italy ranks30th of 88, and among the 24 advanced OECD countries, Italy ranks 16th. This international comparisonconfirms that the Italian stock market is still smaller than that of the other advanced countries, and thatfirms – particularly small and medium sized enterprises – have to depend heavily on bank credit.27

Looking at the country figures alone, banking sector assets accounted for 66.5% of the financialsystem’s total assets at the end of June 2005. In addition, banks control a substantial share of the asset

25 The twin peak model was first discussed by Taylor (1995). The model groups supervision of market behavior of all segmentsof the financial system in one peak, and conduct of business supervision in another. Thus far the model has only been adoptedin Australia and the Netherlands.

26 See among others Beck et al. (2000) and Levine (2002).27 Draghi (2006b), Cardia (2006).


management industry—the second most important class of financial institutions with 16% of totalassets—and the insurance sector, the third class with 12%.28 The pervasive role of the banks is alsoreflected in the growing concern of the central bank, which drew attention to the need to ensure thatasset management companies were independent of the banking and insurance groups which controlthem and distribute their products.29

The degree of concentration of the banking industry has been increasing in recent years. Lookingat the total value of deposits held by the five major banks, Italy ranks 64 out of 80 in the countrysample, and 17th among the 21 OECD countries. However, the number of banks declined from 970in 1995 to 787 in 2004,30 the six largest banks represent 55% of total assets at the end of 2004.31 In2006 the first and third largest banks merged, building up the biggest Italian bank: Intesa SanPaolo.The consolidation process is likely to continue: in February 2007 the Governor of the Banca d’Italiaclaimed that “there is still room for mergers and acquisitions able to create synergies.”32

4.2. Supervisory framework

The supervisory framework is a multi-authority model, built around five institutions. The centralbank (Banca d’Italia) is the supervisor of the banking system and, with a view to preserving financialstability, is also responsible for supervising the asset management industry, as well as other relevantfinancial markets, such as wholesale markets for government securities and interbank markets. Fur-thermore – until the recent law No. 262 of December 2005 – the central bank was the main authorityin charge of enforcing the antitrust law. The central bank was by law assigned at least two goals: main-taining financial stability and enforcing the antitrust law. The Italian Companies and Stock ExchangeCommission (CONSOB) regulates and supervises the Italian securities markets, while the insurancemarket is supervised by the Insurance Authority (ISVAP). Pension Funds are supervised by the PensionFund Authority (COVIP). Finally, the Italian Foreign Exchange Office (UIC) is responsible for anti-moneylaundering and combating terrorist financing.33

From a theoretical point of view, the Italian regime represents a striking example of the so-calledcentral bank fragmentation effect.34 The number of supervisors is directly related to the central bankinvolvement is supervision itself, reducing the degree of supervisory consolidation.

The Italian Parliament, notwithstanding a declaration in favor of supervision by objectives—seebelow on this type of regime—confirmed the multi-authority regime with the above mentioned lawNo. 262 of December 2005 (New Law on Savings). The same law was designed to reform the governanceof the central bank in a number of crucial areas. The law moved the responsibility for regulating anti-competitive behavior from the central bank to the Antitrust Authority, with shared responsibilities ofthe two institutions for bank mergers and acquisitions. The law defined five principles – reaffirmationof central bank autonomy, transfer of central bank ownership to public entities, enhanced collegiality,increased reporting requirements, changes to the mandate of the Governor and the other membersof the Directorate – with key provisions to be spelled out in the amendments of the central bankstatute.35 The role of a government committee – The Inter-Ministerial Committee on Credit and Sav-ings – in supervision makes it difficult to evaluate the real degree of central bank independence in thesupervisory area.36

28 International Monetary Fund (2006).29 Draghi (2007).30 European Central Bank (2005).31 International Monetary Fund (2006).32 Draghi (2007).33 International Monetary Fund (2006).34 Masciandaro (2006).35 International Monetary Fund (2006), Draghi (2006a).36 International Monetary Fund (2006). In July 2007 the Anti-Money Laundering proposed a revision of the legislation, which

transformed the UIC in the Financial Intelligence Unit, as autonomous department of the Bank of Italy. The proposal becamelaw in November 2007, and the reform will be implement in January 2008.


In February 2006 the center-left government proposed a twin-peak supervisory model, or super-vision by objectives.37 The twin-peak model states that all intermediaries and markets be supervisedby two authorities, with each single supervisor being responsible for one goal of regulation. TheBanca d’Italia would be in charge of financial stability, while CONSOB would be responsible for trans-parency and conduct of business. Both agencies supported the view that supervision by objectivesis necessary.38 As part of the reforms, the Inter-Ministerial Committee on Credit and Savings wouldbe eliminated and replaced by a Financial Stability Committee, with three members: the Minister ofTreasury (Chairperson), the Governor of the Banca d’Italia, and the President of CONSOB. The Finan-cial Stability Committee would promote the exchange of information, the coordination between thetwo supervisory agencies, as well as the cooperation between national and international supervisors.Finally, the government proposal defined common rules on the accountability of the two agenciestowards the Parliament and its Commissions.

4.3. The market view: the 2006 survey

In October–November 2006 a survey, prepared by the authors of this paper, was carried out bythe Asset Management Industry (AMI) Association amongst 230 CEOs of the AMI firms. Italy currentlyhas 171 AMI firms; their shareholders are Italian banks (82%), Italian non-bank financial firms (12%),and foreign financial and banking institutions (6%). The AMI managers are highly representative ofthe Italian financial community. As noted above, the asset management industry is the second largestsegment of the financial sector, but more importantly, the AMI firms are mainly controlled by thedomestic banks.

The answers to the questionnaires (68 respondents, 30% of the overall CEO population) offer anoriginal picture of the market view on the key features of the supervisory architecture. In additionto the aim of increasing our understanding of the market view, specific goals of the survey includedthe identification of the market preferences on the actual and optimal level of key features of thesupervisory setting (efficiency, neutrality, staff saving, responsibility) and governance (independenceand accountability), as well as the market’s views on the political feasibility of their reform.

4.3.1. Present structureThe first part of the questionnaire surveys the views on the present regime. Questions 1–8 inquire

about the respondents’ views on the general features of the supervisory architecture such as the risksof supervisory inefficiency, lack of neutrality, staff surplus, and low responsibility due to the multitudeof agencies. Of the respondents, 80% estimated that the risk of supervisory inefficiency is high (morethan 50%) in the present institutional setting. The risk of lack of regulatory neutrality is consideredhigh by 75% of the respondents. For 84% of the managers, the staff surplus risk is high, while 59% ofthem think that the risk of low responsibility is high. Thus, it appears that the market’s appreciationof the overall efficiency of the multi-authority system is low. This view is confirmed by the fact thatonly 40% of the respondents consider the current regime as effective.

4.3.2. Governance of the present structureQuestions 9–14 deal with views on the governance—independence and accountability—of the two

main supervisory authorities: Banca d’Italia and CONSOB. The questions start from the assumptionthat the governance framework has to be designed in such a way that management of the agenciesis free from any form of “capture”. The risks of supervisory capture can be classified in three cate-gories: “political capture,” “industry capture,” and “self-interest capture.”39 Thus, independence frompoliticians (political independence) and the supervised industry (industry independence) can be consid-ered good practice.40 Finally, there is always the risk that a supervisor pursues his/her self interest,

37 Di Giorgio and Di Noia (2007).38 Cardia (2005), Draghi (2006a).39 See Masciandaro et al. (2007).40 Quintyn and Taylor (2003, 2007), and Hupkes et al. (2005).


which may not be consistent with the social welfare. Hence, there must be transparent reportingprocedures on the supervisor’s activities, as well as rules on staff integrity, to avoid self bureaucratcapture. Accountability and transparency provide the society with assurances that supervision is notmanipulated.41

For 45% of the Italian financial CEOs, political independence of the Banca d’ Italia is high (more than50%), while almost the same percentage of respondents (43%) also consider industry independencehigh. In contrast, accountability is high in the eyes of only 9% of the respondents. The CONSOB is highlypolitically independent and industry independent—respectively for 27% and 46% of the responders.The level of accountability of CONSOB is considered high by only 8%.

4.3.3. Preferred supervisory modelThe second part of the questionnaire deals with views on reforms. The aim of questions 15–28 is to

discern if there exists an ideal supervisory setting in the minds of the market participants. The short-comings of the multi-authority model become evident when analyzing the market preferences withregard to a possible supervision consolidation. In the eyes of the respondents, a reform of the supervi-sory setting should produce a high (more than 50%) reduction in the various sources of inefficiencies.Among the respondents, 36% look for a significant reduction in the risk of supervisory inefficiency.The need for a reduction in the risk for a lack of regulatory neutrality is considered high for 47% ofthe respondents. In 45% of the cases, the managers think that the risk the staff surplus should bediminished, and a similar share of respondents favor a reduction in the risk of low responsibility.

While an overall reform is urgent for 79% of the respondents, 49% of them express a preference forthe twin-peak model, while the other 51% are in favor of a single supervisor. The survey does not doc-ument any particular “home bias” preference: exactly 50% of the CEOs think that a national supervisoris better (as opposed to a supervisor at the European level), and 60% prefer national accountabilityprocedures. Regarding the optimal governance rules for supervisors, the financial professionals are infavor of more political independence (74%), more industry independence (72%), but also more account-ability (90%). Among the respondents, 54% is a favor or mixed financing rule—a combination of publicfunds and fees from the supervised intermediaries. What is clear from this survey is that the Italianmarket view expresses a preference for supervisory consolidation.

4.3.4. Belief in the feasibility of the reformsThe final set of questions (29–42) seeks to clarify the market beliefs in the feasibility of a reform. The

purpose is to evaluate the alignment between market preferences and the expected government choice.In general, implementing supervisory reforms is seen as a sign of progress, and respondents see arelatively high probability (more than 50%) that a reform will indeed lead to a reduction in the differentsources of inefficiencies currently experienced. Among the respondents 68% consider a reduction ofthe risk for supervisory inefficiency likely. A reduction in the risk of a lack of regulatory neutrality isestimated as likely by 65% of the respondents. 45% of the managers think that it will also lead to areduction in the staff surplus risk, and 50% of them claim that the risk for low responsibility will bereduced. The financial CEOs think that the politicians prefer to establish accountability rules rather thanindependence procedures. In fact a reform of the supervisory governance is likely to produce higherpolitical independence (41%), higher industry independence (47%), but mainly higher accountability(57%).

However, 86% of the respondents think that the probability of a supervisory reform by the end ofthe legislation (2011) is equal or less than 50%. The conservativeness of the politicians can be explainedin different ways. The government can be in general conservative (28%), or sensitive to the oppositionof the supervisors (26%), their unions (57%), or their boards of directors (61%). Thus, the policymakers’expected behavior seems to be only weakly consistent with the market wishes. However these answersare not sufficient to disentangle the true nature – HH or GH – of the Italian policymaker.

What we can conclude, though, from this experiment is that the operators in the Italian marketsare: (i) fairly dissatisfied with the current supervisory model, although they like the degree of polit-

41 Quintyn and Taylor (2003).


ical and industry independence of the main regulators—Banca d’Italia and CONSOB—but have somedoubts about the low degrees of accountability towards their main stakeholders; (ii) overwhelminglyin favor of a more consolidated model, although there seems to be no outspoken majority for a unifiedmodel. The new model should be independent from government and industry, but respondents aremore concerned with addressing the current accountability deficit; and (iii) reluctant to think that theexpected behavior and views of the policymakers will be aligned with theirs.

To the extent that parallels can be drawn between these results and worldwide trends, it is worthnoting that market participants in Italy are of the view that accountability arrangements are currentlyweak and should be strengthened significantly, and that they think that politicians are of the sameview. This is consistent with worldwide trends, as analyzed in Quintyn, Ramirez, and Taylor (2007),and Masciandaro et al. (2007), which show that reformed supervisory agencies have stronger account-ability arrangements than their predecessors, and in particular than the central banks. So the focus onaccountability is certainly growing.

However let us stress again that the preferences of the market operators can be different from thesocial optimal ones. According to the GHV, the financial industry aims to extract rents from supervision,in order to serve its specific interest. The CEOs are queried about regulatory efficiency, but we do notknow what their benchmark is. That is, when 80% estimate that the risk of supervisory inefficiency ishigh, we do not know what they mean by inefficiency and how they estimate the risk of inefficiency.In general we do not know how much the CEOs are hoping regulators act in the public interest andhow much they hope regulators act in the interest of the CEOs’ industries (or firms).

5. Conclusions

The current worldwide wave of reforms in supervisory architectures leaves the interested bystanderwith a great number of questions regarding the true determinants of, and motivations behind, thesechanges. These questions are all the more justified because the emerging institutional structures arecertainly not homogeneous across countries. Trial and error seems to prevail to some extent.

Thus far, academic discussions of the emerging supervisory architectures have been dominated bypurely economic views: supervisory structures are being revised because of the blurring boundariesamong financial institutions and activities, and the formation of big conglomerates. However, judgingfrom the multiplicity of reform outcomes and politicians’ revealed preferences, the natural questionwhich emerges is: to what extent is the changing nature of the markets really being taken into account?And, related to that, to what extent have policymakers been listening to the views of the markets withrespect to the desirable supervisory structure?

An answer to these questions requires a political economy approach. Indeed, financial supervisoryreform is a political process which involves many stakeholders: the political class, the central bank,the supervised entities, as well as the customers of the financial services. So the all-encompassingquestion is: which considerations and views prevail in the end in the decision-making process, andto what extent are the decision-makers taking into account the views of these different classes ofstakeholders when deciding on a reform of the supervisory structures.

This paper tries to answer some of these questions by looking specifically at the impact of themarket factor on the decision-making process. More specifically, it first develops a model to analyzeto what extent policymakers are taking into account the features of the market structure. Secondly,it reports on the results of a survey among Italian market operators on their views on the efficiencyof the current supervisory structure, and on the optimal structure—both in terms of architecture andgovernance.

To answer the first question, the paper starts from two views on the policymaker—the helpinghand and the grabbing hand view—to find out empirically how market views are being taken intoaccount. Evidence seems to lean towards the grabbing hand view, considering the degree of bankingconcentration a proxy of the capture risk and presuming the market demonstrates a preference forconsolidation of supervisory powers.

The survey sheds interesting light on the Italian case—a strong desire for supervisory consolidationwith the aim of making the supervisory process more efficient, and a strengthening of governancearrangements through more accountability. The survey also shows that markets believe that the reform


views of the politicians are not fully aligned with theirs. However, these findings do not allow us todetect the true nature of the Italian policymaker (HH versus GH).

While the results of this paper are encouraging, further research is warranted. More specifically,the analysis on the determinants of supervisory structures in Masciandaro (2006) and this paperneeds to be combined with the research presented in Masciandaro et al. (2007) on the determinantsof governance arrangements in supervisory agencies. Both shed light on one aspect, but it would beinteresting to find out to what extent these two aspects—supervisory architecture and governancearrangements—are two sides of the same coin. Why do politicians in one country allow the centralbank to be the single regulator, and why are they inclined in other countries to take supervision out ofthe central bank and put it in a newly established unified supervisor? Market trends could be one factorin the decision, as this paper shows. However, other elements might be at play as well, such as thedesire to have more say in the agency (and thus to take the responsibility away from the independentcentral bank). Thus, the government’s helping or grabbing hand can possibly leave fingerprints all overthe new structure.

Acknowledgements

The authors would like to thank Michael Taylor, Martin Cihak, Lucia Dalla Pellegrina, BurkhardDrees and Caryl McNeilly, as well as two anonymous referees, for useful suggestions and discussions.Rosaria Pansini provided excellent research assistance. All remaining errors are the authors’. Addi-tional materials and supplementary tables related to this paper are available on the NAJEF web site at:http://www.sciencedirect.com/science/journal/10629408.

Appendix A. Supplementary data

Supplementary data associated with this article can be found, in the online version, atdoi:10.1016/j.najef.2008.02.002.

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helping hand or grabbing hand?: politicians, supervision regime, financial structure and market view

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