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Assessing the Impact of Supervision

Assessing the Impact of Supervision

by Starling Insights

Starling Insights Editorial Board

Apr 23, 2024


In a blog post published last week, Federal Reserve Bank of New York researchers Beverly Hirtle and Anna Kovner explored the impact of supervision on banks, the financial system, and the economy.

"In March of 2023, the U.S. banking industry experienced a period of significant turmoil involving runs on several banks and heightened concerns about contagion," Hirtle and Kovner wrote. "While many factors contributed to these events—including poor risk management, lapses in firm governance, outsized exposures to interest rate risk, and unrecognized vulnerabilities from interconnected depositor bases, the role of bank supervisors came under particular scrutiny."

Many discussions surrounding banking regulation and supervision use the terms interchangeably, but Hirtle and Kovner emphasized that these are distinct activities. Regulation involves setting the rules under which banks will operate. Supervision, on the other hand, involves monitoring banks to ensure they comply with those rules and act in a safe and sound manner more generally. "[S]upervision also involves qualitative assessments of banks' internal processes, controls, governance and risk management—and taking enforcement actions when weaknesses are discovered," they wrote.

While much less research has been conducted on the impact of supervision than regulation, a growing body of empirical research shows that — within reasonable boundaries — supervision reduces excess risk-taking without impacting performance or growth. "These findings suggest that supervision reduces the risk of bank failure, with little cost to bank profitability," Hirtle and Kovner wrote. Some research has found that increased supervision does reduce loan origination or loan growth. However, the magnitude of this effect is unclear.

"One important caveat to these findings is that they were estimated at levels of supervision prevailing at the time of the analysis," they cautioned. "It is possible (and even likely) that the free lunch suggested in the positive relationship between supervision and risk without significant impact on growth may not hold if supervision were dramatically increased from those levels."

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