Supervisors on Supervision

“There needs to be a degree of trust between the respective parties if the regulator/regulated relationship is to operate in a constructive manner. Regulators need to have trust that industry participants will provide them with information, and engage with them more broadly, in an open manner. Industry participants should always expect to be held accountable for their shortcomings and mistakes, but be able to trust that any response will be proportionate. 

That means one major challenge for a regulator — and it is particularly critical for prudential supervisors — is to strike the right balance between a constructive relationship with industry participants, and enforcement. The right balance is neither at one end of the spectrum or the other. 

A regulator focused entirely on preserving its relationships with industry participants will not be effective in deterring poor risk management or bad behaviour, and inevitably be perceived as weak. At the other end of the spectrum, a regulator that demands 'heads on pikes' and a public shaming for any shortcoming or mistake within a financial firm will fail to gain trust and respect from those it regulates. Indeed, it will likely end up promoting a secretive, 'catch me if you can' culture within firms.
The key to finding the right balance is a careful calibration of the regulatory response function. Firms will expect to be sanctioned if they have done the wrong thing. But they also need to see there are differences, for example, in the severity of response to issues that the firm has identified and rectified (including customer compensation if warranted) through its own risk management, control testing and audit activities, versus the response if the firm was unaware of the issue and it had to be alerted to it by the regulator itself. Regulators should certainly be tough, but they can still maintain constructive relationships if they seek to be fair and proportionate as well."