Why Supervision Must Look Beyond Compliance

In a recent speech at the Madras School of Economics, Swaminathan J., Deputy Governor of the Reserve Bank of India, argued that bank supervision must go beyond assessing compliance if it is to continue to support necessary trust in the financial system.

“Banking involves uncertainty,” he said. “It involves taking risks, managing relationships, making decisions with evolving information and responding to competition. But the supervisor's responsibility is different. The supervisor must ask not only whether the bank is successful, but whether it is safe and sound.”

Swaminathan J emphasized that the costs of supervision are plainly visible, in the size of compliance teams, reports, audits, etc. However, the benefits are much harder to measure. This is the “paradox of good supervision,” he explained: if supervision is successful, it should go unnoticed.

“That is why supervision must look beyond formal compliance,” he stressed. “Compliance asks whether the rule has been followed. Supervision asks whether the underlying risk has been understood and addressed.” While a bank may have the required formal governance mechanisms, supervisors are charged with asking whether those mechanisms function as intended. “Seen in this light, banking supervision is not an obstacle but part of the foundation that allows banking to command public trust,” he said.

“Some public goods are difficult to price because their greatest value lies in prevention,” he added. “Financial stability is one such public good. It is taken for granted when present, but its absence is deeply disruptive. Banking supervision is one of the institutional mechanisms through which that public good is protected.”