The global financial crisis of 2008, also known as the subprime mortgage crisis, is classified as the world’s worst crisis since the Great Depression of 1930. The initial collapse of Lehman Brothers triggered a cascading effect of failures, thus exposing the high systemic risk embedded in a highly interrelated and interdependent banking network. Systemic risk in a banking system is defined as the risk of destabilization of the whole system, caused by the failure of a single or a small set of banking institutions. The collapse of Lehman Brothers threatened the viability of many other large financial institutions. The ones that eventually survived received significant subsidies (through bailout programs) under the Troubled Assets Relief Program (TARP) implemented by the government. The same was not true for a set of smaller institutions that were left to collapse.

Historically, following each banking crisis, a series of acts were introduced aiming to stabilize the banking system and avoid a future reoccurrence of a crisis. The Banking Act of 1933, commonly known as the Glass–Steagall Act, was signed by President Franklin Roosevelt as an attempt to restore confidence in the U.S banking system. The bill was designed to reform the banking system by imposing a dichotomy between commercial and investment banking in order to reduce risk. It also intended to allow for a safer and more effective use of banks’ assets, to regulate interbank control, and prevent banks from conducting speculative operations. This boosted disintermediation, which is the practice of financing directly from capital markets without the intermediation of banks, thus reducing the banks’ share in total financing. As a result, banking institutions pursued the abolishment of the Glass–Steagall Act, and several decades later, the U.S Congress passed the Gramm–Leach–Bliley Act of 1999, which was signed into law by President Clinton. The Gramm–Leach–Bliley Act waved the preexisting barriers in financial markets; hence, banking institutions were again free to engage in security trading and insurance contracts that helped them increase their market share. This newly gained freedom, and the inevitable fierce competition with non-banking institutions, led to the rapid development in the markets of new and diverse financial instruments. In effect, the liberalization of the banking sector led to a significant increase in systemic risk, as banks have since been exposed to investment and other types of risk. Many analysts believe that the 2008 financial crisis is directly linked to the imposition of the Gramm–Leach–Bliley Act. The lack of separation between commercial and investment banking activities, allows financial institutions to be involved in security trading, not only for their customers, but also for themselves, a practice that exposes common depositors to high market risk.

After the 2008 financial crisis, the Obama administration enacted the Dodd–Frank Wall Street Reform and Consumer Protection Act in 2010, in an attempt to minimize systemic risk, enforce financial sector’s transparency and accountability, and implement rules for consumers’ protection; however, the provisions of the Dodd–Frank Act did not include the strict separation between commercial and investment banking, and thus, it cannot fully minimize such risk in the banking sector.

It is essential for the regulators to swiftly pinpoint incidents of bank distress. A prompt identification of instances of increased systemic risk can help minimize the policy reaction time. This can help minimize the contagion and defuse the propagation of a potential financial crisis; thus, an effective and continuous monitoring of financial institutions is necessary for the maintenance of a solvent and stable banking system. Increased supervision and strict regulation of the banking system is also required by the new Basel Accord (Basel III) by the Basel Committee on Banking Supervision, introduced in the U.S. in 2013, and implemented in 2018. Recently, Durana Pavol et al. (2021) revealed the impact of bankruptcy risk on the level of earnings management in the life cycle stages.

According to the new Basel Accord framework, the regulatory authorities are responsible for: (a) implementing extensive supervision of the banking system, and (b) mitigating the effects of possible crises and limiting contagion. A significant concern, apart from finding the appropriate monitoring tools, is the appointment of such a regulatory authority. A great deal of research supports the idea that supervision of the entire banking system should be vested to a single authority. Vives (2001) and Blinder (2010) support the idea that a single authority can (a) establish credible systems, (b) achieve economies of scale, and (c) reach financial stability by taking advantage of the economies of scale between the Lender of Last Resort (LOLR) facility, supervision, and monetary policy. Boyer and Ponce (2012) support the idea that a single supervisory authority preserves a more effective supervision of the banking system than the one achieved by multiple authorities. Following the idea that a single authority can competently optimize the supervision of the entire banking system by providing a timely and efficient intervention, in October 2012, E.U. leaders decided to assign the supervision of the whole European banking network to a single authority, the ECB.

2. Supervision of Complex Banking Networks