Current Legal Issues Affecting Central Banks, Volume IV.

18C. A Swedish Perspective

Robert Effros
Published Date:
April 1997
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A glance at the institutional organization of banking supervision in a number of countries demonstrates the different solutions that have been found. There seems to be no uniform international trend, even though an endeavor to concentrate and to coordinate supervision may be observed in most countries.

Two major models may be noted. In many countries, banking supervision is conducted by the central bank (the central bank model), while such functions in other countries have been entrusted to an authority separate from the central bank, either to a division of the ministry of finance or a supervisory authority under the government (the alternative model).

One might expect that the choice of a model should be based on lengthy analyses or deliberations. However, this does not seem to be the case. Instead, the choice of model may often be explained by historical traditions. In Sweden, for example, the central bank has been under the authority of the Parliament rather than the Government since its establishment as the world’s oldest central (banknote-issuing) bank in 1668. The predecessor of the central bank had gone bankrupt, and the Parliament decided to take over the bank in order to prevent the King from exercising the power to print money and thus maintain control of Sweden’s military. During its first years, the central bank was simply called the Bank, because it was in fact for many years the only bank in Sweden. New, privately owned banks emerged in the mid-nineteenth century, for which bank licenses were granted by the Government. As the privately owned banks at that time also had the right to issue banknotes, and as the central bank competed with those banks in many areas, the issuance of bank licenses was made a government, rather than a central bank, task. It was, therefore, only natural that banking supervision was from its very start a duty to be performed by the Ministry of Finance and not the central bank. Later in the nineteenth century, the position of Bank Inspector and the Bank Inspection Supervisory Board were established. Another such board was established to supervise insurance companies.

In recent years, the question of responsibility for banking supervision has been deliberated by government committees in Sweden, as well as in some other Northern European countries using alternative models similar to Sweden’s.

As a starting point for this discussion, a survey of the current situation in some members of the Organization for Economic Cooperation and Development is helpful. (Additional information on banking supervisory and regulatory practices on the Group of Seven industrial countries can be found in Chapter 17B.) Some arguments that have been made in the Nordic countries for and against the central bank model are also addressed in this chapter.

Organization of Banking Supervision

Different countries have chosen different approaches to organizing supervision. The main determining factor seems to be the history and structure of the particular country’s banking system and the prevailing view of the central bank’s mandate.

The United States is perhaps the most obvious example. A large number of laws, for example, the Glass-Steagall Act1 and the laws that prevented interstate banking, led to the development of a complex banking structure. This structure is reflected in the supervisory system, where, as has been detailed in Chapter 12 and Chapter 17B of this volume, no less than five different authorities, including the Federal Reserve Board, have supervisory responsibilities. The United States has thus chosen both the central bank and the alternative models. However, the organization of supervision in the United States is under more or less constant debate and has been criticized for being overly burdensome to the banks, partly because of overlapping responsibilities among the supervisory authorities. Recently, a proposal was put forward in Congress suggesting that supervision be concentrated in fewer authorities while excluding the Federal Reserve Board from direct supervisory responsibilities.2 The Federal Reserve Board strongly opposed this proposal; most of its arguments for central bank involvement are addressed later in this chapter. The main argument is that the Federal Reserve Board needs the information and experience gained from its supervisory contacts with the banks to perform its other duties, such as conducting monetary policy.

In the United Kingdom, supervision rests with a separate division within the Bank of England. Since London is a central marketplace for banks, domestic as well as foreign, the Supervision Division employs a large staff and forms an important part of the central bank. In England, also, the organization of supervision has been debated, not least in the aftermath of the incident involving the Bank of Credit and Commerce International (BCCI). An argument put forward against central bank supervision was that unsuccessful supervision might harm the general credibility of the central bank and thus impair its ability to perform its other duties, such as implementing monetary policy. There was a fear that the handling of the BCCI failure partly would be blamed on the Bank of England—which it was—and that this would have contagious effects on the Bank’s credibility in performing other central bank activities. The investigation following the BCCI collapse did not find that supervision should be moved out of the Bank of England; however, the investigation suggested a number of measures to strengthen the organization of supervision, including through closer cooperation with other domestic and international authorities.3

In Japan, the main formal supervisory responsibilities lie with the Ministry of Finance, which cooperates closely with the Bank of Japan. Local authorities are sometimes also involved.

In Germany, as explained in Chapter 18B, the Federal Banking Supervisory Office, under the Ministry of Finance, has the primary formal role in supervision. As in Japan, however, constant and close contacts are maintained with the central bank.

In France, supervision is performed by the Banking Commission, a separate authority. The board of the Banking Commission is chaired by the Bank of France, but it also has board members from the Treasury and from other sources, such as court judges and independent experts. However, the Banking Commission’s authority is closely linked with the Bank of France; it uses the central bank staff as a secretariat for its activities, including the examination of banks. Moreover, the head of the Banking Commission has the status of a director of the central bank. The structure of banking supervision in France is examined in detail in Chapter 18D. The organization of this supervision was recently debated in connection with the general discussion on the independence of the central bank. The prevailing organization was more or less upheld, as it was deemed that the existing setup provided a well-functioning balance between the Ministry of Finance and the central bank.

In Italy, the central bank, the Bank of Italy, has the formal supervisory power.

In the Netherlands, the integration of supervision in the central bank is complete. The supervisory division within the central bank is one of the three main pillars of the bank, and the executive director of the division has a seat on the central bank’s board.4

In contrast to the situation in the Netherlands, the Office of the Superintendent of Financial Institutions in Canada has, under the aegis of the Ministry of Finance,5 the formal mandate to perform supervision. However, through the Financial Institutions Supervisory Committee and its Senior Advisory Committee, on which the Bank of Canada is represented, the central bank can influence practical supervision, regulation, and other overriding supervisory issues. In Canada, supervision is not directly under the central bank for historical reasons; the first supervisory authority was established even before there was a central bank.

In Sweden, Norway, and Denmark, the present situation, in which banking supervision is conducted by authorities separate from the central banks, has been deemed after public debate not to require any institutional alteration. Although these countries have thus decided to stick to their traditional alternative models, a number of measures have been proposed in Norway and Sweden to improve banking supervision. The same is true in Denmark, where the banking supervisory authority already works closely with the central bank. In Finland, however, a different conclusion has been drawn. There, it has been considered necessary to make the central bank the banking supervisor, mainly because of the need to involve the experts of the central bank more deeply in supervisory issues.

Although some arguments behind the approaches chosen in the Nordic countries will be addressed in detail subsequently, one rather unique and useful common aspect deserves immediate attention. The amalgamation of bank supervision and the supervision of other financial institutions, such as finance companies, insurance companies, and securities firms and markets,6 has improved supervision—for example, by facilitating the exchange of information among supervisors of different market segments. This fusion of powers also facilitates the supervision of financial conglomerates. It is difficult to tell whether such amalgamation is better suited to the central bank or the alternative approach to supervision. Maybe one could say that, at least so far, the activities of insurance companies and securities firms have not been found vital for the functioning of the payments system and the monitoring of these institutions has therefore not been a priority task for the central banks. However, the activities and roles of different categories of financial institutions are becoming increasingly blurred, and central banks may well have to take a greater interest in the activities of institutions other than banks to achieve their overriding aim of securing the stability of the payments system.

A few conclusions can be drawn from this admittedly unscientific survey of the organization of supervision in a number of countries. First, different approaches have been chosen following one of the two main models—the central bank or the alternative. Second, in all countries where the main responsibility for supervision stays outside the central banks, there are close exchanges of information and cooperation between the two authorities. Third, in those countries whose supervisory structures have recently been reorganized, the tendency has been to move supervision closer to the central banks.

Advantages and Disadvantages of the Central Bank Model

The issue of transferring banking supervision from a separate authority to the central bank has been discussed in recent years in some Northern European countries. In Denmark, Finland, and Norway, banking supervision had been organized in the same way as in Sweden, that is, it had been performed outside the central bank by a separate authority. Mainly as a result of the recent financial crisis, which produced heavy bank credit losses in Finland, Norway, and Sweden, the organization and performance of banking supervision has been the subject of official reports and, later, decisions by governments and parliaments in these three countries. In Denmark, the issue has attracted less interest, and no institutional amendment has been decided. Banking supervision is still performed in that country by an authority separate from the central bank—perhaps because the extent of the bank failure in Denmark has been less dramatic than in the other Nordic countries. Also, the Danish central bank and the supervisory authority seem to cooperate smoothly.

Some of the main arguments that have been put forward during the discussions in Finland, Norway, and Sweden are addressed in turn.

Arguments for the Central Bank Model

The main argument in all three countries for making the central bank the banking supervisor is obvious. As the central bank is ultimately responsible for the payments system and the stability of the financial system—and is also the lender of last resort—the central bank should also be the banking supervisor. To split resources between two or more entities would be ineffective and risk the maintenance of unnecessary bureaucracy. If banking supervision were to be administered outside the central bank, the central bank would still have to monitor the banks as a consequence of its responsibility for the payments system and the stability of the financial system.

Inasmuch as it lends credits intraday and overnight through its payments system and as the main creditor to banks, the central bank must “know its customers.” Most central banks have highly qualified and experienced staffs to analyze the performance of banks. Their staffs are also trained to understand banking risks and the implications of new systems and new financial products.

As central banks are also the main participants in the domestic money and foreign exchange markets, their staffs include experts in the functioning of these markets. It is particularly noteworthy that central banks continuously receive confidential information from other participants in the markets, who regard the central banks as objective “watchdogs.”

Concentration of banking supervision in the central bank would thus more effectively use the available resources. Concentration would also reduce the risk of overlapping supervision by two or more authorities; on the other side of the coin, it would reduce the risk of inadequate supervision in some areas. If two or more entities were to supervise banks, there are obvious risks that some areas would be double-checked while others might fall between the competencies of the entities involved.

Concentration of supervision in the central bank would also represent important advantages from the perspective of the banks. Because the central bank needs the information anyway, it would minimize the need to supply more or less the same information to more than one authority. If possible, the authorities should make every effort to reduce the costs of those supplying requested information. Studies, including those done in the United States, have shown that the actual cost to banks of fulfilling their duties in relation to supervision and regulation is significant.

Among the other arguments for the central bank model put forward in the Nordic countries, the importance of the international perspective should be emphasized. The markets are growing every day and becoming increasingly global and interlinked. With modern technology, an event (or even a nonevent, like a mere rumor) in one marketplace is immediately made known around the world and may have dramatic repercussions in all financial markets. Banks are expanding by forming branches and subsidiaries in other countries. This development represents new challenges to all banking supervisors. Banking supervision has to become international: it can no longer limit itself to activities within national borders. In Europe, this is particularly obvious, as any bank within the European Economic Area (which comprises the member states of the European Community and the European Free Trade Association) with a banking license obtained in any of those countries may, without further licensing, conduct banking in any other country, either directly from the home country or through branches or subsidiaries in the host country.7 The banking supervisors in the European Economic Area are, therefore, making cooperation agreements among themselves in order to facilitate the exchange of information and to promote more efficient cross-border banking supervision. Interestingly, in many European Union countries, the central bank is responsible for important parts of supervision, especially of banks. Similar arrangements in other countries would facilitate international cooperation.

The need for closer international cooperation is an important argument to concentrate supervision in the central bank. Central banks have long been conducting close relationships with other central banks, for example, at the Bank for International Settlements. Supervision often comprises confidential matters. Because central banks have a tradition of trusting each other with such information, it may be deemed appropriate to vest banking supervisory authority in them.

Lastly, the importance for the banking supervisor of having access to the macroeconomic analysis resources of the central bank should be stressed. The need for such resources may be satisfied through close cooperation with the central bank, but the central bank may just as easily function as the banking supervisor.

Arguments Against the Central Bank Model

After considering the arguments in favor of the central bank as banking supervisor, what could be argued against it? Why would it be preferred to have an arrangement whereby a separate supervisory authority or a division of the ministry of finance is entrusted with the task of monitoring banks as the main banking supervisor?

One argument is the difficulty or undesirability of separating banking supervision from the supervision of other credit and financial institutions and financial markets. As previously noted, these categories may no longer be as clearly defined as they used to be. Other institutions are entering the traditional banking areas while banks are expanding outside their traditional activities. An illustration is useful. Insurance companies in competition with banks and mutual funds are constantly developing new products to attract investors. Some of these products are very similar to traditional bank products; for instance, insurance companies are expanding their lending activities in many countries and offering long-term credits to the public. Banks, meanwhile, are responding by creating new products to compete with the insurance companies. In Sweden, for example, banks are now allowed to sell to the public insurance policies, so-called unit-link insurance. Another new feature is that banks may own finance companies (and vice versa) and that such groups may in some countries be owned, in turn, by holding companies. These financial conglomerates may include stockbrokers, finance companies, and mortgage-lending institutions.

To the supervisors, these new developments imply the need to adapt and to cooperate more closely with one another. It would be desirable for these reasons to concentrate all financial supervision in a single body. One alternative would be to make the central bank the sole financial supervisor. In no European country, however, is the central bank the supervisor of all financial institutions, including insurance companies. Furthermore, it would be outside its usual mandate for a central bank to cover all areas and aspects of the financial sector. It could, therefore, be argued that the other alternative—establishing a supervisory authority outside the central bank that is concerned with all financial institutions—seems more natural.

Another argument against the central bank model is the risk of conflict of interest that such a model may produce within the central bank. According to this argument, such conflicts can occur if the central bank is entrusted with banking supervision, in addition to its monetary policy functions. The main creditor of the banks, which is one of its roles, and the main counterpart in money and foreign exchange market transactions, which is another of its roles, should not simultaneously be the banking supervisor. In the latter capacity, it will have access to information that is unavailable to the other creditors and counterparts of the banks.

This argument seems to have been deemed valid by some central banks that simultaneously function as banking supervisors. In the United Kingdom, Finland, and Iceland, where the central banks are the banking supervisors, this function is not entirely integrated with the other central bank functions. It is often administered separately from the other departments of the central bank, in particular from the monetary and foreign exchange department. The governor of the central bank may not ultimately be responsible for banking supervision, as this task is often laid upon a department director acting as head of banking supervision. However, it is essential for the banking supervisor to have access to macroeconomic expertise, and for the monetary and foreign exchange department to be informed by the banking supervisor of its findings. It has further been argued that concentration of supervisory powers in the central bank may make the central bank too powerful, particularly if it is completely independent from government control. This may lead to a situation in which banks hesitate to oppose a decision by the central bank by, for example, bringing the matter to a court of law.

The banking supervisor is in some countries also responsible for consumer protection issues. The unnaturalness of many central banks’ assuming such responsibilities is another argument for making a separate entity the banking supervisor.

Lastly, the “contagion argument” put forward against central bank supervision in the United Kingdom should be noted again. If a central bank, whose main asset in executing monetary policy is its credibility, fails to supervise banks successfully, its credibility and thus its ability to execute monetary policy may be damaged as well. A central bank’s credibility when implementing monetary policy may consequently be harmed by possible banking supervision failures.


The above-mentioned examples of views for and against the central bank model demonstrate the variety of arguments that may be made concerning the subject.

The present institutional arrangements in most countries do not seem to be the result of careful considerations based on thorough analysis, but rather may be explained by historical traditions. If banking supervision works without any major problems, there is no real need to amend the competencies of the authorities, regardless of which model was chosen in the past. However, if a financial crisis occurs in a country (as occurred in Sweden, Finland, and Norway), it is only to be expected that existing supervisory arrangements, including the institutional organization of financial supervision, will be examined and subjected to public debate.

There is arguably, however, another reason for focusing on existing institutional arrangements. Traditionally, banking supervision consisted mainly of gathering necessary data from the banks, evaluating them against the criteria in laws and regulations, and expressing observations and criticisms where banks failed to comply. This description refers to the previous situation in Sweden, and, although slightly exaggerated, it may be valid as a description of practices in other countries. Banking supervision was mainly legal work, and most qualified managers were lawyers. However, the manner in which banking supervision was administered in the past was, as the ensuing bank problems clearly demonstrated, inadequate. Today, it is even less adequate.

The way in which modern legal provisions are formulated supports a less rigid role for supervision. Regulations concerning capital adequacy and risk-control requirements presuppose new ways of conducting banking supervision.

The principal aim of banking supervision is to contribute to the stability of the financial system. It is important for the banking supervisor to identify prevailing risks and take proper remedial action. The banking supervisor needs to understand the functioning of the markets, existing and future financial products, and current bank practices. Furthermore, the supervisor must be well-informed about each institution and understand fully the accounts, so as to be able to make proper analyses.

Another new feature in banking supervision in Sweden, which is valid also in other countries, is the need to ensure that a bank’s management is well-informed of existing risks. A bank’s information system should allow its management to discover continuously—without the assistance of the banking supervisor—possible threats to the financial stability of the institution. In the past, this has not always been the case; sometimes, the management has been surprised to find how vulnerable the bank was to certain events. Bank management lacked a proper information system and was unable to fully understand and evaluate the situation. However, information is not enough. In order to be able to prevent risks and to take proper remedial action, management should also have an adequate risk-management system, including risk control.

The foregoing considerations lead to the conclusion that the banking supervisory authority, whether within or outside the central bank, should be staffed not only by lawyers and chartered accountants but also to an increasing degree by qualified, experienced economists and even mathematicians who are experts in financial risks and their management. The banking supervisor should emphasize the economic and operational risks in the financial system and be less focused on the formal, legal aspects. Of course, fulfilling legal requirements is not unimportant; however, the banking supervisor should rather stress the importance of taking all necessary measures, including formal examinations, to increase the stability of the financial system.

In supervising banks, the functioning of the markets and of derivatives and other financial instruments, as well the macroeconomic prospects, should be given priority. Such priorities may, of course, be made within any organization of institutional arrangements. However, only the central bank, because of its other functions, thoroughly understands the functioning of the markets, the financial instruments, and the macroeconomic prospects—the prerequisites for effective banking supervision.

The central bank has, moreover, a unique understanding of the development of certain financial risks (including interest rate and foreign exchange risks), both domestic and foreign. If banking supervision is administered by an authority separate from the central bank, a close cooperation between the central bank and the supervisory authority will be absolutely necessary.

A closer cooperation between the banking supervisor and the central bank is also of vital importance to the central bank. The latter should have access to the information and analyses conducted by the banking supervisor in order to monitor the markets and its debtors. The central bank is, after all, the authority ultimately responsible for the stability of the financial system.

The following conclusions can be drawn. First, the choice of banking supervisor is not a crucial issue. What is important is that the supervisory authority be adequately staffed and have access to the central bank’s expertise. Second, whatever the present arrangements in a country, there is no need to formulate an institutional amendment “just for the sake of it:” This change should be desirable for special reasons. Alternatively, banking supervision may be amended within the existing framework. Finally, if a country needs to build a new supervisory system, use of the central bank model is recommended. It is interesting to note that the central bank model has been chosen where new central banks are being established in the Baltic countries, Russia, and the other countries of the former Soviet Union. In most cases, the central bank model makes the most effective use of available resources.

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