Supervisors on Supervision

“I’d point to couple of really simple examples. 

First, is a loan being made outside the firm’s stated risk appetite? Is risk being taken outside stated tolerances, exposing the organization to greater risk than intended? 

Second, is an employee behaving toward clients or colleagues in a way that violates behavioral expectations? 

If so, crucially, how does the organization respond? If a salesperson extends a profitable loan outside risk appetite, are they rewarded or penalized? If someone behaves inappropriately, does local management act? Are violations ignored — or even rewarded? 

Reactions can be very different to similar events. That reaction sets the tone. So leadership needs controls to know whether risk appetite — risk and behavioral — is actually being delivered; and they need to help set the tone for how the organization responds when things go wrong. The latter can be even more instructive than the former.”

“A high-level international framework would have its challenges. For example, even the widely known ‘three lines of defense’ framework is not universally agreed or consistently applied. 

Take liquidity risk. In areas like this we are able to say: here are the Basel standards; here’s the data to collect; here’s how to analyze it for an individual institution and across firms. That’s all tangible and quantifiable. But it’s harder for other areas like operational risk, and harder still for governance and culture, beyond basic structures — and even then, not everyone agrees on those. 

So in the judgment-based, non-financial space, it’s harder — but probably not impossible.”

“Supervisory organizations should be aware of their own culture and how it affects their supervision. 

Tone from the top and throughout the supervisor matters, just like tone from the top within firms. It shapes how firms behave. So we have to look at our own culture.”

“A serious think-piece on this topic would, in my view, need three elements: 

First, how supervisors assess the tone that’s set at the top of a firm — what tools they have to assess it, and how leadership prioritizes risk management (prudential and conduct) versus commercial objectives. 

Second, what tools supervisors have to assess how well that tone flows through the organization. If you speak to someone in middle management or a non-management role versus the C-suite, are you hearing consistent overarching themes and priorities, especially around risk versus commercial goals?
And third, through what mechanisms can supervisors compare one firm’s culture with that of its peer group? In supervision, we’re often looking for outliers. If a firm’s culture is an outlier in some way, that’s an important supervisory signal.
So: tone from the top, diffusion through the organization, and peer comparison. A framework that enables supervisors to do those three things — assess tone, assess diffusion, and compare across peers — would have value.”

“Supervision isn’t a simple pass/fail test; it’s an ongoing conversation. There’ll be lots of agreement and some disagreement. When we want a firm to act it may not be effective to just tell them what to do. Rather, we can explain why, and we have an informed discussion about the issue, why it matters, and how it can be addressed. 
It’s rare to direct action without that dialogue, except perhaps ex-post enforcement when a rule has been breached. Day-to-day, it’s a two-way dialogue about expected standards, where the firm sits relative to them, and what to do where it sits outside our tolerance. 
Supervisors’ job isn’t to eliminate risk. Risk is inherent to running any business. Our job is to understand those risks; to assess how effective firms’ mechanisms are to keep risks within their stated risk tolerances; and to ensure that if risks crystallize, they don’t create broader systemic harm. We’re here to support a sustainable banking system that supports the economy, where firms take risk responsibly — and if they get it wrong, it doesn’t cause broader harm.”

“We are very conscious that technological developments and innovations can have a transformative effect on what we do — allowing us to be faster, better, more efficient and more targeted in aspects of our regulation and supervision.”

“One valuable tool supervisors can use to explain and motivate action is peer comparison. Not ‘you vs. Bank B,’ but horizontal analysis across a wide number of firms: ‘You’re in the middle of the pack here, leading there, behind there.’ That helps firms see where to improve. Yes, we must judge what counts as ‘good practice,’ but without that comparative input, firms may struggle to know where to focus.”

“Tone from the top is a necessary but not sufficient condition for a good culture. It gets you about 10% of the way. If you don't have the tone from the top, you haven't got a hope. But just getting it right does not get you there. It is absolutely possible to sit atop a company and not know what's going on.

Tone from the top includes what the board and C-suite say and what they do. There are examples where leaders said the right things, but major events later showed the risk culture wasn’t there. There are also examples where public statements aspired to one culture, but behaviors, controls, and internal discussions sent a different message. Actions matter.”

“Supervision has to be judged against its objectives. For the PRA, our primary objective is the safety and soundness of supervised institutions. That doesn’t mean firms won’t fail; it means we’ll have analytical framework and mechanisms to ensure we can identify which firms pose risks to our objectives, including that they may fail, so we can ensure they can fail without threatening the system. 

Good supervision involves: individuals or teams with the knowledge, empowerment, and tools to assess a firm against a defined supervisory framework at the firm level; who can judge whether the firm meets requirements and benchmark it against peers; who can form judgments about where risks of falling short may come from; and who can communicate those judgments effectively to the firm in a way that’s understood and actionable.”

“Leadership is important in explaining how to weigh competing priorities internally; then put in place mechanisms and controls to see that those priorities are carried through in practice. Leaders can then be held accountable — by the board, shareholders, regulators, and other stakeholders — but it’s not only about being held to account after the fact. It’s about ensuring the mechanisms are in place to run the organization as articulated.”

“In our Policy Approach document, which we published in February, we described three regulatory ‘foundations’ which represent the ways our regulation underpins the UK’s growth and competitiveness. These are: (i) maintaining trust among firms in the PRA and UK prudential framework; (ii) adopting effective regulatory processes and engagement; (iii) adopting a responsive and responsibly open approach to risks and opportunities.”

“Innovation comes with costs and risks both to individual firms and the system. It often requires significant upfront investment, often with uncertain outcomes, as well as long-term planning. 

These risks can be financial, arising through new or more complex risk profiles of innovative products. They can be operational, for example as firms transition to new technologies or embed dependencies on new third parties. Or they can be conduct-related as financial services are delivered to new sets of consumers or through different ways. 

This means that we need to take a thoughtful approach to our regulatory framework, if we are to support innovation by giving firms sufficient certainty and confidence to invest in new technologies and approaches in a way that ensures that risks are appropriately managed.”

“For banks, the Basel Committee is the natural place for standard setting [with regard to questions of culture risk governance and supervision]. For a broader set of financial institutions, it could be one of several other standard-setters — or the FSB.”

“We also use regular industry engagement to understand the demand to innovate, for example through regular roundtables and conferences, as well as ad-hoc meetings and supervisory engagement. Through these, we seek to understand where firms are looking to evolve how they operate, or the services they provide, so we can consider how our regulation can support those efforts to develop in a resilient way. And to inform our overall approach to innovation we arranged a bespoke roundtable for industry participants.”

“Whilst supervisors might well agree such a framework would be useful, I’m sure they’ll diverge on timing and priority. Standards are set by standard-setting bodies. But priorities matter, and capacity matters. This hasn’t been built before because it’s hard to do and other priorities have taken precedence — right now, for example, Basel implementation, in multiple jurisdictions.”

“Third parties are already used for some things. On the quantitative side, we’ve used independent experts to review areas like regulatory reporting across firms and allow us to make cross-firm comparisons. 

Firms also commission their own board-effectiveness reviews, which touch culture and governance, from independent experts who can benchmark them. That informs both firms and supervisors. 

It doesn’t have to be the supervisor doing every assessment, though we have a strong interest in the outcome. It could be a third party.”