Supervisory Architecture and European Banking Supervision

There is a major debate going on at the moment in Europe about how to stimulate the economy with more robust policies and a more aggressive approach towards bank lending. This comes against the background of record low interest rates and rising unemployment figures across the continent. The European Central Bank has been widely criticized at the lack of stimulus it has offered to the banking system, and many have even blamed its sluggish performance on Draghi’s insistence on keeping interest rates very low. These arguments notwithstanding, there is no doubt that credit scores have taken a battering in the past year or so. This means that potential borrowers are turned off and banks are less willing to lend, with some even closing their doors.

Firm Investment

One of the ways that this problem can be solved is by increasing bank supervision. For example, there is strong suspicion that senior managers at banks are busy pursuing their own interests and not actually doing what they are supposed to do, which is run on the banks. Increased supervision would surely help but without acting quickly and providing a concrete supervisory role, this can only be a temporary solution. There is also no guarantee that any increased regulation will bring about any improvement in the quality of loans. If anything, banks may still end up having to resort to excessive leverage or dumping risk in order to keep their balance sheets balanced.

The best way to go about this is to start an overhaul of regulation and introduce a supervisory body that can be trusted to oversee all aspects of banks, including firm investment. Such a body should be led by an independent regulator, such as the Office of the Superintendent of Bankruptcy, which would be independent from government control. In the UK, the FSA was brought in to reorganise and strengthen regulatory standards, and although it is not a bank, it does have the powers to supervise Northern Rock and other large UK banks.

Supervisory architecture also needs to be based on sound principles and a thorough examination of the risks posed by current practices. Many firms are guilty of introducing too many new business activities into their portfolio, leading to a risk of conflict of interest and too much concentration on quarterly profits rather than long term investment strategy. Supervisory architecture needs to be highly flexible, and be able to respond quickly to changes in financing conditions and in order to minimise potential losses and rewards. Some European supervisory architecture solutions already contain certain elements of this, including the principle of a single supervisory authority, where there is just one head in a firm that oversees all activities under that authority. There is also the principle of fixed minimum ratio of assets to liabilities, where there is a fixed proportion between total assets held and total liabilities.

Supervision should be localised in order to deal with the specific issues faced by different firms in different locations. Supervision should be combined with strong decision making and problem solving capabilities. This can be done through the development of new capabilities such as real time accounting and decision support systems, and developing systems that allow the sharing of information across the different local supervisors. Another important idea is for firms to look at ways of aligning supervision to the most appropriate parts of the firm. When problems arise, decisions should be made to take the appropriate action.

One other key area that some European firms are looking at when discussing the future of banking supervision is the idea of more centralised supervision. There is some concern that a more centralised approach would mean that there would be less control over financial operations and this could in turn lead to increased risks and difficulties. Centralised supervision might involve the establishment of a few ‘house’ banks, where all financial activities would be conducted under one set of principles, with each having their own size, capital and ability to borrow. If the aim is to create a more democratic approach, then a good place to start is by establishing and maintaining a platform where all major decisions can be voted on and revised by shareholders and other members of the firm. The establishment of a number of house banks, operating in a number of countries across Europe, provides a valuable template for how to deal with the issues of bank supervision when it comes to investment decisions.