Supervisors should never act in a way which implies that they assume responsibility for the banks’ ongoing activities. Third, the supervisors must have a broad range of powers at their disposal to address different banking problems. This range should include limited measures such as requesting changes in the bank’s management or requesting improvements in risk management or control management. Also more far-reaching measures should be available such as stopping or restricting certain payments or activities, or the ultimate measures, to withdraw the banking license or to liquidate the bank. Preferably, some of these powers should be “pro-active” so the supervisor is allowed to act even before a problem becomes acute, for instance when the capital ratio is declining but has not yet reached the minimum level. Fourth, the supervisors must have a well defined and documented work process. This includes a set structure of approaches to collect and analyse information and to use this as a basis for taking action. The approaches are, for instance, offsite monitoring, onsite examinations and ongoing contacts with the bank. Offsite monitoring means analysing regulatory and financial reports from banks, from their internal and external auditors, and from external media. Onsite examination is a tool to ensure that the bank actually works as reported and to gain further insights into the bank’s operations. The modern approach in this field is not to look at all transactions and documents but rather at a sample of those, including the more important ones.
The regulation will not obstruct developments in banking while at the same time it prevents banks from behaving in a way that might harm customers or themselves, other institutions or markets, or society as a whole. Without going into detail I could mention the new Basel II framework for capital requirements on banks as an example of such flexible regulation. Under Basel II, banks may assume risks as long as they can prove to the supervisor that they have adequate capital to back up those risks. The banks must also have the necessary governance structures to ensure that they have the capability to identify, manage and control all major risks. Please do not misunderstand me; I am not advocating that all countries should adopt the Basel II, not at all. In fact, it would even be hazardous for countries to adopt Basel II unless the underlying preconditions and regulations for basic banking are adequate. My point is only that Basel II is a type of regulation which maintains a balance between “carrots and sticks”. It lets the banks do their business as long as they manage and control it well, but if there are shortcomings in the banks’ handling then Basel II provides increased powers to the supervisor to intervene at an early stage to rectify the problems. To sum up, Basel II mixes responsibility and flexibility for banks with strong supervision by authorities and the general public. Whenever appropriate I would also promote a functional rather than an institutional approach to regulation.