Supervisors on Supervision

“Culture only happens within the governance framework you have in your backpack. It’s very difficult to try to change culture if the governance framework all the time works against you.”

“I ended up negotiating and finalizing Basel III. It was finalized, I think, in 2016 or 2017, and it came out of the Global Financial Crisis. So it took 10 years. Even then you could say, ‘Oh my gosh, this is too slow.’ Now it comes into full effect in Europe by 2033. Most of the attempts and complaints about Basel III are about diluting what was agreed.

So if you are a supervisor in this environment, the effort to have somebody else fighting you when you say ‘no’ is relentless. We're talking about 25 years after an obvious disaster, putting in place new rules, and keeping at it for 25 years while trying to dilute the rules. By 2033, most of those who remember the global Financial Crisis won't be around anymore. And then people will say, ‘Well, Grandma and Grandpa didn't know what they were doing. Now we're much smarter and this time is different.’ And you keep at it. 

If you run into what is called a systemic financial crisis, then you have the accounting cost of that, which is basically: who's losing money? How much money did the government have to put in? All the rest of it. But the true cost to society as a whole is unemployment and the loss of output in the economy during the years it takes to put the pieces back together. And in many cases, you can never claw back that loss of output. So that loss of output is a loss to society forever, and that's why you would like to avoid a systemic financial crisis. 

But that, of course, also means that you need to say ‘no’ quite a good number of times in good times, in order to avoid that very bad outcome. But the problem with all of this is that the timeframe is such that maybe disaster does not happen, or maybe it takes 10 years. And that's what is absolutely the hardest thing for us human beings to deal with. 

In the short run in politics, you tend to cater to the median voter. And the median voter usually wants to buy a house, or a car, or something, and you would like to make it possible for them to make that happen. And if that means that bad things happen 10 years from now, well, there are many moons and many elections until we get to that point, and it'll be someone else's problem. 

But it still means that it is meaningful, in my view, to think about it in cultural terms because it says something about what you are expected to do and how you're expected to think about things when you are a supervisor.”

“Culture is so difficult to deal with because, essentially, when you talk to bankers, it’s passing judgment on individuals. You can have all three lines of defense in place, AI, and many other things, but eventually you have to pass judgment on individuals: do I trust them, do I think they understand what they’re doing?”

“When you move into risk-based supervision, you become responsible for taking a stand: Do I trust these people or not? Do I have a sense that these board members actually don’t know what they’re doing because of their background, or do they have the professional background to understand what is going on?”

“Part of your job as a supervisor is also to say no. But in order to say no, you need a legal framework supporting you. And if you don’t have that, you’re stuck. Because otherwise, if you say no, you get fired by the political elite, or the bankers show up in the newspapers and on the news every morning saying the supervisors do not know what they are doing. 

This is also why, in many parts of the world, supervision is handled or guided by the finance ministry, not the central bank. That’s why you sometimes move supervision out of the central bank — because central bankers are trained to say no, and politicians don’t like it. If you move supervision out, the finance ministry can have the final say. 

Another version is to move supervisory decisions into law, because draft laws are usually written in the finance ministry or in parliament. If that happens to you once as a supervisor, you realize you’re stuck. Even if you say no, there’s nothing you can do because they’ve taken the right away from you and put it in the law. 

It’s a very asymmetrical system: in supervision — whether banks, insurance, or securities markets — you always get the blame when things go wrong, and no one knows about the disasters you’ve avoided. This creates a very difficult environment. 

I know of examples in other parts of the world where the supervisory agency was deliberately dependent on the finance ministry. Ultimately, that means if a big bank runs into trouble, you can’t do much without talking to politicians. And the politicians will tell you what to do and what not to do. It’s very difficult to say no in such an environment. This is why there is no global concept of supervisory culture, and no global standard for how to supervise.”

“What is very striking when it comes to supervision — and it doesn’t really matter where the supervision happens to be located, inside the central bank or outside the central bank — is that there is no global best practice when it comes to how to organize it. 

If supervision happens to be inside the central bank and things go wrong, then you move it out because politically you feel that you need to do something. And if something goes wrong and supervision is outside the central bank, you move it into the central bank, because action has to be taken. Whether this really produces results or not is very hard to tell. 

We do know from history that we never learn when it comes to the financial sector. We make the same mistakes over and over again. It’s just so easy to increase leverage in the short run, pump up the system, and get all the gains in the short run, while the costs come in the long run — but that’s way beyond the next electoral cycle. And for bankers, it pays to increase leverage in the short run.
This is where the whole concept of culture on the side of the supervisors — not within the banks — really matters. And it’s very difficult to deal with because it depends on what kind of national or domestic governance structure you have, because it’s within that framework that you are expected to act, react, decide, or do something. 

There is a difference between supervision outside the central bank and supervision inside the central bank. When things really go wrong, supervisors don’t have any money, but central bankers do. That means the central bank always has an informal say, whether you like it or not.”

“One more cultural issue that is very difficult to deal with is the issue of transparency. My entire professional life, I have been in favor of transparency, and there have always been others who have told me that transparency is bad. 

The basis of that argument is that, if people truly understand what's going on, they'll take their money out. And if people are informed, there's no time to quietly fix the problem. This creates a constant tension between transparency and how you deal with issues — how open you need to be about what’s going on.”

“For many years in the Toronto Centre, one of the main training issues has been moving supervision from ‘ticking the boxes’ to risk-based supervision. This is indirectly a cultural issue: if I just tick the boxes, I can never be wrong. Things can still blow up, but I did nothing wrong — so don’t blame me, blame those who decided those were the boxes.”