Effective Banking Supervision

Effective supervision of banking organisations is an essential component of a strong economic environment in that the banking system plays a central role in making payments and mobilising and distributing savings. The task of supervision is to ensure that banks operate in a safe and sound manner and that they hold capital and reserves sufficient to support the risks that arise in their business. Strong and effective banking supervision provides a public good that may not be fully provided in the marketplace and, along with effective macro-economic policy, is critical to financial stability in any country. While thecost of banking supervision is indeed high, the cost of poor supervision has proved to be even higher.

Banking supervision should foster an efficient and competitive banking system that is responsive to the public's need for good-quality financial services at a reasonable cost. Generally, it should be recognised that there is a trade-off between the level of protection that supervision provides and the cost of financial intermediation. (9)

Supervision cannot, and should not, provide an assurance that banks will not fail. In a market economy, failures are a part of risk-taking. (10) Such matters cannot therefore always be entirely the responsibility of banking supervisors; however, supervisors should have in place adequate arrangements for resolving problem bank situations.

1. Providing sound and sustainable macro-economic policies are not within the competence of banking supervisors. Supervisors, however, will need to react if they perceive that existing policies are undermining the safety and soundness of the banking system. (11) Therefore, sound macro-economic policies must be the foundation of a stable financial system.

2．A well-developed public infrastructure needs to cover the following facilities, which, if not adequately provided, can significantly contribute to the destabilization of financial systems: A system of business laws including corporate, bankruptcy, conttact, consumer protection and private property laws; Comprehensive and well-defined accounting principles and rules that command wide international acceptance; A system of independent audits for companies of significant size.

3．Effective market discipline depends on an adequate flow of information to market participants, appropriate financial incentives to reward well-managed institutions and arrangements that ensure that investors are not insulated from the consequences of their decisions. (12)

4．Sufficiently flexible powers are necessary in order to effect an efficient resolution of problems in banks. (13) Where they are not, the prompt and orderly exit of institutions that are no longer able to meet supervisory requirements is a necessary part of an efficient financial system. Forbearance, whether or not the result of political pressure, normally leads to worsening problems and higher resolution costs.

5．Deciding on the appropriate level of systemic protection is by and large a policy question to be taken by the relevant authorities, particularly where it may result in a commitment of public funds. (14) In order to preserve the operational independence of supervisors, it is important to draw a clear distinction between this systemic protection role and day-to-day supervision of solvent institutions.

A In the absence of sound macro-economic policies, banking supervisors will be faced with a virtually impossible task.

B The way in which failures are handled, and their costs borne, is in large part a political matter involving decisions on whether, and the extent to which, public funds should be committed to supporting the banking system.

C Where problems are remediable, supervisors will normally seek to identify and implement solutions that fully address their concerns.

D Supervisors will also normally have a role to play because of their in-depth knowledge of the institutions involved.

E The lower the tolerance of risk to banks and the financial system, the more intrusive and costly supervision is likely to be, eventually having an adverse effect on innovation and resource allocation.

F Off-site monitoring can often identify potential problems, particularly in the interval between on-site inspections.

G While thecost of banking supervision is indeed high, the cost of poor supervision has proved to be even higher.

H Among the issues to be addressed are corporate governance and ensuring that accurate, meaningful, transparent and timely information is provided by borrowers to investors and creditors.

(9)