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Supervisors Should Strengthen Financial Sector Oversight, Says IMF

As the financial rule book becomes more complex, oversight will become more difficult, the IMF said (photo: William Manning/Corbis)

GLOBAL ECONOMIC CRISIS

Supervisors Should Strengthen Financial Sector Oversight, Says IMF

IMF Survey online

May 18, 2010

  • Ensuring compliance with rules requires combination of will and ability
  • Many countries struggle to implement key elements of good supervision
  • Supervisors need to be more intrusive, look at the big picture

Financial watchdogs need to be more knowledgeable about the markets they supervise, the IMF says. How well a country fared in the recent global financial crisis was influenced by the skills and effectiveness of its financial watchdog, according to an IMF paper released on May 18.

The paper emphasizes that while the global agenda has been very focused on regulatory reform, the importance of supervision to ensure those new rules are properly implemented should not be forgotten.

The paper, The Making of Good Supervision: Learning to Say No, was released as countries reform their financial regulations in the wake of difficult lessons from the global financial meltdown. According to the paper, as the financial rule book becomes more complex, oversight and implementation of the rules will become more difficult.

Supervisors need to see the big picture of risks across the financial system, and be more intrusive and proactive, the paper said. The paper recognizes the difficult task facing supervisors and notes that support for supervisors as they take unpopular positions and challenge industry is crucial to their success.

Financial supervisors and regulators, those who ensure banks and other financial institutions follow the rules set out by governments, failed to recognize and address some of the growing risks in the lead up to the financial crisis in 2008, according to the paper.

Regulations also did not capture the risks that banks were exposed to, the paper said.

The IMF conducts routine assessments of countries financial sectors, which are part of the Financial Sector Assessment Program. The paper found that while most countries have the necessary financial rules and regulations in place, in more than a third of the 120 country assessments, including some of the most advanced economies, standards in a number of areas were not met. This reflects both a lack of supervisory ability and will, according to the paper.

The alchemy of good supervision

The IMF paper says that good supervision is a combination of the will and ability to act. The elements of ability include

• Legal authority to make rules and issue guidance, as well as flexibility that allows for a range of swift regulatory responses

• Sufficient and stable sources of funding to keep supervisory staff up to date with the right skills

• A clear strategy for the strategic supervision of financial institutions

• Clear decision making processes and oversight of actions taken by supervisors

• Effective working relationships with other domestic and international regulators, as well as finance ministries and central banks.

The elements that create the will to act include

• Clear and realistic objectives to help maintain financial system stability and consumer protection

• Independence from political and financial industry pressures

• Accountability to the public for their performance as supervisors

• Staff with the right skills to supervise increasingly complex rules and regulations

• Strict ethics codes to help avoid conflicts of interest between supervisors and the institutions they oversee

• Supervisors holding a company’s board of directors accountable for staying informed about the emerging risks within an institution so it can respond.

Reduce risk with more vigilance and new skills

In response to a number of shortcomings in their oversight of financial rules, countries have begun to take actions to correct the problems.

The IMF paper suggests a number of areas where improvements can be made, including stronger support for supervisory actions and more international cooperation among regulators to strengthen existing arrangements.

International financial institutions, such as the IMF, also have a role to play in helping countries reform and improve their oversight of financial rules. The paper suggests the Fund and others should include factors affecting both a country’s will and ability to act in its assessments of the financial sectors.

Also, agencies that provide technical assistance to countries should focus on providing new skills and training for supervisors to strengthen their will and ability to act.