Optimal Supervisory Architecture and Financial Integration in a Banking Union∗

Both in the United States and in the Euro Area, bank supervision is the joint responsibility of local and central supervisors. I study a model in which local supervisors do not internalize as many externalities as a central supervisor. Local supervisors are more lenient, but banks also have weaker incentives to hide information from them. These two forces can make a joint supervisory architecture optimal, with more weight put on centralized supervision when cross-border externalities are larger. Conversely, more centralized supervision endogenously encourages banks to integrate more crossborder. Due to this complementarity, the economy can be trapped in an equilibrium with both too little central supervision and too little financial integration, when a superior equilibrium would be achievable. JEL Classification Number : G28, G21, L51.