Supervision, by contrast, is the dynamic pursuit of the relevant authority’s statutory objectives, through oversight of firms’ activities. To do this effectively, you of course need regulation – but one without the other in financial services would, in my view, be futile. At the PRA, we have committed ourselves to a judgement-based, forward-looking supervisory approach. This means that we proactively take action to meet our objectives and we evolve our methods to reflect emerging developments. It also means that we rely heavily on the judgement of supervisors and get them to unearth and scrutinise the top risks at any given firm. This is delivered by a keen supervisory focus on business models and the prudential health of firms rather than a sole preoccupation with firms’ compliance with regulation, important though that is. And because we rely heavily on judgements, the PRA has a central spine of decision-making committees, with the most important supervisory decisions reserved for the Prudential Regulation Committee (PRC). But where did this approach come from? Most comparisons between the PRA’s current supervision model and those that preceded it focus heavily on the differences between the PRA’s approach and that taken by the FSA before the global financial crisis. But the truth is that the practice of supervision in the U.K. has evolved slowly over time; indeed, the roots of supervision lie much deeper and can be traced back over the past 100 years or so.
In that financial utopia, the interests of accountants, investors and regulators would be perfectly aligned. Accountants would have a verifiable valuation yardstick; investors a true and fair view of their true worth; and regulators an objective means of evaluating solvency. Fair value would serve treble duty. In practice, the fair value debate is contentious and has been for at least a century. Through history, accountants, investors and regulators have not always sung in tune. Today, accountants are singing opera Pacioli-style, regulators are rapping at 300 words a minute, while investors are left to whistle. In part this discord has been blamed on failures of EMH, “the precarious yardstick of current market quotations”. It should come as no surprise that fair value principles have faced their stiffest tests at times of crisis – the Great Depression during the previous century, the Great Recession during this. For it is at crisis time that EMH itself faces its stiffest test, perhaps none greater than recently. The heterodox British economist George Shackle observed: “Valuation is expectation and expectation is imagination”. 9 Imagination, and thus valuation, is apt to run wild at the peak of the boom and trough of the bust. These episodes of over-active imagination, or deviations from EMH, can be grouped roughly three ways.