Featuring Michael Johnson, Executive Vice President, Supervision, Regulation & Credit, Federal Reserve Bank of Atlanta
In the changing regulatory landscape, supervisors are in a key position to aid regulators and banks to work together. However, challenges in transparent communication can lead to major issues in implementation, Michael Johnson, Executive Vice President, Supervision, Regulation & Credit, Federal Reserve Bank of Atlanta, told us at RiskMinds International. So what can be done? Johnson introduces some of the new key initiatives from the Federal Reserve and emphasises one of the biggest risks of all: complacency.
Note: Michael Johnson’s comments are his own and do not necessarily represent the views of the Federal Reserve.
Transparency is one of the most critical aspects of risk management and supervision and it is by no means a Eurocentric issue – there is room for improvement in financial markets around the world. Although languages and cultures vary, in the field of risk and regulation, the same themes are present globally.
There are three fundamental dimensions in the field of risk:
In each case, both quantitative and qualitative information will inform evaluations and analysis. It is also helpful to look back on financial history and listen carefully to both public and private rhetoric today. Are we hearing the types of language that we have heard before, just prior to a major downturn?
After learning from the aftermath of the financial crisis, some institutions are renewing their approaches to supervision. In the US, for example, effective this year, the Federal Reserve has launched a new strategic plan for supervision function of its system. The key themes for the new plan are focused on:
Each area is focused on ensuring strong and effective Fed programmes with good cost-benefit dynamics and outcomes.
Although the regulation of financial markets is a highly complex endeavour, the framework around the regulation is already fairly transparent. However, there is significant room for improvement in the supervisory area, from guidance and communication about specific topics and programmes to the scope, process, and results of examinations. Market participants should have adequate knowledge of programmes that pertain to them and a clear understanding of the basis for findings and actions.
For both sides, supervisory and supervised, there are challenges with opacity and understanding that can lead to inconsistency in implementation and examination. This scenario could introduce unnecessary risk into the financial system as communications and coordination break down. Important measures to mitigate these risks include encouragement of and engagement in debate as part of the examination process and a commitment to clear communications with senior leadership and boards. As Randal Quarles, Vice Chair of Supervision of the Board of Governors of the Federal Reserve System, has said, "Transparency supervisory principles and guidance also allow firms and the public to understand the basis for supervisory decisions and allow firms the ability to respond constructively to supervisors".
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In accordance with the new vision, the Federal Reserve has developed a programme of more frequent formal and informal communications. This constitutes a shift from a more traditional reactive posture, where the Fed responded to questions and request for information, but did not actively reach out to the broader marketplace. This stance had the unintended consequence of benefitting the few, often larger firms, who were proactive themselves.
The new programmes include “Ask the Fed”, a series of 15-20 events per year in the form of video and web-enabled conference calls, with industry invited to participate. The content of the calls is centered on news about supervisory processes and expectations. Publications are also part of the plan, including Community Banking Connections and Consumer Compliance, which contain information for smaller institutions. FedLinks, provides resources online.
These programmes are augmented by more direct contact with firms, through regular (though not too frequent) meetings with boards of directors and focused conferences, where the Fed will invite directors from each large bank for updates and sharing best practices.
Finally, the Fed produces a semiannual supervision and regulation report, which coincides with VC Quales’ congressional testimony. The first report was published in November 2018 and provided an overview of banking, regulatory developments, supervisory developments and aggregated supervisory information. The follow-on report came out in May 2019 and provided deeper descriptions of supervisory programmes, including information for the Bank Exams Tailored for Risk (BETR) programme geared towards smaller bank community banks. A third report was published in November 2019.
Supervision and regulation report, Nov 2019
While there is a tendency to be vigilant just following a financial crisis, it is all too easy to fall back into a business-as-usual mindset. Yet, with complacency may come risk-inducing and risk-enabling behaviours once again. These days, the general sense is that banking conditions over all are good: capital levels have never been higher, the party line is that there is plenty of liquidity, and asset quality is viewed favorably. However, there may be reasons to raise awareness and observe the industry more carefully now. After years of relative calm in the markets, is there growing tolerance and acceptance of risk without mitigation?
Some examples of common rhetoric that deserve to be challenged include such things as:
In light of such attitudes, Michael Johnson advises, “The supervisory role is never more important than at times like these.” In that regard, he is echoing VC Quales, who noted, “A healthy banking system does not make vigilance any less necessary.” However, with proper attention and dedication to clear and constructive dialogue, perhaps the next financial crisis may be averted.
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