Supervisors on Supervision

“True to the University of Chicago tradition, what we’ve always tried to do is measure things that don’t at first appear measurable — or apply economics to behaviors people thought it couldn’t touch. Things like the economics of marriage or drug addiction. 

You start with a behavioral model — not a perfect one, but one that gives you a benchmark to test hypotheses or prompt new insights. That’s what intrigues me about this culture conversation. I agree it’s important, but unless we make it concrete — with structure and measurement — it’s hard to get traction.”

“They’re clearly interrelated. Governance, as I see it, involves setting incentives, managing information flows, and implementing control mechanisms. Culture is an essential part of that, especially when it comes to how those incentives and flows play out. 

You could argue it either way, but I tend to see culture as a subset of governance — a particular set of behaviors and reward systems embedded within the broader structure.”

“I sometimes joke that if the Financial Policy Committee at the Bank of England is doing its job, it will be known only to the aficionados. It’s like the dog that didn’t bark. 

It’s the same with fire insurance — you pay for decades, and there was no fire. So was it a waste? You might get lucky. But when the fire comes, it really comes. I live in Chicago. We had a big pretty big fire here a while back! So, the answer depends on whether paying for the insurance also came with adopting meaningful safeguards — new roofing, better materials, behavioral shifts.

It's an uphill battle for making preventative investments by government, especially when there’s no crisis. But that’s why you need a framework: one that explains where the risks are, what data you have, what you don’t know, and where more resources could help. 

At the Bank of England, I routinely ask: what data did you use to reach this conclusion? What data do you wish you had? That’s how we build capacity for better decisions.”

“The point about Credit Suisse is that the problem cases were real; they were amplified, sentiment shifted, and the bank's main customers lost confidence. That has real financial consequences.”

“Culture is clearly a part of management. You can shape a risk-averse culture or a risk-seeking one. Economists usually interpret culture as a shorthand for incentives: what behaviors are rewarded or discouraged, what risks are addressed or ignored. So, in that sense, yes — if culture is shorthand for the incentive structures that drive behavior at the firm, then it’s absolutely important. 

Think about the ‘M’ in CAMELS: management quality. That rating tends to be very high-level. It would be far better to have something more concrete. Culture could certainly be a part of that.”

“It’s the challenge of metrics. When supervisors or executives are given two objectives — one abstract, the other with a number — they’ll usually focus on the number. Capital adequacy has ratios. You can debate their components endlessly, but at least there’s something concrete. Culture doesn’t yet have that. 

After the Financial Crisis, we did start to look more closely at incentives — how bonuses were paid, clawback provisions, things like that. Those are concrete and they relate directly to risk taking behavior, which is part of culture. But before that, it didn't receive the attention it deserved. 

And even now, it lacks the kind of structured measurability that capital or liquidity metrics have. Liquidity, for example, is critically important, but much harder to define and standardize — so it took longer to become central. Culture is in a similar place today.”

“Crises don’t always have clear connections. The SVB collapse had no direct link to Credit Suisse, but it sparked concern. Markets often use the same strategy as jackals — look for the weakest in the herd and pounce. Credit Suisse had high capital ratios, but its business model and culture raised doubts. When the market starts asking, ‘What don’t we know?’, and markets may then assume the worst. 

That’s why we need a structured approach to culture. We haven’t done much here, so the marginal return on even modest investment could be high. Not everything will work. But it’s worth trying. Rather than rerunning 50-year debates on inflation-unemployment trade-offs, the payoff could be significant of investing in understanding the behavioral and cultural risks that we’ve largely ignored.”

“The credibility of the supervisory process is vital to financial stability. Without it, people become skittish — quicker to withdraw funds or demand higher protections, which makes the system more brittle.

Trust reduces the friction in financial relationships. You don’t need contracts that anticipate every possible contingency — just shared understanding. Trust between supervisors and firms is especially important. If supervision becomes a ‘gotcha’ exercise, you get cynicism. I saw this firsthand at the Fed. Both supervisors and bankers could fall into a box-checking mindset. 

And it’s not just about the regulator-firm relationship. The public also needs to trust that supervisors are vigilant and thoughtful. That doesn’t mean they’ll prevent every crisis — far from it. But they should demonstrate that they’ve thought seriously about the risks, even those they can’t fully anticipate.”

“You don’t know and you have to be honest that you can’t know everything. But if you have a framework for thinking about these things you can use simple cost-benefit logic to justify resource allocation.”

“It’s everyone’s job — regulators, academics, firms, and ultimately taxpayers. 

Academics, particularly in behavioral economics, have made strides in the last 20 years. But central banks remain quite conservative. Their research departments often stick to traditional macro topics — capital adequacy, inflation/unemployment tradeoffs — because they’re more amenable to established methods. 

But understanding behavior during a crisis — on both the bank and depositor side — is first order important. It’s central to financial stability. And yet, we devote few resources to it. We should be doing more. 

Central banks put huge weight on inflation expectations, but we don’t fully understand how people form those expectations — or whether changes in expectations actually drive changes in behavior. 

My colleague Jane Risen, here at the University of Chicago, has studied ‘magical thinking’: you can convince someone that flying is statistically safer than driving, and they’ll still ask for the car keys. That disconnect is real. It can be studied. We just need to care enough to do it. 

I’ve made arguments publicly and privately to encourage focus on these issues. Richard Thaler's work has helped to move behavioral economics from the fringe to the mainstream — even here at Chicago.”

“Ultimately, this comes down to leadership. If central bank governors and deputy governors don’t prioritize this, nothing happens. If they do, they create powerful incentives for research departments to engage. Yes, it’s high-risk research, and yes, there will be dead ends — but that’s the nature of innovation. You learn even when something doesn’t work. 

In traditional areas, incremental progress is easier to measure. In behavioral and culture-related areas, the payoff might be harder to define, but potentially much larger. You have to design institutions that reward calculated risk-taking in research, just like in the private sector. 

First and foremost, you need senior leadership — presidents, governors, chairs — saying: “This is a priority.” Without that, nothing moves. Then, assign a point person internally. Make it someone whose job it is — publicly and privately — to champion this. That person can then use the institution’s convening power to bring in outside voices — academics, behavioral scientists, organizational psychologists. 

The leader should show up. Deliver opening remarks. Sit in the sessions. That signals seriousness. It also incentivizes PhD students and academics to do work that’s relevant to central banking. There’s a wealth of underused data in financial services that could be mined with fresh behavioral insights. But unless the institution makes it a priority — and allocates resources accordingly — nothing will happen at scale. 

Institutions like the BIS could play a role, since they cut across jurisdictions. 

Look at what Mark Carney did with climate risk. It was previously seen as irrelevant to central banking. Now almost every central bank is doing work on it. Some more than others, but still, it’s on the agenda. That shift started with a leader who cared, made hires, convened discussions, and gave the issue status. Culture could follow that path. But it takes leadership.”