# **Appendix III: Central Bank Governance and Financial Supervision**

Central banks often have mandates regarding financial stability and supervision, but often central bank legislation is less specific about the clear functions and responsibilities of central banks in this regard (Ortiz 2009). Nonetheless, elements of this task, such as the lender-of-last-resort function or oversight of the payment system, have long been central bank functions (Freixas et al. 2000).<sup>22</sup> Although the trend since the 1990s has been toward consolidation of financial supervisory functions, these changes have primarily focused on consolidating functions in an agency separate from the central bank. Despite those developments, according to the results of a survey of 160 countries completed in 2019, approximately 68 percent of central banks still have banking supervisory responsibilities (Anginer et al. 2019).

Empirical evidence on the link between central bank independence and financial supervisory responsibilities remains limited. Some research has shown that <mark>central bank independence exercises a positive impact on bank soundness and that central bank involvement in banking supervision mitigates the adverse effects of financial crises (Doumpos, Gaganis, and Pasiouras, 2015). H</mark> owever, this more extensive mandate can impact the central bank's autonomy, decisionmaking, and transparency. Initial findings from the research explored in this report indicate that countries with better overall governance environments and lower country risk usually have an entity different from the central bank for financial supervision, as seen in Table III.1. The variables used here are described earlier in the paper, and as a measure of whether central banks also have supervisory responsibilities, we use the World Bank's regulation and supervision survey (World Bank 2019). This comprehensive survey covers multiple subjects on banking regulation and supervision practices 160 jurisdictions. We use this survey to establish whether the central bank or a separate entity is responsible for financial supervision. This variable aims to analyze whether reserve management is different in central banks with more responsibilities and more complex governance structures. The survey's last edition was in 2019.<sup>23</sup>

**Table III.1  Financial Supervision and the Broader Governance Environment**

<!-- Start of picture text --> Independence of Corruption Governance Government<br> Variables<br>central bank Perceptions Index Pillar Score Effectiveness<br>Central bank is financial supervisor -0.086 -0.268*** -0.281*** -0.291***<br>Note: The significance level of the pairwise correlations is displayed with asterisks, where *** stands for a p-value below 0.01 (i.e.,<br>extremely significant), ** stands for a p-value below 0.05 (i.e., very significant), and * stands for a p-value below 0.1 (i.e., significant).<br><!-- End of picture text --> Regarding the impact on reserve management, the correlations suggest that countries where the central bank is also a financial supervisor tend to have an independent investment committee to which the middle office reports (see Table III.2). This arrangement may result in a lower risk appetite in managing reserves and imply that the central bank accounts for and manages the

> 22. Henry Thornton (1802) and Walter Bagehot (1873) developed the classic doctrine of lender of last resort. According to Bagehot, in a panic situation monetary authorities should lend unsparingly but at a penalty rate to illiquid but solvent banks. See Freixas et al. (2000) for further background. 23 _._ <u>https://www.worldbank.org/en/research/brief/BRSS.</u>

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