DP9546 | Supranational Supervision - How Much and for Whom?

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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 failures 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 their supranational orientation. 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.