## _spn1008

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### Executive Summary (overview)
- The quality of financial sector supervision has emerged as a key issue from the financial crisis.
- While most countries operated broadly under the same regulatory standards, differences emerged in supervisory approaches.
- International response focused on more and better regulations (e.g., bank capital, liquidity and provisioning) and on developing a framework to address systemic risks, but there has been less discussion of how supervision itself could be strengthened.
- IMF assessments over the past decade suggest progress in putting regulation in place, but work remains to be done in many countries to strengthen supervision.
- Key elements of good supervision identified: intrusive, skeptical, proactive, comprehensive, adaptive, and conclusive.
- “Ability” to supervise (resources, authority, organization, and constructive working relationships) must be complemented by the “will” to act.
- Supervisors must be willing and empowered to take timely and effective action, intrude on decision-making, question common wisdom, and take unpopular decisions.
- Developing the “will to act” requires a clear and unambiguous mandate, operational independence coupled with accountability, skilled staff, and industry relationships that avoid “regulatory capture.”
- Strengthening supervision is essential for effective delivery of the regulatory reform agenda.
- Society must support supervisors as naysayers in times of exuberance.

### Introduction and scope
- Question posed: Why were some countries with similar financial systems and global rules less affected in the crisis? One offered reason: “better supervision.”
- Supervision includes implementation, monitoring, enforcement of regulations, and assessing institutions’ risk management, culture, and risk appetite.
- Regulatory changes (capital, liquidity, provisioning, accounting, compensation) are necessary but insufficient without better oversight.
- As the rule book becomes more detailed and complex, supervisory approaches and skills required to implement rules become more challenging.
- Focus: lessons from supervisory failures during the crisis and how supervision must adapt to the new regulatory framework.
- Emphasis: microprudential supervision discussion is relevant to macroprudential and market conduct supervision.

### Supervision and the Financial Crisis: What Went Wrong?
- Regulatory framework shortcomings:
  - Regulations did not capture adequately some risks (example: regulatory approach to market risk capital for trading book positions).
  - Regulatory perimeter was not expansive enough; risks built up in the shadow banking system.
  - Legal and regulatory frameworks occasionally hindered consolidated regulation and supervision in some countries, though often they did not impede supervision.
- Generalized supervisory failures across jurisdictions:
  - Staying on the sidelines / insufficient intrusion into institutions:
    - Supervisors were too deferential to bank management in some cases.
    - High reliance on institutions’ internal controls and risk management was not matched by ensuring robust governance.
    - Failures of internal oversight at firms were transmitted through supervisors.
    - Reliance on market discipline proved misplaced: institutional investors relied on rating agencies; rating agencies ignored conflicts of interest.
  - Not being proactive or adaptive:
    - Supervisors sometimes lacked capacity to identify risks or to act when risks were identified.
    - Some supervisors did not anticipate effects of emerging risks on the financial system or larger economy.
    - Supervisors did not respond strongly to institutions moving toward higher-risk strategies, leverage buildup, or innovative products.
    - Supervisors did not dig deeply enough into complex products or ensure boards understood the risks.
    - Supervisors did not react appropriately to increased dependence on short-term wholesale funding or risks in off–balance sheet entities.
  - Not being comprehensive in scope:
    - Interest confined to risks within regulated entities without extending to risks posed by other parts of the system or systemically important institutions.
    - Addressing this gap requires strengthened rules and reconsideration of the regulatory perimeter.
  - Not taking matters to their conclusion:
    - Supervisors sometimes failed to consolidate supervisory conclusions or develop a system-wide view of emerging risks despite awareness of problems.
    - Lack of timely and effective coordination and information-sharing among supervisors contributed to regulatory arbitrage and excessive risk concentrations.

### Box 1: What makes financial sector supervision different?
- Nature of relationship:
  - Supervisors license, ensure fitness of owners/managers, set rules, guide risk management and disclosure, continuously monitor, impose penalties, and lead resolution.
  - Successes are often unheralded; failures are dramatic with potential systemic consequences.
- Evolution of approaches:
  - Earlier compliance/enforcement-based approaches emphasized rule adherence but risked being backward-looking and ill-equipped to handle innovation.
  - Shift toward risk-based or risk-focused supervision to allocate supervisory resources to major risks.
  - Financial globalization and Basel II increased need for international cooperation and acceptance of banks’ internal models; mainstreaming of the three-pillar approach (Pillar 1, Pillar 2, and Pillar 3).
- How countries fare against supervisory standards:
  - The IMF/World Bank FSAP has conducted more than 150 assessments (including updates).
  - Findings since 2000: most countries have necessary legislation, regulations, and supervisory guidance, but many lag on supervision “nuts and bolts.”
  - Basel Core Principles (2000 methodology): 120 assessments show general compliance on legal/institutional frameworks and authorization/conduct, but in more than one-third of assessments countries did not meet standards on:
    - CP 13 (supervision of risks other than credit risk),
    - CP 20 (consolidated supervision),
    - CP 1.2 (adequate resources and operational independence),
    - CP 20 (enforcement powers).
  - Revamped methodology (Basel Committee, 2006): 24 recent assessments identified large incidence of deficiencies in:
    - CP 24 (consolidated supervision),
    - CP 1.2 (operational independence),
    - CP 23 (powers to take corrective action),
    - CP 7 (comprehensive risk management / supervisory review process as in Basel II Pillar 2).
  - IOSCO assessments against 30 Core Principles: weakest areas include CP 2 (operational independence), CP 3 (adequate powers, resources, capacity), and CP 10 (inspection/investigation/enforcement).
  - IAIS assessments of 26 countries (2003 ICPs): key weaknesses identified in CP 3, CP 9, CP 13, CP 17, and CP 18.
- Core characteristics of good supervision:
  - Intrusive: intimate knowledge, day-to-day monitoring, intensity according to risk profile.
  - Skeptical but proactive: question industry direction; supervision should be countercyclical.
  - Comprehensive: vigilance at regulatory perimeter, include unregulated affiliates and off–balance sheet structures; address SIFIs, interconnectedness, cyclicality; macroprudential tools helpful.
  - Adaptive: constant learning about new products, markets, business models.
  - Conclusive: follow-through from reporting and examinations to enforcement and final resolution.

### Bringing about good supervision — Ability to act and Will to act
- Core concept: ability and will must act together.
- Ability to act — elements:
  - Legal authority: enabling legal framework, powers to make rules, issue guidance, and mount/fund legal actions.
  - Adequate resources: sufficient and stable funding; technology and data for offsite surveillance; human capital for onsite inspection; competitive compensation for technical skills.
  - Clear strategy: strategic approach to supervision and communication; drivers include industry nature, resources, and institutional framework.
  - Robust internal organization: clear decision making, accountability, balance of judgment and oversight; internal processes to support supervisors against adverse company reaction.
  - Effective working relationships: coordination with domestic and international agencies; advantages where one agency has regulatory and supervisory responsibility; strong relationships with central bank and finance ministry; coordination for cross-border groups.
- Will to act — elements that create willingness:
  - Clear and unambiguous mandate: objectives related to financial stability, systemic soundness, and safety and soundness; manage conflicts between objectives.
  - Operational independence: resist political and industry interference; appointment/dismissal processes, stable funding, legal protection for staff; avoid industry representatives on supervisory agency boards.
  - Accountability: public reporting on resource use, key decisions, and effectiveness while protecting confidentiality.
  - Skilled staff: rigorous hiring and competitive remuneration; blend of long-term supervisors and experienced industry professionals.
  - Healthy relationship with industry: arm’s-length dialogue; policies on staff turnover to prevent conflicts; strict ethics codes.
  - Effective partnership with boards: hold boards responsible; ensure boards and directors are empowered and informed.

### Advancing the supervisory agenda and policy recommendations
- Supervisory agencies expanding risk analyses to include all group activities and developing emerging risk capacities.
- FSB and standard setters have issued strengthened guidance on risk management elaborated by the Basel Committee as part of the supervisory review process (Pillar 2).
- Required changes to supervisory approach:
  - Strengthen internal governance expectations of boards of directors.
  - Address management responsibilities such as remuneration practices to constrain incentives for excessive risk-taking.
  - Supplement reliance on internal controls with direct and independent assessments.
  - Adopt forward-looking risk assessments and a range of responses including:
    - Requiring firms to change strategy or exit particular lines of business.
    - Replacing senior management where necessary.
  - Demonstrate determination to act.
- Skills and professionalization:
  - Supervisory skills must expand to include macroprudential capabilities (e.g., setting countercyclical capital buffers; supervising “living wills”).
  - Suggestion to professionalize supervision via targeted training and college programs to create a cadre of supervisors.
  - Adequate funding to hire, train, and equip staff is critical to create independent naysayers.
- Cross-border cooperation:
  - Strengthen cooperation via clear agreements on information sharing and efficient communication channels.
  - Work jointly for common supervisory approaches and improved joint monitoring.
- Role of governments and international community:
  - Reaffirm elements of will and ability: clear mandate, adequate resources, sufficient authority for corrective actions.
  - Commit to legal and governance structures promoting operational independence.
  - Ensure adequate budgets for experienced supervisors and legal frameworks/tools commensurate with market sophistication.
  - International financial institutions should include will and ability discussions in assessments and focus technical assistance on strengthening both.

### Conclusion: characteristics and institutional foundations of effective supervision
- Effective supervision must be intrusive, adaptive, proactive, comprehensive, and conclusive.
- Policy and institutional environment must support both supervisory will and ability to act.
- Essential elements include:
  - Clear and credible mandate free of conflicts.
  - Operational independence.
  - Adequate budgets and experienced staff.
  - Legal frameworks and tools commensurate with market sophistication.
- The IMF should increase emphasis in bilateral surveillance and technical assistance on foundations for effective financial sector supervision.
- Society and governments must support supervisors as they perform this often unpopular role.

*Source: Executive Summary and Sections I–II, Box 1, and Annex I of the provided IMF content unit.*

### Executive Summary ......................................................................................................

### Executive Summary

### Executive Summary (overview)
- The quality of financial sector supervision has emerged as a key issue from the financial crisis.
- While most countries operated broadly under the same regulatory standards, differences emerged in supervisory approaches.
- The international response has focused on the need for more and better regulations (e.g., in areas such as bank capital, liquidity and provisioning) and on developing a framework to address systemic risks, but there has been less discussion of how supervision itself could be strengthened.
- IMF assessments of compliance with financial sector standards over the past decade suggest that while progress is being made in putting regulation in place, work remains to be done in many countries to strengthen supervision.
- The paper identifies the following key elements of good supervision: that it is intrusive, skeptical, proactive, comprehensive, adaptive, and conclusive.
- To achieve these elements, the “ability” to supervise (appropriate resources, authority, organization, and constructive working relationships with other agencies) must be complemented by the “will” to act.
- Supervisors must be willing and empowered to take timely and effective action, to intrude on decision-making, to question common wisdom, and to take unpopular decisions.
- Developing this “will to act” requires supervisors to have a clear and unambiguous mandate, operational independence coupled with accountability, skilled staff, and a relationship with industry that avoids “regulatory capture.”
- These essential elements of good supervision need to be given as much attention as regulatory reforms at national and international levels. Only if supervision is strengthened can the regulatory reform agenda be effectively delivered.
- Society must stand with supervisors as they play their role as naysayers in times of exuberance.

### Introduction
- Question: Why were some countries with similar financial systems, operating under the same set of global rules, less affected than others in the recent global financial crisis?
- One offered reason is “better supervision.”
- Supervision is not only about implementation, monitoring, and enforcement of regulations, but also about assessing whether an institution’s risk management controls are adequate and whether culture and risk appetite increase the likelihood of solvency and liquidity problems.
- The international response has emphasized more and better regulations in areas such as capital, liquidity, provisioning, accounting, and compensation.1
- These regulatory changes are necessary but must be accompanied by better oversight of the financial sector; expanding the rule book alone will not be sufficient.
- The role of the other pillars of oversight—supervision, governance, and market discipline—has been less prominent in the global response.
- As the rule book becomes more detailed and complex, supervisory approaches and skills required to implement the rules will become more challenging.
- The paper focuses on lessons from supervisory failures during the crisis and how supervision needs to adapt to the new regulatory framework.
- Much of the international consensus on elements of supervision works well, but the consensus failed to deliver in some circumstances leading up to the crisis.
- Effective supervision needs to be intrusive, adaptive, skeptical, proactive, comprehensive, and conclusive.
- The policy and institutional environment must support both the supervisory will and ability to act.
- While the discussion is mainly focused on microprudential supervision, the issues are relevant to macroprudential supervision2 and market conduct supervision.

### Supervision and the Financial Crisis: What Went Wrong?
- The regulatory framework was part of the reason supervision lost focus in several countries:
  - Regulations did not capture adequately the risks that banks were exposed to (e.g., the regulatory approach to market risk capital for trading book positions).
  - The regulatory perimeter was not expansive enough and did not take into account the buildup of risks in the shadow banking system.
  - Legal and regulatory frameworks occasionally did not facilitate needed supervisory action (e.g., ability to perform consolidated regulation and supervision in some countries), but in many cases did not impede supervision.
- Generalized descriptions of supervisory failures observed across jurisdictions include:
  - Staying on the sidelines and not intruding sufficiently into the affairs of regulated institutions.
    - Supervisors were too deferential to bank management in some cases.
    - High reliance on institutions’ internal controls, internal risk management systems, and management perceptions of risk was not matched by ensuring governance was sufficiently robust.
    - Failures of internal oversight and risk governance at firms were transmitted through supervisors.
    - Reliance on market discipline proved misplaced in some cases: institutional investors did not do their own due diligence and relied on rating agencies; rating agencies ignored conflicts of interest in their business models, creating incentives to overrate products and clients.
  - Not being proactive in dealing with emerging risks and adapting to the changing environment.
    - Supervisors sometimes lacked capacity to identify risks or to act when risks were identified.
    - Some supervisors did not anticipate effects of emerging risks on the financial system or larger economy.
    - In some cases, supervisors did not respond strongly to institutions moving toward higher-risk strategies and innovative products, or to the buildup of leverage and high-risk exposures.
    - Supervisors did not dig deeply enough into the implications of complex products, nor satisfy themselves that boards understood the risks.
    - Supervisors did not react appropriately to increased dependence on short-term wholesale funding or to risks building up in off–balance sheet entities.
  - Not being comprehensive in their scope.
    - Interest was confined to risks faced by regulated entities from within the regulated system, without extending to risks posed by other parts of the system or by systemically important institutions.
    - Addressing this gap requires strengthened rules and regulation and reconsideration of the regulatory perimeter to be wide enough for risk identification.
  - Not taking matters to their conclusion.
    - In some cases, supervisors were aware of worsening underwriting standards and markets flooded with misrated financial products, but did not move quickly enough to consolidate supervisory conclusions or develop a system-wide view of emerging risks.
    - Lack of timely and effective coordination and information-sharing among supervisors contributed to regulatory arbitrage opportunities and excessive risk concentrations.

*Source: Executive Summary and Sections I–II of the provided IMF content unit.*

### Box 1. What makes financial sector supervision different?

### Box 1. What makes financial sector supervision different?

### Nature of supervisory relationship and uniqueness
- Supervisors are involved in the birth, life, and death of the institutions they supervise: license them; ensure owners and managers are fit; lay out rules; guide risk management and disclosure; continuously monitor; impose penalties; and lead resolution when they fail.
- Supervisors’ successes are often unknown and unheralded, while failures are dramatic and headline-grabbing, with potential serious consequences for the global economy.
- The varied expectations across these roles make supervision extremely challenging and often underappreciated.

### Evolution of supervisory approaches
- Earlier forms: more “compliance based” or “enforcement based,” focused on adherence to rules for safety and soundness or conduct of business.
- Risks of a mainly compliance-based approach:
  - Excessive focus on more easily observed noncompliance (e.g., breaches of capital adequacy requirements, demonstrable cases of customer mistreatment).
  - Insufficient understanding of key business drivers and flaws in risk management practices.
  - Backward looking and may fail to identify major future risks; can deal poorly with innovation.
- Need for some compliance monitoring and enforcement to ensure minimum standards and regime credibility.
- Shift after 1970s–1980s deregulation and technology changes:
  - Explosion of off–balance sheet items; complex products such as derivatives and securitizations.
  - Blurring boundaries between banks, securities firms, investment banks, and insurance companies.
  - Bank books acquired market risks (equity, debt, commodities, foreign exchange).
- Movement toward risk-based or risk-focused supervision: focus limited supervisory resources on major risks, combining rigorous risk assessment with resource management; prioritize risks where supervisor has best chance of mitigating them.
- Financial globalization and Basel II:
  - Emergence of large global financial groups increased need for internationally agreed standards and cooperation between home and host supervisors.
  - Home supervisor model advocated: primarily responsible for consolidated supervision based on information from host supervisors.
  - Competition and market-friendly approaches led to greater recognition of banks’ own risk-management methods; Basel II increased acceptance of banks’ internal models and mainstreamed the three-pillar approach (Pillar 1, Pillar 2, and Pillar 3).3

### How countries fare against supervisory standards (assessment findings)
- The IMF (with the World Bank) conducts assessments of compliance with the Basel Core Principles, IOSCO Objectives of Securities Regulation, and IAIS Principles of Insurance Supervision through the Financial Sector Assessment Program (FSAP).
- To date, more than 150 assessments under the FSAP have been conducted (including updates).
- Findings since 2000: most countries have necessary legislation, regulations, and supervisory guidance, but a significant proportion do not do as well on the nuts and bolts of supervision across sectors.4
- Basel Core Principles (assessments):
  - 120 assessments using 2000 methodology (assessing compliance with 25 Core Principles, 1997 version) show most countries largely in compliance on legal and institutional frameworks and authorization and conduct of banking business.
  - In more than one-third of assessments, countries did not meet standards relating to:
    - supervision of risks (other than credit risk) (Core Principle [CP] 13),
    - consolidated supervision (CP 20),
    - adequate resources and operational independence (CP 1.2), and
    - enforcement powers (CP 20),5 reflecting supervisory “will” and “ability.”
  - Deficiencies included lack of supervisory awareness and training; inadequate and dated tools and methodologies to evaluate banks’ risk management; absence of authority to require capital against such risks.
  - Consolidated supervision weaknesses: lack of reliable consolidated information; limited ability and skills to examine some financial activities; lack of direct access to nonconsolidated subsidiaries and holding companies.
  - Enforcement weaknesses: lack of clarity matching sanctions to severity; inconsistent application; regulatory forbearance; lack of credibility of supervisory actions.
  - Revamped methodology (Basel Committee, 2006) with stronger focus on implementation: recent assessments of 24 countries using revised methodology identified large incidence of deficiencies in:
    - consolidated supervision (CP 24),
    - operational independence (CP 1.2),
    - powers to take corrective action (CP 23),
    - comprehensive risk management (CP 7) (supervisory review process as in Basel II Pillar 2).
- IOSCO Objectives of Securities Regulation:
  - Assessments against 30 Core Principles reveal weakest areas: operational independence (CP 2); adequate powers, resources, and capacity (CP 3); and credible use of inspection, investigation, surveillance, and enforcement powers (CP 10).
  - A 2007 IMF Working Paper (Carvajal and Elliott (2007)) summarizing 74 countries: enforcement of compliance emerged as the overriding weakness—chronic lack of skill and knowledge in inspections and reporting tools, lack of resources, skill, and legal authority for investigations and enforcement; difficulty ensuring compliance undermines regulatory process.
- IAIS Principles of Insurance Supervision:
  - Assessments of 26 countries against the revised (2003) 28 Insurance Core Principles identified key weaknesses in:
    - CP 3 (adequate powers, legal protection and financial resources, operational independence and accountability, skilled and professional staff),
    - CP 9 (supervisory compliance of governance standards),
    - CP 13 (onsite inspection),
    - CP 17 (group-wide supervision),
    - CP 18 (Risk Assessment).

### What is good supervision? — Core characteristics
- Good supervision is intrusive:
  - Premised on intimate knowledge of supervised entity; cannot be outsourced or rely mainly on offsite analysis; day-to-day monitoring; intensity varies by institution risk profile.
- Good supervision is skeptical but proactive:
  - Supervisors must question industry direction even in good times; supervision must be intrinsically countercyclical; prudential supervision most valuable when least valued.
- Good supervision is comprehensive:
  - Vigilance about happenings at the regulatory perimeter; includes unregulated subsidiaries, affiliates, and off–balance sheet structures; addresses systemic risks posed by SIFIs, interconnectedness, and cyclicality; macroprudential supervision tools helpful.
- Good supervision is adaptive:
  - Constant learning mode to understand new products, markets, services, and risks; monitor changes in business models and regulatory perimeter; form views on institutions’ future resilience.
- Good supervision is conclusive:
  - Follow-through from offsite reporting to onsite examinations to enforcement actions; every identified issue needs follow-up to final resolution.

### Bringing about good supervision — Two supporting pillars: ability to act and will to act
- Concept: both ability and will must act in tandem; neither alone is sufficient.

- Ability to act — elements:
  - Legal authority:
    - Enabling legal framework providing adequate powers; strong regulatory capacity to make rules and issue guidance; legal framework for swift regulatory responses to ongoing and emergent situations; capacity to mount and fund substantial legal actions when necessary.
  - Adequate resources:
    - Sufficient funds and stable funding to carry out mandates in good and bad times; supervision is resource intensive; offsite surveillance requires technology and data; onsite inspection requires human capital; constant skill development; follow-through resource intensive; technical skills require sufficient compensation to attract and retain; adequate resources drive budgetary autonomy and operational independence.
  - Clear strategy:
    - Agencies need strategic approach to supervision and internal and external communication (e.g., standard examination cycle); strategy drivers include industry nature, resources, and institutional framework; mature, innovative sectors demand proactive approaches; clear strategy for activities and markets that can create systemic risks.
  - Robust internal organization:
    - Well-defined decision making; clear accountability; balance judgment and oversight; use of peer review or committee structures while allowing urgent action; internal processes to support supervisors in case of adverse company reaction.
  - Effective working relationships with other agencies:
    - Coordination and cooperation with domestic agencies, national authorities, and international organizations; advantages to one agency having both regulatory and supervisory responsibility; excellent relationships with central bank and finance ministry; coordination with other domestic and overseas supervisors for cross-sector and cross-border groups.

- Will to act — elements that create willingness:
  - A clear and unambiguous mandate:
    - Clear objectives ideally related to financial stability and systemic soundness, and safety and soundness of institutions; objectives should be realistic; identify and manage potential conflicts between objectives.
  - Operational independence:
    - Ability to resist inappropriate political interference and inappropriate influence from the financial sector; reflected in appointment/dismissal processes, stable funding, and legal protection for staff; avoid provisions requiring referral of key company decisions to government; avoid industry representatives on boards of supervisory agencies.
  - Accountability:
    - Agencies should report to the public on use of resources, key decisions, and, as far as possible, effectiveness of supervision in relation to objectives while protecting confidential information.
  - Skilled staff:
    - Critical for both will and ability; staff must respond to changes in industry practices with confidence; rigorous hiring and competitive remuneration to attract and retain; successful agencies blended long-term supervisory staff and experienced industry professionals recruited mid- or late-career.8
  - A healthy relationship with industry:
    - Dialogue while maintaining arm’s-length relationship; policies on staff turnover between supervision of individual institutions and movement into regulated institutions; strict ethics codes to avoid conflicts of interest and regulatory capture.
  - An effective partnership with boards:
    - Boards are first line of defense; supervisors should hold boards responsible and ensure boards and directors are empowered and informed to understand and respond to emerging risks.

### Advancing the supervisory agenda
- Some supervisory agencies are expanding risk analyses to include all activities within a group and developing emerging risk capacities to analyze new products and business lines to better understand potential risks.9
- The Financial Stability Board (FSB) and standard setters have issued strengthened guidance on risk management elaborated by the Basel Committee as part of the supervisory review process (Pillar 2).

*Source: _spn1008 - Box 1. What makes financial sector supervision different?*

### 2009. Revised principles for enhancing corporate governance for credit institutions are currently

### 2009. Revised principles for enhancing corporate governance for credit institutions are currently

### Supervisory failures and lessons from the crisis
- Supervisors in some of the most advanced economies with a strong tradition of independent and well-resourced institutions were unable to act in an effective and timely manner.
- Failures suggest the scope and nature of supervisory action needs to be broader and more intrusive than in the past.
- Specific weaknesses persisted even a year after identification, as noted in the Senior Supervisors Group (SSG) 2009 report.

### Empirical findings referenced
- A 2007 IMF survey of governance practices covered 140 supervisory agencies in 103 members and discussed findings on supervisory remuneration practices and ability to hire and set staffing and salary levels.
  - The survey finds differences in these abilities based on location and function, with supervisors inside the central bank and standalone bank supervisors usually faring better than those in consolidated and integrated agencies.
- Senior Supervisors Group (SSG), 2009: evaluated progress by major global financial firms since the start of the crisis in implementing changes in risk management practices and internal controls.

### Required changes to supervisory approach
- Supervisors need to:
  - Focus more on strengthening internal governance of institutions, for example, by raising expectations from boards of directors.
  - Directly address issues previously seen primarily as management responsibilities, such as remuneration practices, to constrain incentives to take excessive risk.
  - Supplement reliance on internal controls with more of their own direct and thorough assessments and independent analysis.
  - Adopt forward-looking assessments of risks and a range of responses that includes:
    - Requiring companies to make significant changes in strategy (perhaps pulling out of particular lines of business).
    - Replacing senior management.
  - Demonstrate the determination to act.

### Skills, capacity building, and professionalization
- Supervisory skills must be supplemented to incorporate new skill sets into the existing portfolio, especially for a macroprudential dimension to regulation.
- New framework and tools will require supervisors to address issues such as:
  - Setting countercyclical capital buffers.
  - Supervising “living wills.”
- Suggestion: make supervision a more defined profession by providing more professional training and targeted college programs aimed at creating a cadre of supervisors.
- Adequate funding to hire and train skilled staff and equip them with requisite tools is critical to create independent naysayers.

### Cross-border cooperation
- Supervisors must strengthen the effectiveness of cooperation by:
  - Pursuing clear agreements on specific information to be shared through efficient communication channels.
  - Working together for a common supervisory approach to improve joint monitoring of the main risks facing the financial system.

### Role of governments and the international community
- The G-20 Leaders’ London Declaration stated commitment to strengthening both regulation and supervision of the financial sector.
- Countries should reaffirm key elements of will and ability that underlie effective supervision by:
  - Providing an enabling framework with a clear mandate, adequate resources, and sufficient authority to take a range of corrective actions.
  - Committing to a legal and governance structure that promotes operational independence.
  - Ensuring adequate budgets that provide sufficient numbers of experienced supervisors.
  - Establishing a framework of laws that allows for the effective discharge of supervisory actions and tools commensurate with market sophistication.
- International financial institutions should:
  - Include discussions of the components of both will and ability to act as a matter of course in their work and assessments.
  - Focus technical assistance and capacity-building efforts on strengthening both supervisory will and ability.

### Conclusion: characteristics of effective supervision
- To be effective, supervision must be intrusive, adaptive, proactive, comprehensive, and conclusive.
- Policy and institutional environment must support both supervisory will and ability to act.
- Essential elements include:
  - A clear and credible mandate, free of conflicts.
  - Operational independence.
  - Adequate budgets and experienced staff.
  - Legal frameworks and tools commensurate with market sophistication.
- The IMF should place increased emphasis in bilateral surveillance and technical assistance on issues identified in the paper as foundations for effective financial sector supervision.
- Society and governments must support supervisors and stand by them as they perform this unpopular role.

### Annex I: mapping of core principles and standards (selected entries)
- The Annex lists correspondences across several standards frameworks, including:
  - Basel Core Principles 1997 and 2006
  - IAIS Core Principles
  - IOSCO Principles
- Representative mapped items include:
  - CP 1.1 Objectives and responsibilities ↔ CP 1.1 Responsibilities and objectives ↔ ICP 1. Conditions for effective insurance supervision
  - CP 1.2 Independence and resources ↔ CP 1.2 Independence, accountability, and transparency ↔ ICP 2. Supervisory objectives
  - CP 1.3 Legal framework for authorizing and supervising ↔ CP 1.3 Legal framework ↔ ICP 3. Supervisory authority
  - CP 1.4 Legal framework for compliance and soundness ↔ CP 1.4 Legal powers ↔ ICP 4. Supervisory process
  - CP 1.5 Legal protection ↔ CP 1.5 Legal Protection ↔ ICP 5. Supervisory cooperation and information sharing
- Selected function-level correspondences (preserving original phrasing and numbering from the source) include:
  - 1. The responsibilities of the regulator should be clear and objectively stated
  - 2. The regulator should be operationally independent and accountable in the exercise of its functions and powers
  - 3. The regulator should have adequate powers, proper resources, and the capacity to perform its functions and exercise its powers
  - 4. The regulator should adopt clear and consistent regulatory processes
  - 5. The staff of the regulator should observe the highest professional standards, including appropriate standards of confidentiality
  - 6. The regulatory regime should make appropriate use of Self-Regulatory Organizations (SROs)
  - 7. SROs should be subject to the oversight of the regulator and should observe standards of fairness and confidentiality
  - 8. The regulator should have comprehensive inspection, investigation, and surveillance powers
  - 9. The regulator should have comprehensive enforcement powers
  - 10. The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance, and enforcement powers and implementation of an effective compliance program
  - 11. The regulator should have authority to share both public and nonpublic information with domestic and foreign counterparts
  - 12. Regulators should establish information-sharing mechanisms that set out when and how they will share both public and nonpublic information with their domestic and foreign counterparts
  - 13. The regulatory system should allow for assistance to be provided to foreign regulators who need to make inquiries in the discharge of their functions and exercise of their powers
  - 14. There should be full, accurate, and timely disclosure of financial results and other information which is material to investors’ decisions
  - 15. Holders of securities in a company should be treated in a fair and equitable manner
  - 16. Accounting and auditing standards should be of a high and internationally acceptable quality
  - 17. The regulatory system should set standards for the eligibility and the regulation of those who wish to market or operate a collective investment scheme
  - 18. The regulatory system should provide for rules governing the legal form and structure of collective investment schemes and the segregation and protection of client assets
  - 19. Regulation should require disclosure, as set forth under the principles for issuers, which is necessary to evaluate the suitability of a collective investment scheme for a particular investor and the value of the investor’s interest in the scheme
  - 20. Regulation should ensure that there is a proper and disclosed basis for asset valuation and the pricing and the redemption of units in a collective investment scheme
  - 21. Regulation should provide for minimum entry standards for market intermediaries
  - 22. There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake
  - 23. Market intermediaries should be required to comply with standards for internal organization and operational conduct that aim to protect the interests of clients, ensure proper management of risk, and under which management of the intermediary accepts primary responsibility for these matters
  - 24. There should be a procedure for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk
  - 25. The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight
  - 26. There should be ongoing regulatory supervision of exchanges and trading systems which should aim to ensure that the integrity of trading is maintained through fair and equitable rules
  - 27. Regulation should promote transparency of trading
  - 28. Regulation should be designed to detect and deter manipulation and other unfair trading practices
  - 29. Regulation should aim to ensure the proper management of large exposures, default risk, and market disruption
  - 30. Systems for clearing and settlement of securities transactions should be subject to regulatory oversight, and designed to ensure that they are fair, effective, and efficient and that they reduce systemic risk

*IMF staff paper content as provided in the source unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2010/_spn1008.pdf_