Let Bank Supervisors Do Their Jobs

IMF Blog, February 13, 2019

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Healthy banking sector supports a healthy economy; strong and stable banking systems are a matter of public concern.
Supervisors must have freedom and flexibility to identify weak points and take prompt corrective action to preserve financial stability.
Operational independence prevents supervisors from succumbing to “capture” by industry or political actors.

The crisis demonstrated the costs of insufficient supervisory independence and capture.
The IMF and World Bank highlight that diluting regulatory frameworks or failing to take corrective action increases systemic risk.
A decade after regulatory lapses helped provoke the most painful financial crisis in a century, policymakers must renew their commitment to vigilant, independent, and accountable supervision.

The Financial Stability Board’s 2010 report on enhanced supervision stated that operational independence of supervisory agencies “is critical to ensuring supervisory effectiveness.”
The Basel Committee on Banking Supervision elevated the issue in the 2012 revisions to its core principles for effective banking supervision.
The revised standards require supervisors to possess:
- operational independence,
- transparent processes,
- sound governance,
- legal protection, and
- sound budgetary processes.
Laws should spell out banking supervisors’ responsibilities and objectives; objectives should be published and regulators held accountable through a transparent framework.

Of the 29 Basel Core Principles, the IMF and the World Bank found progress to be weakest on independence and resources—to the extent that almost no country is fully compliant.
Weak governance and inadequate human and budgetary resources remain the greatest shortcomings, creating opportunities for outside influence and pressure.
These vulnerabilities affect both emerging market economies and advanced economies, and are a concern whether supervision is housed inside or outside the central bank.
Joint financial sector assessment reports by the IMF and the World Bank often identify potential for government interference in prudential decisions, especially in countries where state-owned financial institutions play dominant roles.

Operational independence is not unlimited; supervisors must be held accountable for actions and inactions.
Diluting the regulatory framework—easing supervision or failing to take corrective action—undermines the mandate of banking supervisors.
If policymakers wish to support specific sectors or industries, they should use budget resources rather than creating market distortions or weakening prudential regimes.

Give supervisors a clear mandate.
Provide adequate human and budgetary resources.
Establish strong governance structures and legal protections.
Require publication of supervisors’ objectives and a transparent accountability framework.
Resist political or industry pressure that would weaken prudential oversight.
Use targeted budgetary support for sectors that need nurturing, rather than undermining supervisory standards.

Tobias Adrian and Aditya Narain — February 13, 2019