Supervising Your In‐Group? How Social Identification Shapes Financial Sector Regulatory Leniency

ABSTRACT Both practitioners and governance scholars recognize the importance of external oversight, especially in regulated industries like the financial sector. However, the failure of financial sector regulators and enforcement officials (supervisors) to act is often cited as a primary cause of ineffective governance. Drawing on social identity theory, we hypothesize that social identities influence how supervisors perform their supervisory duties. We tested our predictions using a unique experimental design and survey of supervisors working at two Dutch financial sector supervisory agencies. Consistent with our main argument, we find that supervisors' social identification with the financial sector leads to lenient supervision. Additionally, we demonstrate that prior experience in the financial sector indirectly fosters leniency through sector identification and that this pathway is weaker for supervisors with a strong professional identity. These results clarify how and when sector identification impacts financial sector supervision.