Abstract:
· A single supervisor is more appropriate for universal banks;
· It is essential that the supervisor and the central bank work very closely together;
· The independence of the supervisor must be guaranteed with regard to both lobbyists and the government;
· International coordination is necessary in the context of international financial groups.
On November1, Mr. Villeroy de Galhau will succeed Mr. Noyer as head of the Banque de France. This appointment has been the subject of debate and controversy due to Mr. Villeroy de Galhau’s previous position as deputy CEO of a private banking group. However, the competence of a supervisor cannot be reduced to that of its director; many other criteria determine the quality with which a supervisor can carry out its task. The main criterion remains regulation, the body of rules established and voted on by national parliaments, defining the regulations to which financial institutions must comply. Supervision can only be effective if the regulations are already in place. The supervisor’s mission is to enforce these regulations, and their ability to carry out their mission depends on several characteristics of their structure and functioning.
1. The structure of supervision
The structure of supervision is defined according to two dimensions: single/sectoral and integrated/non-integrated into the central bank.
A single or sectoral structure
Supervision may be divided among several agencies with jurisdiction over certain financial sectors (such as banks, insurance companies, investment companies, etc.) or integrated within a single structure. Today, the trend is toward concentrating supervisors within a single entity. This is evidenced in France by the creation of the Autorité de Contrôle Prudentiel et de Résolution[1] (ACPR) in 2010, but also by the Financial Services Authority between 2001 and 2013 in the United Kingdom, and the BaFin in Germany since 2002.
This trend can be explained by the ever-increasing diversification of banks, which today are simultaneously banks, insurance companies, and financial investors. Bringing the supervision of these different sectors together under a single agency therefore facilitates the supervision of these universal banks. A single supervisor also puts an end to potential competition between supervisors, who may seek to increase their scope of supervision (and their revenues) and lead to a phenomenon of downward levelling of requirements. In the early 2000s, this situation arose in the United States, where a system of supervisors at the state and federal levels coexists. In spring 2007, for example, Countrywide Financial, finding its federal supervisor too oppressive, changed its status to come under the wing of a less strict supervisor. The single supervisor model, on the other hand, is more susceptible to the phenomenon of « regulatory capture » (Boyer and Ponce, 2012), as it is easier for lobbyists to influence a single institution than several.
Integration within the central bank
The second dimension of the supervisory structure is whether or not it is integrated into the central bank. Through its monetary policy operations on the interbank market, the central bank has accurate information on the health of the banking sector. Entrusting it with the task of supervision therefore allows for better coordination between monetary policy and the supervisor, particularly in the event of a crisis. The disappearance of the single supervisor in the United Kingdom and its integration into the Bank of England is primarily due to coordination problems that arose between these two institutions during the collapse of the retail bank Northern Rock.
The central bank already plays a major role in supervision as it acts as lender of last resort, which involves a certain amount of monitoring of the financial sector. But more generally, central banks are well-established, independent institutions with a solid reputation, competent staff, and extensive experience in financial markets. However, these characteristics, which are essential for a good supervisor, take a long time to build. Integrating the supervisor into the central bank therefore makes it possible to quickly and inexpensively establish a credible supervisor for the financial sector. However, integration carries a reputational risk: the failure of a bank under the responsibility of the central bank could call into question its credibility in achieving its objectives as a supervisor and as a stabilizer of inflation. A conflict of culture and objectives may also arise between the central banker, who has a macroeconomic objective, and the microprudential supervisor, who monitors individual banks.
A single supervisor integrated into the central bank therefore seems to be the most appropriate structure at present and the one towards which many countries (France, the United Kingdom, European Union countries, etc.) are converging. However, other supervisory structures are possible as long as they have the « right » characteristics: continuous information sharing between different agencies and close coordination, close proximity to the central bank, qualified and experienced staff, and a well-established reputation.
2. How the supervisor works
While an adequate structure is important, it does not guarantee « good » supervisory practice, which is subject to numerous external pressures and internal operational biases.
Private sector lobbying
Private lobbies are a significant source of external pressure on regulators. They spend more than €120 million per year in Brussels and $300 million in the United States (Corporate Europe Observatory, 2014) in an effort to influence regulators and supervisors. Supervisors must therefore have competent staff and substantial financial resources to enable them to avoid being overly influenced by the rhetoric of financial lobbies. However, these are not the only sources of pressure facing regulators.
Independence from the state
The government may also be tempted to push the supervisor to relax regulatory constraints in order to promote short-term economic growth (facilitating real estate loans, credit, etc.) without taking into account the long-term benefits of supervision as a guarantee of financial stability, as was the case on a smaller scale in Spain and Italy in the early 2000s. A supervisor must therefore have guaranteed independence, both in its operations (independent financing from the state, limited interference in the appointment of executives, etc.) and in its objectives.
National bias
The context of international competition and the defense of national champions can also be a source of national bias for the supervisor, who will tend to be less strict with national institutions and more strict with subsidiaries of foreign groups. In the United States, this national bias is even evident between states, as when a bank is supervised at the state level, it is half as likely to have its supervisory rating downgraded than when it is supervised at the federal level (Agarwal et al., 2014). This national bias is one of the main motivations for the establishment of the Banking Union in Europe. Strong international coordination is therefore necessary to address this national bias, particularly in the case of international banks, or even the delegation of supervisory tasks to a supranational agency (Calzolari et al., 2015), such as the Federal Reserve or the Banking Union.
Cultural biases
Cultural biases can nevertheless arise when the supervisor and the banking and financial system are too close. In the United States, the relative leniency of the Securities and Exchange Commission (SEC) controls after Bernard Madoff, or the dismissal of Carmen Segarra from the New York Federal Reserve after she refused to conceal a conflict of interest at Goldman Sachs, are examples of this closeness[3], which generates biases in supervisory practices, making them more inclined to cover up misconduct and breaches.
Conclusion
Several characteristics of a « good » supervisor can be identified, both in terms of its structure and its functioning: a single agency integrated into the central bank, with qualified staff and independence from the financial sector and the government. Nevertheless, assessing the quality of supervision in terms of costs/benefits remains very complex, because while the costs are fairly easy to calculate, the benefits resulting from a reduction in the probability of a crisis remain subject to laborious estimates. Finally, without appropriate regulation, a supervisor will always be powerless.
Bibliography
Agarwal S., Lucca D., Seru A. and Trebbi F., 2014, « Inconsistent Regulators: Evidence from Banking, » The Quarterly Journal of Economics (2014) 129 (2): 889-938.
Boyer P. and Ponce J., 2012, « Regulatory capture and banking supervision reform, » Journal of Financial Stability Volume 8, Issue 3, September 2012, Pages 206–217
Calzolari G., Colliard J-E., Loranth G., 2015, « Multinational Banks and Supranational Supervision »
Corporate Europe Observatory, 2014, « The Fire Power of the Financial Lobby »
[1] Which brings together the former entities: the Banking Commission, the Insurance and Mutual Insurance Supervisory Authority, the Insurance Companies Committee, and the Credit Institutions and Investment Firms Committee.
[2] In the United States, supervision is rotated between local (state) and federal (Federal Reserve) supervisors.
[3] Proximity that can manifest itself in many ways: revolving doors, loyalty to a particular body or training, etc.
