“The Prudential Regulation of Banks”

In a speech delivered at a recent conference, Claudia Buch, Chair of the Supervisory Board of the European Central Bank (ECB), argued that modern bank supervision is rooted in a clear theoretical foundation and must remain vigilant in the face of evolving risks.

“Banks are largely funded by small, dispersed depositors,” she noted. These depositors “may lack the information or expertise to monitor effectively how banks are managed,” creating what she described as “a structural governance gap” that supervisors are charged with filling, acting on behalf of depositors to ensure risks are properly managed.

Buch traced this framework to the seminal 1994 book, The Prudential Regulation of Banks, by economists Mathias Dewatripont and Jean Tirole. That book established that capital requirements serve as intervention triggers, shifting control “from shareholders to supervisors” when a bank's performance deteriorates. This theoretical insight, she argued, continues to shape the ECB's core mandate of “keeping banks safe and sound.”

Reflecting on recent supervisory lessons, Buch cautioned against complacency. “Resilience is a forward-looking concept,” she stressed. She further warned that strong current performance should not distract from “evolving risks and vulnerabilities,” especially given “elevated geopolitical risks and the reduced capacity of fiscal policy to buffer shocks.”

“Being challenged in our work and encouraged to reflect upon it is invaluable if we are to remain focused on our overarching objective of contributing to the public good of financial stability,” Buch concluded. “In the broader policy debates now underway, it remains essential to keep a clear vision of why good regulation and supervision enhance welfare rather than pursuing short-term objectives that may ultimately weaken growth and resilience.”