Supervisors on Supervision

"After the Global Financial Crisis (GFC), efforts to shore up financial stability and confidence in the financial system focused on rebuilding resiliency including restoration of capital levels on bank balance sheets and achieving stronger governance of risk culture. While the need to rebuild capital was obvious, the supervisory work on governance of risk culture is probably least understood, even if it was identified as the root cause of the GFC. Since the GFC, the discipline for supervising risk culture is marked by less consistency and transparency in different markets. Moreover, the prevailing view is that is not measurable.

Currently, there's a strong drive in the US and elsewhere to focus more on financial risk and to de-emphasize the supervision and regulation of non- financial risk or as it has come to be considered, "the soft-stuff". This worries me because the post crisis diagnosis was correct. Namely, a root cause of the GFC was that risk culture was out of whack with the goals of sustaining stability and resiliency. We need to be able to answer this challenge: How do we make it more credible to the outside world — to bankers and policy-makers — that focus on a well governed risk culture is a true north, a key component of effective supervision?"

“Governance is at the heart of supervision. It is a common saying in banking supervision that ‘well-run banks do not fail.’ And it is true. Inadequate governance and risk management are a recurrent theme underpinning virtually all bank failures. 

The events of [2023] show how ‘intangible’ nonfinancial risks can result in very tangible financial losses. Indeed, throughout my career, I have seen that strong governance is the true north guiding a sound bank, and hence a sound banking system. 

Bank governance and risk culture are closely intertwined. Risk culture refers to the collective mindset and the shared set of norms, attitudes and behaviours related to the awareness, management and control of risks at all levels in a bank. This is what shapes the day-to-day decisions of management and staff and affects their risk-taking behaviour.”

“A strong tone from the top for an appropriate risk culture is set by leadership that builds, invests in and continuously, genuinely supports an environment where employees feel empowered to speak up, which encourages constructive criticism and challenge. The tone from the top is a crucial element in delivering on the right culture. But it is not the only one.

Risk culture is supported by structures that enable it to flourish in an organisation. These structures are like the timbers that hold a house together in a storm. Strong policies and processes represent the key structures building a good risk culture within a bank. Policies creating appropriate incentives and establishing clear lines of accountability and ownership as well as necessary checks and balances, and processes promoting diversity of thought and a culture of effective challenge all immediately come to mind. But there is far more to it than that.

A culture must also be reinforced by risk management, legal and human resources structures that are aligned, underpinning an overall governance framework at the supervisory and management body levels that is healthy. The structures that support the governance framework and risk culture need to be tested and monitored to determine whether they operate as intended and can withstand stress. And coherence across all elements is essential.”

“Banking supervision and central banking will have to evolve if we want to continue delivering on our public mandate in this era of rapid technological change. This means embracing innovation while carefully managing the associated pitfalls and risks. 

Banking supervision needs to harness the benefits that technology can offer given the rapid rate of technological progress currently underway. Technological innovation can deliver the speed, scale and scope required to properly identify and address governance concerns in the banking sector. This is especially true where technological advances make it possible to sift through vast amounts of data, potentially making it possible to rapidly detect any misalignment between management expectations for a strong risk culture and reality. 

In a rapidly evolving world, we must match the pace of change. One of our objectives at the ECB is to harness the power of AI to make our supervisors’ jobs easier while remaining mindful of the related limits and risks. We aim to put our supervisors firmly in the driver’s seat, empowering them to apply supervisory judgement effectively in our revised supervisory process supported by innovation.”

“We have rolled out suptech tools for use by both ECB staff and [national competent authorities (NCAs)]. Success was made possible by leveraging our diverse talents, adopting a user-centric approach and ensuring seamless collaboration, especially between colleagues on the IT side and supervisors within the ECB and the NCAs. The focus is on active collaboration rather than a top-down approach characterised by development of solutions that are distant from the end user.

Investment in technological innovation has become an imperative, not only for the private sector but for public institutions as well.”