Box-Checking Supervision Doesn't Work

Bank supervision matters because it is one of the financial system’s early-warning systems.

When it works, supervisors help identify real problems before they threaten consumers, businesses, banks, or the broader economy. They look for the risks that could actually undermine safety, soundness, and trust.

But in recent years, unclear rules and paperwork-heavy requirements have made supervision slower and less effective. Today, too much time is spent checking boxes instead of identifying and managing the real risks that could threaten consumers, banks, and the broader financial system.

Box-checking can bury real risks

Good supervision should be focused, substantive, and risk-based. When vague rules and unclear requirements bury regulators and banks in paperwork, supervision stops serving the public as well as it should. Time and attention shift away from identifying real risks and toward checking boxes and following procedures for its own sake. That does not protect consumers or make banks safer—and it does not help supervisors keep pace with a fast-moving financial system.

• Michael Hsu, former Acting Comptroller of the Currency, observes that when banking supervision follows a "check-the-box" model, it "artificially limits" the supervisors' ability to focus attention on the areas of greatest need. "The problem with check-the-box supervision is that there are a lot of boxes to check, and each box is given equal weight. This ensures comprehensiveness, but artificially limits our ability to focus supervisory attention where it is needed most."
• Eugene Ludwig, former Comptroller of the Currency, writes that his greatest concern is an overemphasis on procedure and an insufficient emphasis on "rare, catastrophic events," whose future prevention requires greater flexibility and foresight. "My greatest concern lies with a lack of focus on rare, catastrophic events that can devastate the financial system on the one hand, while we dwell on an overemphasis on process and procedure on the other hand. This excessive focus, akin to the Maginot Line, is likely to prove too rigid and to blind us to the true sources of future danger."

Supervision also needs to move at the speed of risk

Today’s financial system moves quickly. Technology changes, fraud tactics evolve, cyber threats emerge, and market conditions can shift in real time. Supervision that takes months or years to produce final findings doesn't protect consumers from today's risks, much less from those of tomorrow.

• Raj Date, former Deputy Director of the Consumer Financial Protection Bureau, observes that supervisory reports often take months or years to make it to banks, rendering them outdated by the time they arrive. "[M]anaging overly broad examination agendas requires, at least in today's breathtakingly manual approach to supervision, long cycle times between the activities being supervised and the rendering of final supervisory results. Bank management teams and boards typically receive final exam output not weeks or months after the beginning of the time period examined, but rather quarters or even years later. In a fast-changing market, this guarantees that supervisory remediation demands will feel stale by the time they are finally rendered. Indeed, because preliminary exam results are typically (and wisely) shared informally with bank management, and because bank management typically (and wisely) tries to respond to fix problems that are even informally raised, final exam reports can feel decidedly anachronistic by the time they finally emerge."
• U.S. Rep. French Hill, Chairman of the House Financial Services Committee, expressed the need for regulators to evolve alongside innovation in the markets. "Financial innovation is accelerating rapidly. Federal agencies have to keep pace with these new technologies, and that is a challenge inside a big federal compliance and supervisory bureaucracy. This raises important questions about whether the agencies have the structure and the expertise to respond effectively, and we must ensure that our regulators evolve alongside the markets, the very markets that they oversee."

The goal should be clear: targeted, timely, risk-based supervision

Supervision done the right way strengthens the financial system, protects consumers, and helps banks and regulators identify risks before they become crises. But endless process and vague requirements can turn a crucial safeguard into a paperwork exercise. Consumers, bankers, and supervisors all benefit from clearer standards that focus attention where it belongs: on the real risks that affect the safety, stability, and reliability of the financial system.

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