Does the political independence of banking regulators and supervisors improve financial stability?

Does higher political independence for banking regulators and supervisors improve financial stability? Policy makers seem to agree that this is the case. Since the 2008 financial crisis, regulators and supervisors have been granted increased independence from political bodies. One of the main pillars of the Basel Committee’s core principles for effective banking supervision is the independence of supervisors from governments. The International Monetary Fund and the World Bank regularly assess compliance with this principle as part of their Financial Sector Assessment Program. These assessments often flag independence as one of the principles with the lowest compliance.¹

The reason why independence can benefit financial stability is straightforward. Elected officials may have incentives to pressure authorities to loosen banking regulations or relax supervision to accommodate credit expansion ahead of elections. In this way, politicians could stimulate short-term growth and boost their electoral prospects. Independent supervisors are insulated from such cycles, allowing them to prioritize long-term financial stability over short-term political gains.

But is regulatory and supervisory independence (RSI) actually associated with a more stable banking system? We investigate this question in a new study (ungated version at this link). Although the benefits of RSI for financial stability are well-established from a theoretical perspective, empirical evidence on this link is scant and has limitations. We address this issue by creating a new index measuring the political independence of bank regulators and supervisors for 98 countries during 1999–2019. The data are freely available at this link.

The index measures the statutory independence of supervisors and regulators based on three aspects: institutional, regulatory, and budgetary. Institutional independence is measured based on the appointment, removal, and term length of the head of the supervising agency. Regulatory independence measures the degree of autonomy in setting technical rules and regulations for the sector it regulates and supervises. Budgetary independence captures how independent the supervisor is in determining its own resources, as politicians could pressure agencies by restricting the resources at their disposal to perform their functions.² Crucially, this index differs from the traditional central bank independence measure, which focuses on monetary policy. Moreover, in many countries, bank regulation and supervision are delegated to an agency that is separate from the central bank.

The RSI index reveals that there is substantial heterogeneity across countries, with bank supervisors presenting a very high degree of independence and others reporting significantly lower levels (figure 1). We also notice that the independence of regulators and supervisors did not develop at the same pace as central bank independence (figure 2). While central bank independence grew steadily and at a relatively quick pace from the early 2000s, RSI increased more slowly over time and followed a more discontinuous pattern.
 

Figure 1: Independence of bank regulators and supervisors

Figure 2: Evolution of independence for bank regulators and supervisors and central banks

So, does regulatory and supervisory independence actually improve financial stability? We test this on a sample of more than 2,500 banks based in 69 countries and find that it does. We show that higher independence of regulators and supervisors is significantly associated with more stable banking systems. Specifically, banks operating under more independent supervisory frameworks hold fewer nonperforming loans, which are a key indicator of financial distress. Higher independence is associated with improvements in other financial stability indicators, such as banks’ z-scores (a measure of insolvency risk) or volatility of return on assets.

This relationship holds across a range of robustness checks. Whether we control for bank-specific traits, like size or capital levels, or country-level factors, such as inflation, credit to gross domestic product, or cultural attitudes, the link between independence and financial stability remains strong. We also verify the result using instrumental variables, confirming that the association is not driven by reverse causality or omitted variables.

Importantly, the beneficial impact of RSI does not hinge on specific bank types. Whether banks are large or small, state-owned or privately owned, or politically connected or not (based on the presence of politically connected individuals on the bank’s board), the positive effects of independence are consistently observed. This result underscores the ability of statutory independence to strengthen supervision beyond political economy constraints.

However, we find that the overall supervisory structure matters. The impact of RSI is greater when supervision is housed within the central bank, and can even backfire in contexts where supervisors are too powerful—possibly due to increased risk of regulatory capture from the private sector (as our indicator focuses on independence from the public sector).

We also tested whether this effect holds during times of crisis. While independence continues to be associated with lower nonperforming loans during crises, the statistical significance of this relationship is weaker than in normal times. This suggests that although RSI strengthens the resilience of banking systems overall, its protective effect may be partially muted when systemic shocks hit. Nonetheless, our evidence supports a clear policy implication: insulating banking supervisors from political pressure improves financial stability—making RSI a reform worth pursuing.
 

References

Adrian, T., M. Moretti, A. Carvalho, H. Kyong Chong, K. Seal, F. Melo, and J. Surti. 2023. “Good Supervision: Lessons from the Field.” Working Paper No. 2023/181, International Monetary Fund, Washington, DC.

Adrian, T., and A. Narain. 2019. Let Bank Supervisors Do Their Jobs, IMF Blog, February 13, 2019. https://www.imf.org/en/Blogs/Articles/2019/02/13/let-bank-supervisors-do-their-jobs.

Fraccaroli, N., Sowerbutts, R., & Whitworth, A. (2025). Does regulatory and supervisory independence affect financial stability? Journal of Banking & Finance, 170, 107318. https://doi.org/10.1016/j.jbankfin.2024.107318

Romelli, D. (2022). The political economy of reforms in central bank design: Evidence from a new dataset. Economic Policy, 37(112), 641–688. https://doi.org/10.1093/epolic/eiac011 

 

^{(1) Adrian et al. (2023); Adrian and Narain (2019).}

^{(2) One limitation of this index is that it measures “de jure” and not “de facto” independence—that is, it measures the degree of independence of supervisors as enshrined in the country’s statutes, which does not necessarily correspond to their actual independence. For instance, when a country has weak checks and balances mechanisms, the executive power could be able to influence the supervisor’s decisions even if the law provides the supervisor with strong independence.}