FSI Chairman on Rules Versus Discretion in Early Intervention Regime

The FSI Chairman highlighted that legislation or prudential regulation requires supervisors to impose or, at least formally consider imposing, certain supervisory actions if a financial institution breaches defined thresholds or meets certain conditions. Depending on the jurisdictions involved, those regimes are referred to as prompt corrective action or early intervention measures. The FSI Chairman also talked about finding the right balance between rules and discretion, particularly in the context of taking action against weak banks. The limited data points from the financial crisis indicate a pragmatic application of the early intervention rules in both the United States and the EU. In both cases, the evidence suggests that, in practice, corrective actions taken against systemically important weak banks were addressed by supervisors using mainly their normal supervisory powers, which are typically more discretionary and discreet in nature. Public disclosures of formal early intervention actions and the potential adverse effects such disclosures might have on financial stability may also have contributed to the use of more discreet supervisory powers in both the United States and the EU. In conclusion, Mr. Restoy shared the following thoughts on the implications for the design and role of early intervention frameworks as well as on some key implementation challenges: 

• Supervisors must have the necessary powers to take a range of discretionary measures during the normal course of supervision.
• Effective discretionary-based supervisory actions should be taken well before a bank starts showing stress in its capital position. Various forward-looking, judgment-based supervisory tools that have been introduced post-crisis (such as supervisory review of business models and supervisory stress tests) provide a tangible means of addressing problems at an early stage.
• Formal early intervention regimes, such as prompt corrective action and early intervention measures, are useful backstops to discretionary-based, forward-looking supervisory tools. Nevertheless, supervisors need to retain sufficient flexibility in their use of enforcement tools to tailor the supervisory response to institution- and context-specific circumstances.
• Close cooperation among all relevant players—supervisors, deposit insurers and resolution authorities—is particularly important in dealing with problem banks. While fully respecting the specific responsibilities of the supervisory authority to assess banks' solvency and viability, all relevant safety-net players must be involved when supervisory action is taken against weak banks, not only when those banks are subject to formal early intervention regimes or when they are failing or likely to fail.

Related Link: Speech