It’s Hip to Be Square—Why Good Financial Sector Supervision Is Important

By José Viñals 

Financial supervisors often get a raw deal. They are the stodgy “buttoned-up” guys who stand in the way of innovation, the dyed-in-the-wool bureaucrats who resist change and meddle with markets. On the list of thankless jobs they rank somewhere between traffic wardens and tax administrators.

And yet, as the global financial crisis taught us, supervision is incredibly important. Countries with the same set of rules had very different experiences during the crisis. Why? There are clearly many reasons but one of them is “better supervision.” After all, rules are only as good as their implementation. In some countries, the financial supervisor became the unsung hero of the crisis. One might say “It’s hip to be square!”  

When you think about it, the role of the financial supervisor is pretty unique. They are there during the birth, life, and death of the institutions they supervise. They license them, monitor them, lay out the rules, guide them, penalize them, and step in when they fail. The supervisor acts as a midwife, parent, mentor, cop, judge, and undertaker—all rolled into one.

These are hefty responsibilities. And unfortunately, supervision often comes up short. In an assessment of standards across countries since 2000, we found that while most countries have adequate legislation, regulation, and supervisory guidance, a significant chunk do not do as well when it comes to the actual nuts and bolts of supervision.

Five key factors

So what makes a good supervisor? A recent IMF Staff Position Note identifies five factors—intrusive, proactive, comprehensive, adaptive, and conclusive.

Intrusive means having an intimate knowledge of the supervised entity—in short, stick your nose in, and know what’s going on. To be proactive, a supervisor must first be skeptical. She must always question, even in good times, the industry’s direction or actions, not worrying about being the party-pooper. Supervision is most valuable when least valued. Good supervision is also comprehensive—that means leaving no stone unturned, and being especially vigilant about what’s going on the edge of the regulatory perimeter. To be adaptive, supervisors must keep their eyes on the ever-moving ball, keeping abreast of new products, new markets, new services, and new risks. And finally, supervision must be conclusive—don’t just identify problems, follow up too.

Learning to say No

How do we develop a good system of supervision? How do we learn to say “no”? There are really two pillars—the ability to act and the will to act.

The ability to act depends on proper legal authority, adequate resources, a clear and well-defined strategy, a robust internal organization, and an effective working relationship with other agencies. Once all that is in place, we still need a willingness to fulfill the role of supervisor. This is often the hard part, and involves standing up to the “cool kids” and the vested interests. A number of factors can help here, including a clear and unambiguous mandate, operational independence that is free from political or industry interference, accountability, a skilled staff, a healthy arms-length relationship with the industry, and an effective partnership with boards of directors.

Supervisors are the people who don’t get swayed by collective euphoria. They are the people who are not afraid to say no. In short, supervisors are cool. And they need all the support they can get—including from politicians.

2 Responses

  1. The US needs to just say no to the IMF use of US money for Greece.

  2. Sincerely, what do you mean by a raw deal?

    The gullible regulators in the Basel Committee allowed banks to hold absolute minimums of capital [a minuscule 1.6 percent which implies a leverage of 62.5 to 1] as long as they lent to clients or invested in instruments rated AAA, for having no risk, which launched a frantic race to find AAA-rated investments wherever and finally took the markets over the cliff of the subprime mortgages.

    Personally I feel they should be forced to wear a cone of shame, for a decade at least, and prohibited from any further involvement with regulations. That is of course if we believe in accountability.

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