What Do Banking Supervisors Do?

by Beverly Hirtle and David Lucca – Liberty Street Economics, Federal Reserve Bank of New York

In most developed economies, banking is among the most regulated and supervised sectors. While “regulation” and “supervision” are often used interchangeably, these two activities are distinct. Banking supervision is a complement to regulation, but its scope is much broader than simply ensuring that an institution is in compliance with regulation. Despite the importance of supervision, information about it is often limited, both because of the heavy reliance upon banks’ confidential information and because many supervisory activities and actions are themselves confidential.

In a recently released Staff Report, we shed more light on the topic by describing the Federal Reserve’s supervisory approach for large, complex financial institutions and how supervision of such firms is conducted on a day-to-day basis at the Federal Reserve Bank of New York as part of this broader supervisory program.

The paper draws from multiple sources. Last summer, we, along with fellow New York Fed economists Thomas Eisenbach, Anna Kovner,Andrew Haughwout, and Matthew Plosser, conducted a series of discussions with our colleagues in the New York Fed’s Financial Institution Supervision Group (FISG) who are involved in the day-to-day supervision of large, complex banking and financial institutions. We also examined a wide variety of documents describing the structure and goals of supervision in the Federal Reserve System, including guidelines provided to supervisory staff and Federal Reserve Supervisory and Regulation Letters (SR Letters) describing expectations and objectives of the Federal Reserve’s supervisory program for large, complex financial institutions (see, for example, SR Letter 12-17). Finally, we paired the descriptive analysis with management data about supervisory inputs (staff headcounts and hours) and outputs (supervisory actions).

What is banking supervision? The Federal Reserve System (“System”) is responsible for the prudential supervision of bank holding companies (BHCs) on a consolidated basis and certain other financial institutions operating in the United States. Prudential supervision involves monitoring and oversight of these firms to assess whether they are in compliance with law and regulation, but also, importantly, whether they are engaged in any unsafe or unsound practices, and, if so, ensuring that firms take steps to correct such practices. Prudential supervision is interlinked with, but distinct from, regulation of these firms, which involves the development and promulgation of the rules under which BHCs and other regulated financial intermediaries operate. This distinction is sometimes blurred in the discussion by academics, researchers, and analysts who write about the banking industry.

Our paper describes how prudential supervisory activities are structured, staffed, and implemented at the New York Fed. We focus primarily on the supervision of large, complex BHCs and the largest foreign banking organizations and nonbank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve. These firms are the most systemically important, so understanding how they are supervised is especially consequential. Given the size and complexity of these companies, the approach to their supervision also differs from that taken for smaller and less complex firms. While we focus on the supervisory activities of New York Fed staff, supervision of these large, complex firms is conducted through a comprehensive System-wide program governing supervisory policies, activities, and outcomes (SR Letter 15-7).

We hope that our overview will generate, for those not involved in supervision, insight into what supervisors do and how they do it. To be clear, however, we do not provide an “end-to-end” description of each element of the supervisory process. Further, while we explain the stated rationale for the approaches taken, we do not assess whether those approaches are efficient or meet specific objectives. Understanding how prudential supervision works is a critical precursor to determining how to measure its impact and effectiveness. As such, we hope that this paper will spur further and much needed analytical work aimed at understanding and measuring banking supervision.

Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Source:

http://libertystreeteconomics.newyorkfed.org/2015/05/just-released-what-do-banking-supervisors-do.html#.VWb3OM9ViWU

About the Authors

Beverly Hirtle is a senior vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

David Lucca is a senior economist in the Research and Statistics Group.