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Should the Monetary Authority also Regulate Banks? National Conditions Provide “Right” Answer

Combining monetary policy and bank supervision allows a central bank to better consider the implications of its actions for the economy and the commercial banking system, according to proponents of this structure. However, those who suggest separating the two functions worry that the interests of the public may be compromised by a monetary authority that is overly concerned with the effects of policy on commercial banks. A recent Federal Reserve Bank of Cleveland Economic Commentary reviews arguments for each approach and suggests that the appropriate structure for a central bank depends on a country’s financial system, its political environment, and the preferences of the public.

The Commentary’s author, economist Joseph Haubrich, says that the diversity and success of actual practice around the globe belie any simple answer to the combination/separation question. Combination is particularly needed, proponents argue, in economies that are prone to financial crisis, when, they say, only direct supervision can deliver essential information on time. Haubrich also points out that combination may be important in a country with an undeveloped financial sector, where effective monetary control may rely on direct bank controls, such as interest rate ceilings and credit limitations.

Haubrich says that changes in technology, finance, and the global economy will create new challenges for monetary policy and the need for continuous reappraisal of the regulatory structure. He concludes that these changes may ultimately reshape the world’s central banks.

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