We explore the behavior of supervisors when a centralized agency has full power over all
decisions regarding banks, but relies on local supervisors to collect the information necessary
to act. This institutional design entails a principal-agent problem between the central and
local supervisors if their objective functions differ. Information collection may be inferior to
that under fully independent local supervisors or under centralized information collection.
And this may increase risk-taking by regulated banks. Yet, a “tougher” central supervisor
may increase regulatory standards. Thus, the net effect of centralization on bank risk taking
depends on the balance of these two effects.
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