Supervisors on Supervision

“Compared to more specific and tangible prudential and conduct rules, ‘culture’ is a woolly mammoth — not an easy creature to define or bring to life."

“Culture assessments often start with how an organisation feels. That is important, but I prefer to start with how it acts.”

“Real-time and continuous surveillance and intervention by the supervisor is an important part of addressing cultural failings in banks. What you see with some of the banks that have had longstanding cultural problems is that every few years, they'll have another blow-up, and it'll turn out that nothing's changed since the last blow-up. How do you tell, in between those big events, whether the culture is moving in the right direction? If you can answer the question of how to measure progress on culture when there hasn’t been a blow-up for some time, then you are in a better position to drive change.”

“One of the lessons from the Global Financial Crisis was that supervisors had been quite busy — but they had been busy doing the wrong things or doing them in the wrong way. Part of the response was, ‘Oh, well, we need to do something called judgment-based supervision.’”

In the prudential supervision of banks, there are some cornerstone activities that any supervisor needs to do. First, they need to assess the adequacy of capital. Second, they need to assess whether there is sufficient liquidity. And third is resolution planning. When you dig down into each of them, there’s a lot of supervisory discretion involved. 

There’s a lot of discretionary activity that supervisors can or can’t do, based on the resources they have, their perception of where the risks lie in the firm, and the amount of trust that they have that the firm will itself do things correctly.”

“Within the supervisor itself, there can be an interesting cultural issue about the approach to supervision. 

Is supervision something that’s left to the operational level, with an assumption that line supervisors are competent to choose what actions to undertake and to judge whether they are being effective? Or is there a really good three-lines-of-defense model, where the board of the supervisor sets expectations of the intensity of activities that the supervisors should undertake in relation to firms with a particular risk profile, and then applies the three-lines-of-defense model in checking that the supervisor’s activities reflect the board’s risk appetite and are followed through in a timely manner? 

The Silicon Valley Bank episode shows what can happen when the three-lines-of-defense model is underdeveloped and supervisory concerns are not followed up rigorously.”

“There is sometimes a view that, because regulators do not have a profit motive, they are at less risk of control failures.

It’s great to have colleagues with a strong sense of public duty — but that is simply not enough, and confronting a regulator with evidence of its impact (or lack of it) can help to move the culture from feeling good to doing good.”

“Whether supervisors have a rigorous framework enforced by three lines of defense and an effective challenge function is a culture point as much as an organizational design point. It comes back to a question of culture: Should you trust us because we’re good guys doing public service? Or should we accept that we’re human beings who make mistakes and need careful checking just like the banks we supervise”

“Many regulators (financial or otherwise) would probably admit that they have not always held themselves to the standards they require of the businesses they regulate.

More recent failures of regulation and supervision — the crises among US regional banks and at Credit Suisse [in 2023] — have shifted the lens to the culture of financial regulators themselves, and revelations about the culture of the US Federal Deposit Insurance Corporation (FDIC) have intensified this focus.

If a regulator can show that it engages with those it exists to serve, that it is making a positive impact, and that it holds itself to the standards it requires of the businesses it regulates, then there is every chance that [it] will go on to find that it has a sound culture.”

“There is a fundamental question for some banks of whether they are in the right businesses given their resources and competitive strengths. Will they be constantly reaching for results which they can’t sensibly and safely reach, because the business model isn't realistic and sustainable?

If a bank’s ambition is wrong-sized for the strengths that the bank has, that’s when you then see people getting into all sorts of cultural troubles. 

Silicon Valley Bank is a classic example of that. What was the bank trying to do? What were its capabilities to identify and manage the risks of its business model? There was a mismatch between SVB’s ambition, capabilities, and governance and the net result was a cultural failure to acknowledge and manage risks, leading to a massive blow-up.”

“If you look at Credit Suisse and ask, why was it constantly falling into disrepute? It's because there were questions about the sustainability of its business model given its size and ambition. 

The business model didn’t align with the firm’s capabilities. And therefore, across the firm, people were reaching for more risk than they could responsibly manage.”

“It is noteworthy that when Michael S. Barr produced a report on the failure of the Silicon Valley Bank, he called out failures in SVB’s 3LoD system but had much less to say about how to change the Fed’s own 3LoD system. 

Similarly, the Swiss Financial Market Supervisory Authority’s (‘Finma’) report on ‘Lessons Learned from the Credit Suisse Crisis’ covers deficiencies in Credit Suisse’s 3LoD system quite extensively, but does not suggest how Finma’s own 3LoD system could be improved.”

“Strong governance in a regulator requires speaking truth to power. Without it, first culture and then performance will suffer.”

“The analysis that there wasn't enough judgment being applied prior to 2008 was correct. But what has sometimes been lacking — both before and after 2008 — has been a framework to ensure that there is a tailored programme of supervisory activity and a set of time-bound outcomes that can be overseen within a three-lines-of-defense model.

You see that problem with both Credit Suisse and Silicon Valley Bank, where important issues were identified but either they were not escalated or they were escalated but then remediation was allowed to drift for unacceptable periods of time. 

Supervisory culture issues can be more acute in areas where there is no binding international standard forcing action, such as interest rate risk in the banking book. 

That’s what crystallized with Silicon Valley Bank and in the absence of a binding standard, the supervisors lacked the confidence to drive prompt remediation. Judgement-based supervision is all very well but there need to be adequate checks and balances.”

“Without measurement of impact over the medium to long term, the regulator cannot hold itself to account — and neither can others.”

“There is currently pressure from a number of governments on the regulators to stand back and not be so intrusive. The danger is that it has a cultural impact on the regulators — and that they therefore decide that maybe they’ll do less supervision, and the supervision they do won’t be so demanding. While that may go along quite well for a while — eventually it’ll blow up with a loud bang. 

If you look at the cultural influences on the supervisors, they’re quite complex. They come from the government, they come from other politicians, they come from lobby groups, and they come from the firms themselves. There’s a risk of capture or groupthink coming from a number of different directions.”

“How does a supervisor make a bank remediate its culture issues? The problem is not so much that when the bank is hit with a capital scalar related to culture issues, it just shrugs and says it's the cost of doing business. It's more that the bank may genuinely not know how to turn its culture around. 

It's a difficult thing because a lot of these banks are federated in terms of their cultures and there are long chains of command to different business units. So trying to send a message down those chains about the desired culture, and to get that message turned into action, is difficult.”

“Some standards exist, but most of the standards which mention culture address the culture of the supervised bank and not the culture of its supervisor. So far as supervisory culture is concerned, there are a few expectations that are mostly implicit rather than explicit in publications by the Basel Committee and the Financial Stability Board. 

The periodic Financial System Assessment Program reviews by the IMF can also help to identify cultural shortcomings at supervisors. However, compared to the number of standards which relate to the culture of supervised banks, the standards applying to supervisors and the controls to ensure those standards are followed are not very extensive, rigorous, systematic or transparent.”