Supervision more important than regulation

By Hubert Roy | April 26 2010 05:16PM

A financial sector with strong regulatory rules, but with weak supervisory oversight, is not a safe and sound financial sector. Julie Dickson, Canada's Federal Superintendent of Financial Institutions, issued this warning at a conference in New York in mid March.

 "If we take the view that supervisory judgment has failed time and again, and that we should therefore rely far more on rules than on supervisors going forward, we may create a system with even more risk, as rules often have unintended consequences which can take quite some time to see," she told the Heyman Center on Corporate Governance.

Ms. Dickson adds that stricter rules, like substantially higher capital requirements, may create a false sense of security. "An institution will never have enough capital if there are material flaws in its risk management practices. That is why supervision matters," she explains.

Why, then, is so much attention being focussed on putting in place new rules? According to Ms. Dickson, it may be because changing a rule is seen by the public as a concrete step, as taking decisive action. She reminded the audience that at the start of the global financial crisis, it was apparent that the minimum level of capital that banks were required to have under international capital agreements was too low. The solution proposed was to change capital requirements, "which is easier to change [than] a supervisory system - particularly on a global basis," she points out.

Ms. Dickson thinks the financial industry could learn from the sports world. "Referees, for example, do much more than blow whistles during games to enforce rules. They talk to players and coaches about what is expected, what is acceptable and not acceptable, and what situations they will be watching given past experience. They know the personalities of the players in the game, they use carrots and sticks, give some players the benefit of the doubt, and give others no room at all."

"The rules are important, but ultimately it is the referees that control the flow of the game."

So in crafting new international rules for the financial sector, we need to start focusing on the role that day-to-day supervisory oversight plays, because rules are just one part of the equation," Ms. Dickson says. Another factor to consider: market discipline. It must be asserted or the system will be skewed by managers, who will place too much reliance on supervisory agencies.

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