Current Legal Issues Affecting Central Banks, Volume IV.
Chapter

17B. Bank Supervision in the G-7 Countries

Author(s):
Robert Effros
Published Date:
April 1997
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Author(s)
ELIZABETH ROBERTS

This chapter addresses central bank involvement in banking supervision, primarily in the Group of Seven (G-7) countries. In the United States, the Federal Reserve (the central bank), in addition to specific domestic banking supervisory responsibilities, is responsible for monitoring the combined U.S. operations of foreign banking organizations. As part of this process, it has attempted over the years to understand better how these banks are regulated in their home markets.

A specific effort was made by the Federal Reserve to catalog banking supervision and regulation practices in the G-7 countries. Central banks were found in all but one G-7 country (Canada) to be either de jure or de facto involved with the supervision and regulation of banks. More broadly, central banks have either total or shared responsibility for banking supervision in three-fourths of the members of the Organization for Economic Cooperation and Development. Therefore, one can assume that most countries have come to understand that banking supervision and regulation have economic consequences that are important for stability and economic growth. However, the specifics of each central bank’s role vary from country to country, depending importantly on cultural and historical features, as well as on the institutional structure and degree of concentration within the home country financial system.

Nine Factors Affecting Banking Supervision and Regulation

A recent review by the Federal Reserve of supervisory practices in the G-7 countries included analyses of nine specific areas relating to banking supervision and regulation:

  • the legal basis for supervision;
  • the agencies involved in banking supervision;
  • chartering responsibilities;
  • examination authority;
  • reliance on external auditors;
  • statistical reporting and surveillance;
  • corrective measures and sanctions;
  • rule-making responsibility; and
  • deposit insurance.

After briefly addressing each of these nine factors, this chapter summarizes the findings for each of the G-7 countries.

Legal Basis for Supervision

In each of the G-7 countries, a specific law designates responsibility for banking supervision. In some countries, the banking supervisors historically have relied more on a series of agreements than on formal exercise of statutory powers. This was certainly true of the United Kingdom prior to passage of the Banking Act, 1979.1 However, in recent years, particularly in Europe, the various EC banking directives have given impetus to formalize banking supervision and regulation.2

Agencies Involved in Banking Supervision and Regulation

In numerous countries, there is a single supervisory and regulatory agency—the central bank, the ministry of finance, or a separate banking agency. In other countries, two or more agencies are involved in the supervisory and regulatory function. It is interesting to note which agency is responsible for banking supervision, and, if more than one agency is involved, how the responsibilities are divided among the agencies and how they interrelate with one another.

Chartering Responsibilities

A key function within any supervisory structure is the chartering or licensing of new institutions and the various requirements that go along with this chartering process. This function is usually tied to other supervisory responsibilities. Although, in some countries, such as France, it is the responsibility of a separate agency, most supervisors approve the formation of banking institutions for which they will ultimately maintain responsibility.

Examination Authority and Reliance on External Auditors

The fourth and fifth factors, examination authority and reliance on external auditors, are really intertwined. For U.S. supervisors, the examination function serves as the backbone of the supervisory process. In many other countries, however, the supervisory agencies rely instead on the reports of external auditors. In addition, many countries use a system that is a hybrid of examinations, usually conducted once every several years, and reports compiled by external auditors in the interim years.

It is important to note which of these three methods is utilized. In those countries where the supervisors conduct on-site examinations, the frequency with which these examinations are conducted, and by which agency or agencies, is significant. Meanwhile, where external audits are used, how much control the supervisory agencies have over the independent audit process is important. For example, does a bank have to choose an auditor from a preapproved list compiled by the supervisory agency? Do the supervisors have any input into the content and focus of the audits? What are the responsibilities of the independent auditors with regard to communicating problems at a specific institution to the supervisory agencies? Finally, in those cases where the supervisors rely on the reports of external auditors, do the supervisors have any examination authority of their own, either in general or in extraordinary circumstances?

Statistical Reporting and Surveillance

Obviously, supervisors and external auditors cannot be in all banks at all times. Therefore, statistical reporting and off-site surveillance are important tools in the supervisory process. The continuing off-site monitoring or surveillance of financial institutions should constitute a significant portion of any supervisory program. What type of information is collected and how often, and how this information is utilized by the supervisory agencies, is important.

Corrective Measures and Sanctions and Rule-Making Responsibility

The seventh and eighth factors are fairly self-explanatory. A critical aspect of any supervisory regime is the ability to require corrective action and the legal authority to impose sanctions in the most serious circumstances. Similarly, the responsibility for rule making is critical to any supervisory structure. Different countries allocate this responsibility in different ways.

Deposit Insurance

With regard to the ninth factor, deposit insurance plans, if they exist at all, vary across countries. These plans can range from formal, government-sponsored plans, to less formal, private plans, arranged by organizations such as bankers’ associations. It is important to understand what, if any, role the banking supervisory authorities have in administering the deposit insurance plan and, conversely, what, if any, role the deposit insurance agency plays in banking supervision.

Specific Countries

United States

The United States is in a unique position among the G-7 countries because of its dual banking system, in which, in most cases, federal and state officials share authority over individual institutions. In addition, the United States has a diverse banking system, with over 11,000 commercial banks, a large number of small institutions, and a system that, until recently,3 limited the activities of individual banks primarily to one state.

The dual banking system in the United States has led to the creation of a rather complicated banking supervisory structure. Commercial banks in the United States have the option of obtaining state or federal charters. National banks, or those with federal charters, are supervised by the Office of the Comptroller of the Currency, which is an agency of the Department of the Treasury. State banks, which receive their charters from the states in which they operate, are subject to supervision not only by these states but also by a federal banking agency. This responsibility is split between the Federal Reserve, which supervises state-licensed banks that are members of the Federal Reserve System (so-called state member banks), and the Federal Deposit Insurance Corporation, which supervises state-licensed banks that are not members of the Federal Reserve System (so-called state non-member banks). Many banks are owned by bank holding companies, which are supervised by the Federal Reserve. Unlike most other countries, savings banks and credit unions in the United States are supervised by yet two additional supervisory agencies: the Office of Thrift Supervision, for savings banks, and the National Credit Union Association, for credit unions. Proposals are made periodically in the United States to streamline the banking supervisory structure.

France

France, like the United States, has multiple agencies involved in supervision.4 These agencies, however, are divided along functional responsibilities, as opposed to categories of banking institutions, as in the United States. Currently, several primary agencies are involved in banking supervision and regulation in France. The Bank of France (the central bank) exercises indirect but significant authority over the supervision and regulation of the banking system. The Banking Commission, which is responsible for ensuring the safety and soundness of all credit institutions and monitoring compliance with banking laws and regulations, is chaired by the Governor of the Bank of France and is staffed by central bank employees. The Banking Regulations Committee, on which the Governor of the Bank of France acts as Vice-Chairman, establishes prudential regulations and accounting standards. The Credit Institutions Committee, on which the Governor of the Bank of France serves as Chairman, is responsible for chartering individual banking institutions.

It is apparent that the French system assigns tasks such as rule making and chartering to institutions separate from those that are charged with the day-to-day supervision of banking institutions. The unifying force is the indirect involvement of the Bank of France in all of the various supervisory functions and its very direct involvement—because of the staffing of the Banking Commission—in the day-to-day supervision of the banks.

Japan

In Japan, banking supervision and regulation is the legal responsibility of the Ministry of Finance, although the Bank of Japan (the central bank) is also involved de facto in the monitoring, analysis, and supervision of banks and in the resolution of problems within the banking sector. While the authority of the Ministry of Finance is statutory, the Bank of Japan’s authority is contractual, based on an individual agreement entered into by each bank using central bank services. Credit institutions must obtain the approval of the Ministry of Finance in order to commence operations.

The Ministry of Finance and the Bank of Japan share examination responsibilities and conduct regular on-site examinations, generally in alternate years. The Bank of Japan is involved in the examinations of all commercial banks, as they all maintain accounts with the central bank. Both the Ministry of Finance and the Bank of Japan conduct extensive off-site monitoring of financial institutions by reviewing statistical returns and meeting periodically with bank management.

The Ministry of Finance has sole legal authority to impose corrective sanctions on banks. However, the Bank of Japan may use its ability to withhold its central banking services from a particular bank to influence that bank, if necessary.

Germany

The supervisory situation in Germany is particularly interesting because of the frequent misperception that the Deutsche Bundesbank (the central bank) is not involved in the day-to-day supervision of German banks. The banking law established the Federal Banking Supervisory Office as the primary banking supervisory body in Germany.5 The Supervisory Office exercises its supervisory functions in close coordination with the Bundesbank. The Supervisory Office is formally the lead supervisor. However, with a single office in Berlin, it relies heavily on the Bundesbank, which has regular dealings with banks and a network of offices throughout Germany. In practice, a partnership exists between the Supervisory Office and the Bundesbank.

Many of the Bundesbank’s supervisory functions are conducted through the state central banks, which are akin to Federal Reserve Banks in the United States. The state central banks are actively involved in the ongoing surveillance of financial institutions through the collection and analysis of monthly and quarterly financial returns, as well as through the annual reports of external auditors. Both the Bundesbank and the Supervisory Office have the power to conduct on-site examinations. In practice, however, with the exception of the foreign exchange examinations, which are conducted by the Bundesbank, they rely on the annual audit reports.

All so-called sovereign functions, such as the chartering of individual institutions, are the responsibility of the Supervisory Office. In practice, these administrative acts are conducted only after consultation with the Bundesbank. The Supervisory Office issues regulations but must, by law, confer with the Bundesbank before doing so. The degree to which the Bundesbank is entitled to participate is based on the extent to which the regulations affect its central banking functions. Therefore, when issuing regulations concerning capital and liquidity, the Supervisory Office is required to reach agreement with the Bundesbank while, on other matters, the Bundesbank has merely to be consulted. It is apparent, however, that the two agencies reach agreement on virtually all major regulatory and supervisory matters.

Although both the Supervisory Office and the Bundesbank are authorized to examine banks, they almost exclusively rely on the reports of external auditors. Guidelines for the contents of these audit reports are formally established by the Supervisory Office. These reports are routinely submitted to the state central banks, which review them and prepare summaries. The reports and summaries are, in turn, provided to the Supervisory Office; the Bundesbank, in Frankfurt, normally receives only the summary report.

United Kingdom

The United Kingdom is one of two countries in the G-7, along with Italy, where banking supervision is in effect the sole responsibility of the central bank. Banking supervision in the United Kingdom is conducted by the Bank of England (the central bank), which is the statutory supervisor of all financial institutions authorized under the Banking Act.6 All institutions engaged in banking activities in the United Kingdom must be authorized by the Bank of England. The Bank of England, like the German banking authorities, relies primarily on the reports of external auditors, rather than on on-site examinations.

The 1987 Banking Act created an advisory committee to the Bank of England known as the Board of Banking Supervision.7 The Board comprises nine members, three of whom are the Governor, Deputy Governor, and one of the executive directors of the Bank of England. The role of the six independent members is to advise the bank members on the exercise by the Bank of its supervisory functions under the Banking Act. In addition, following passage of the 1986 Financial Services Act,8 the concept of a lead regulator was developed to avoid duplication of supervisory efforts for those institutions conducting a wide range of financial functions. This arrangement provides for one supervisor to monitor an institution’s financial condition on behalf of all of the regulatory entities. The Bank of England has been designated as the lead regulator for all banks engaged in expanded activities.

Italy

The other G-7 country with essentially a single supervisor is Italy. The Bank of Italy (the central bank) is responsible for the supervision and regulation of the banking system, subject to broad directives from the Interministerial Committee for Credit and Savings. The Bank of Italy is empowered to authorize the establishment of new banks and the opening of new branches. The Bank of Italy is responsible for establishing regulations for credit institutions within the scope of its authority.9 It also has the power to prescribe minimum capital levels, establish lending ceilings for banks, and exercise ongoing controls through a number of returns, inspections, and prudential ratios. The Bank of Italy is also responsible for ensuring that the banks comply with these regulations.

Canada

The only G-7 country where the central bank has a very limited role in supervising and regulating the banking system is Canada. The Office of the Superintendent of Financial Institutions (OSFI) is the sole supervisory authority for banks, trust and loan companies, insurance companies, investment companies, and cooperative credit societies. OSFI is part of the Department of Finance, reporting to the Minister of Finance. Although the Bank of Canada (the central bank) does not have responsibilities for prudential supervision, it routinely receives most of the supervisory reports filed with the Superintendent.

In addition, the Governor of the Bank of Canada is a member of the Financial Institution Supervisory Committee, which was established to facilitate the confidential exchange of information among its members on all matters related to the supervision of financial institutions. The other members of this committee are the Superintendent of OSFI, the Deputy Minister of Finance, and the Chairman of the Canadian Deposit Insurance Corporation.

Other Issues

There are several other issues related to central bank participation in banking supervision and regulation. For example, it can be argued that central bank involvement in banking supervision is less critical in countries where the local banking market is highly concentrated. In these countries, the scope for informal involvement by the central bank, through personal relationships and ongoing contacts independent of the supervisory process, is far greater than in some countries, such as the United States. A good example of this is Switzerland, where the Swiss National Bank has no formal role in banking supervision and regulation. However, the Swiss banking system is highly concentrated; therefore, in the event of a nationwide systemic problem, there are probably only three banks with which the Swiss National Bank would need to work. Undoubtedly, personal relationships would allow it to do so quite easily.

There is also a political aspect to central bank involvement in countries where the independence of the central bank is a controversial issue. For that reason, central banks in numerous countries are, de facto, more involved in banking supervision and regulation than may be apparent on the surface. Many central banks wield their influence over the banking system behind the scenes and as discreetly as possible, because they do not want to add to the controversy regarding their independence by emphasizing their critical role in banking supervision and regulation.

The role of central banks in the supervisory process is subject to periodic review. Such a review was conducted recently in France, in the context of the new law establishing the independence of the Bank of France.10 However, the role of the central bank in the supervisory process was left unchanged. In the United Kingdom in late 1993, the Treasury and Civil Service Committee of the House of Commons reviewed the role of the Bank of England in several areas, including supervision.11 It was concluded that there was no overwhelming case to move supervisory responsibility outside the Bank of England. The role of central banks in banking supervision and regulation will be a topic of interest for many years to come.

COMMENT

JOHN P. DANFORTH

The topic of the role of central banks in banking supervision and regulation is of significant interest. This comment considers bank supervision and regulation in the United States from a somewhat different perspective, that is, from more of a banking industry than a central bank perspective.

For many years, there has been academic concern about the role of the central bank in bank supervision. This concern has been related to what some would describe as the possibility of an inherent conflict between the monetary policy and supervisory roles. There are arguments on both sides of this debate.

A more significant issue for banks is the complex and overlapping system of supervision and regulation in the United States at present. Banking organizations often are subject to supervision and regulation by several federal and state banking supervisors. The prior system of geographic restrictions on banking in the United States caused the development of a truly bizarre system of supervision and regulation that sometimes led to a situation in which an institution with banks in several states had several charters—a national bank charter, a state member charter, a state nonmember charter, and a federal savings bank charter. Such an institution is subjected to extremely complex and sometimes conflicting regulatory guidelines.

This situation was severely exacerbated in the United States as the bank supervisory agencies became more aggressive and intrusive in performing their supervisory functions, in response to both the significant losses passed on to U.S. taxpayers because of the debacle in the thrift industry and the surge in bank failures, as measured by the number of institutions and the amount of assets affected during the late 1980s and early 1990s. As the supervisory authorities became more aggressive, the difficulties associated with overlaps and redundancies in supervisory authority became more pronounced.

This development, rather than concerns about the independence of monetary policy from supervision, led certain individuals to believe that the issue of supervisory reorganization should be revisited, and that legislation should be adopted to simplify a convoluted system of regulation. There have been numerous proposals.1 From a banker’s perspective, the great majority of banks in the United States are quite comfortable having the Federal Reserve in a supervisory role. Some banks, as a response to the policies and standards adopted by the Comptroller of the Currency, the supervisor of national banks, have altered their charters so as to be regulated by the Federal Reserve rather than by the Comptroller of the Currency. In addition, these banks are enjoying the advantages associated with having the same regulator for their holding companies as for their subsidiary banks. A number of organizations have, in fact, acted as missionaries, advocating that more institutions replace the Comptroller of the Currency as their supervisor by the Federal Reserve by changing their charters from national bank charters to state member bank charters.

For this reason, most bankers in the United States are earnestly opposed to a thorough streamlining of the country’s regulatory and supervisory process. Under the current regime, they are permitted to change their charter and supervisor should they become dissatisfied with the quality or rigor of supervision provided by that supervisory authority. Apparently, this is a very unusual situation. Some observers have warned of the possibility of a competition in laxity of regulation that allowing bankers a choice might promote in the banking community. Nevertheless, in the United States today, the prevailing concern among bankers is that having only one supervisor might lead to a situation in which there would be no market discipline to encourage that supervisor to deal reasonably with banks. Perhaps it is the inherent distrust of government in the United States that allows that view to be so prominent.

In conclusion, based upon the foregoing, the Federal Reserve is not likely to be excluded from banking supervision activities in the United States. Moreover, no change is likely to be made to the current situation, whereby banks can leave one primary supervisor for another should they believe that they are not being treated fairly by that supervisory authority.

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