Central Supervision of Local Financial Regulators

I study central supervision of local financial regulators in an economic union. Regulators each privately observe benefits from lenient local macroprudential policies. Separate deposit insurance funds allow no discretion to set policies because, with integrated financial markets, regulators cannot charge deposit insurance fund contributions independently of each other. A common fund makes discretion feasible but requires central supervision to contain moral hazard. I show that optimal central supervision emphasizes maintaining discretion over protecting the common fund