New bank regulation has dominated the headlines in recent months, with the Basel
3 agreement a landmark in setting the bank regulatory guidelines – at least for the time being!.

Now it’s time to focus on what really counts: how are the national bank
supervisors going to apply this mountain of (often conflicting!) new
and old rules?

If there is a simple answer, it’s called ‘judgment, backed by whatever rules may be relevant’. Our survey in a recent book ( Effective Bank Regulation and Supervision) asked about 30 bank regulators and other expert observers of the banking scene to summarize how the successful national regulators and supervisors fared during the past crisis against the
unsuccessful ones. The simple answer was that they applied their experienced judgment to what their respective banks were doing and used existing tools – largely from the long-standing Basle 2 toolkit – to inform their institutions to change their behavior, using the penalties in Pillar 2 of that toolkit, to enforce their judgment. Thus most EU regulators/supervisors as well as their peers in countries like Canada, Australia and Norway, sailed through the banking crisis with minimal damage.

Now the toolkit is full to overflowing – including 2300 pages of Dodd-Frank
legislation! But the critical factor is still judgment: do we supervisors think our banks are taking undue risks? Most of us acknowledge that we can’t prevent the next crisis, but our supervisors certainly can assess risk and take action accordingly. If we supervisors don’t understand what the bankers are doing, we can apply some simple penalties until we’re happy with their behavior!

In a word, let’s move to the real, imperfect world and apply the judgment
of experienced regulators and supervisors rather than debate the
niceties of the new rules!

Effective Bank Regulation is published by Searching Finance.