Lessons on Supervisory Effectiveness

Last July, the Basel Committee on Banking Supervision published a working paper which surveys the academic and policy literature to determine what drives supervisory effectiveness.

The paper defines effective supervision as that which promotes safety and soundness by “promptly assessing prudential risks, identifying material shortcomings within banks, and using the supervisory toolkit and powers appropriately to ensure that banks remediate shortcomings in a timely manner.” Notably, the authors argue that supervisory effectiveness should be judged by outcomes, not level of activity.

To organise the evidence, the authors offer a “house of supervisory effectiveness” framework comprising a foundation, three pillars, and a roof. The foundation refers to the institutional and legal arrangements that enable (or constrain) supervisory action. These include mandate and independence, resources and powers, credible crisis-intervention frameworks, and the ability to leverage supervisory technology (SupTech) and other innovative tools.

The “house” rests on three pillars: (i) risk identification and assessment, (ii) remediation and enforcement, and (iii) collaboration and transparency. The paper stresses that these elements are interdependent. “ correct and timely risk identification
and assessment of a bank’s shortcoming… can be considered a prerequisite for ensuring a successful remediation,” the authors write, while disclosure can “complement or even substitute enforcement actions.”

Finally, the paper places particular weight on the “roof”: supervisory culture and risk management. It defines supervisory culture as “the collective values, beliefs, attitudes and behaviours” that shape how authorities conduct oversight. This matters because all three pillars are “shaped by and critically depend on the overarching culture and strategy,” the authors argue.