A Starling Insights Deeper Dive Report

Supervisors on Supervision

— Closing Comments to Chapter Two —

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The opening chapters of this stocktake and study have reaffirmed what many in the supervisory community have long understood, but perhaps not yet fully operationalized: that concern for culture related risk is neither ephemeral nor ancillary. Culture shapes risk appetite and risk management, it determines how institutions respond under stress, and — crucially — it also defines the capacity of supervisors to exercise their mandate in a credible and effective manner.

This chapter has examined culture related risk not as an ethical or abstract concern, but as a practical challenge to effective supervision and institutional legitimacy. Failures of risk governance in the industry, and of supervisory judgment in the official sector, both reflect the same reality: when culture is misaligned, risk becomes invisible until it is irreversible.

We have seen this play out with clarity in recent episodes of distress. Credit Suisse, Silicon Valley Bank, and other institutions that appeared solvent by prevailing metrics were imperiled nonetheless due to collapsing confidence. That collapse was not caused by insufficient capital, but by the absence of trust in internal governance, risk controls, and institutional leadership. These were failures of judgment, of incentive alignment, and — most importantly — of cultural coherence.

The natural impulse in the wake of such failures is to re-examine regulatory standards, to ask whether the rules were sufficiently stringent or the buffers adequately sized. But we must also recognize that rules alone do not avert crises. Rules may help to constrain activity, but they do not ensure prudence. They can define limits, but they cannot replace the need for adaptive and anticipatory supervision.

Indeed, as I have argued elsewhere, we may be approaching the limits of what further regulation can achieve without imposing disproportionate burdens on the sector’s capacity to intermediate credit and serve the real economy. The marginal social gains of new regulation may be diminishing, while the marginal private costs — especially in terms of complexity and operational burden — are increasing.

This makes the case for improving supervision all the more compelling. What is needed now is not merely more rules, but more effective frameworks for identifying, assessing, and responding to risks that emerge not from capital shortfalls, but from behavioral and organizational pathologies.

Why Supervision Must Now Do More

It is important to acknowledge that the post-Crisis prudential reforms have greatly enhanced the formal resilience of banks. They have raised standards, improved loss-absorbency, and introduced resolution frameworks that, in many cases, have realigned expectations around state support.

But recent events — most notably but not exclusively in 2023 — have exposed material gaps in how those standards are applied and, more importantly, how weaknesses are identified before they manifest in crisis. Evidence reveals that authorities are often subject to critical shortcomings. In particular:

• Supervisors often lack the institutional frameworks, powers and tools, to escalate concerns early, particularly when risks were qualitative rather than quantitative;
• Supervisory agencies sometimes lack the required human resources and infrastructure (including technology) to properly perform risk-based supervision and, in particular, to timely identify vulnerabilities, and 
• The internal cultures of supervisory bodies themselves were not consistently conducive to early intervention, often defaulting to procedural defensiveness over-proactive engagement.

These weaknesses often reflect a mismatch between supervisory ambition and supervisory infrastructure — between what is expected of supervisors, what supervisory frameworks allow them to do, and what their own cultural proclivities prompt them to do in practice.

The Case for Structured Discretion

Much has been said in this report about supervisory discretion, and rightly so. Discretion is indispensable. Rules, no matter how comprehensive, cannot fully anticipate the complexity and evolution of financial risk. Discretion allows supervisors to adapt, to intervene, and to apply judgment in the face of uncertainty.

This is critical. But discretion, if it is to remain legitimate, must be disciplined by process and informed by frameworks. We must ensure that ‘discretion’ does not become a synonym for ‘arbitrariness’ — or worse, for inaction. 

In general, it is hard to imagine an effective supervisory framework which does not effectively rely on a fair amount of reasonably constrained judgment. Constraints could take the form of the ex-ante determination of areas of application, a flexible suit of tests and indicators on which to base actions, and a suitable governance process seeking consistency across institutions but without rigidly establishing binding industry benchmarks, whether implicitly or explicitly.

In addition, the deployment of judgment should not lead to an excessive variability of supervisory criteria. To the extent possible, banks should have sufficient clarity on what is expected from them in terms of capital, liquidity and management actions over not too short horizons to facilitate planning.

Finally, banks need to have the opportunity to discuss supervisory decisions. Current supervisory processes contain different instances for a supervisory dialogue and typically include a “right to be heard” provision. In many cases, banks have access to a board of appeal within the supervisory organisation where they can challenge supervisory decisions before litigating. 

Yet, the limited activity of some of those boards when non-negligible litigation exists may suggest that a possible enhancement of the role of those boards of appeal could help achieving more efficiency in dispute resolution. 

Qualitative Measures Are Not Soft Options

Too often, there is an assumption — implicit if not explicit — that qualitative supervisory actions are somehow less rigorous, or less effective, than quantitative requirements. This view is not only misguided; it is dangerous.

No feasible amount of capital or liquidity can compensate for governance failures, incentive distortions, or internal communication breakdowns. As recent experience shows, culture — when misaligned — can render even the most robust balance sheets irrelevant in the face of eroding trust. 

We must therefore treat qualitative supervisory tools — dialogue, ratings, moral suasion formal recommendations, binding requirements, sanctions — as essential instruments of financial stability policy. But their effectiveness depends on clarity, prioritization, and follow-through. In this connection, several steps are critical:

• Supervisory ratings must elevate the role of governance and business model viability, not just traditional risk categories;
• Supervisory messages to firms must be consolidated, prioritized, and time-bound, avoiding diffuse laundry lists of concerns; and
• Responsibilities for remediation must be clearly assigned — to individuals, committees, or boards — not left as general obligations.

These are not cosmetic changes. They form the basis of a supervisory architecture that is credible, explainable, and effective.

The Role of Culture within Supervisory Institutions

Supervisors are often tasked with evaluating the internal culture of banks. But as this chapter makes clear, our own institutional cultures warrant equal scrutiny.

This is not simply a matter of fairness or introspection. It is a precondition for supervisory efficacy. If supervisors are risk-averse, siloed, or procedurally inflexible, they will not act in time — even when the signals are clear. If line staff are discouraged from exercising judgment or escalating concerns, no amount of senior commitment will suffice.

Reforming supervisory culture requires leadership. But it also requires institutional support mechanisms, including:

• Internal feedback loops and culture assessments
• A clear framework for supervisory prioritization; and
• Internal incentives for forward-leaning supervision

In that context, I have argued for the development of risk tolerance frameworks that can effectively support an effective supervisory culture. These frameworks would allow agencies to articulate, ex ante, the degree of uncertainty or litigation risk they are willing to tolerate in pursuit of early intervention. They would also provide internal alignment and procedural clarity — key ingredients in enabling supervisors to act decisively when early signs of deterioration appear.

The absence of such frameworks leaves supervisors vulnerable to the pathologies of institutional caution, where defensiveness outweighs foresight, and where procedural integrity displaces substantive accountability. These are the very troubles that arise in the context of culture risk governance and supervision, and it is recognition of this that prompts the production of this study.

These should not be viewed as bureaucratic refinements. They are, in fact, core infrastructure for the exercise of effective public authority.

Toward a More Credible Supervisory Compact

The real test of a supervisory regime is not whether it identifies risks after the fact, but whether it prevents foreseeable failures from materializing. In this respect, the supervisory community has work to do.

If culture shapes behavior, and behavior shapes risk, then culture must be a first-order concern of supervision.

But we should not see that as a weakness. On the contrary, the current moment offers an opportunity. The tools exist. The knowledge exists. The imperative now is to organize those resources around a supervisory compact that is both disciplined and dynamic. This compact must accept that supervision is not a binary function — ‘tough’ or ‘lenient’ — but a continuous engagement structured by informed judgment. 

It must recognize that culture is not incidental to safety and soundness, but constitutive of it. And it must reaffirm that legitimacy — of supervisors, as much as of firms — is earned through consistency, transparency, and a demonstrated willingness to act before harm is allowed to unfold. This includes the consumer harms that occupy conduct regulators, and the harms that concern prudential regulators when control systems are unwittingly undermined by cultural propensities that go unrecognized and, thus, unaddressed.

Final Observations

The increasing complexity of financial systems requires an equally mature approach to governance and supervision. We cannot rely indefinitely on regulation to offset institutional blind spots, nor can we defer to discretion that is not supported by structured reasoning — not without inviting further political protestations amidst an already fraught political climate.

If culture shapes behavior, and behavior shapes risk, then culture must be a first-order concern of supervision. Not examined episodically, but systematically. Not symbolically, but operationally.

This chapter has outlined the perils of the status quo. What lies ahead is the work of innovation and implementation: to reconsider supervisory frameworks, to refit organizational structures, and to reform internal cultures so that we may realize the ambition of truly modern oversight.

That work begins, as always, within our own institutions.

Fernando Restoy became Chair of the Financial Stability Institute on 1 January 2017. He had been Deputy Governor of the Bank of Spain since 2012. Previously, he held other senior positions at the Bank of Spain, which he joined in 1991. From 1995 to 1997, he was Economic Advisor and Head of the Monetary Framework Section at the European Monetary Institute in Frankfurt. He was Vice Chair of the Spanish Securities and Markets Commission (CNMV) from 2008 to 2012 and Vice Chair of the IOSCO Technical Committee (now Board). He was the Chairman of the Spanish Executive Resolution Authority (FROB) from 2012 to 2015 and was a Member of the Supervisory Board of the ECB's Single Supervisory Mechanism from 2014 to the end 2016.