Risk culture and banking supervision

Author:Alessandro Carretta, Vincenzo Farina, Paola Schwizer
Position::University of Rome Tor Vergata, Rome, Italy
Pages:209-226
SUMMARY

Purpose This paper aims to analyzing the main risk culture traits of a sample of Central Banks and Supervisory Authorities in Europe as well as of the European Central Bank (ECB). Design/methodology/approach Risk culture is measured through text data processing of the official discourses made by the head Supervisory Authorities, during the years from 1999 to 2012. Findings... (see full summary)

 
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Risk culture and
banking supervision
Alessandro Carretta
University of Rome Tor Vergata, Rome, Italy
Vincenzo Farina
Department of Management and Law, University of Rome Tor Vergata,
Rome, Italy, and
Paola Schwizer
University of Parma, Rome, Italy
Abstract
Purpose This paper aims to analyzing the main risk culture traits of a sample of Central Banks and
Supervisory Authorities in Europe as well as of the European Central Bank (ECB).
Design/methodology/approach Risk culture is measured through text data processing of the ofcial
discourses made by the head Supervisory Authorities, during the years from 1999 to 2012.
Findings Results highlight heterogeneous but converging risk cultures for European Union (EU)
supervisors and the presence of a “distance” between these cultures and the risk culture of the ECB.
Originality/value The paper points out that cultural differences, especially in presence of credit markets still
characterized by poor integration, could create unwanted distortion effects during the initial stages of the Banking
Union.
Keywords Financial supervision, EU integration, Risk culture
Paper type Research paper
Introduction
Since the ability in assessing the risks is one of the main reasons for the existence of nancial
intermediaries, risk management is in the spotlight of banks and Supervisory Authorities.
Prudential regulation seeks to inuence risk-taking in regulated entities. However, this is
difcult to do directly because a nancial institution more or less continually makes risk
decisions. Therefore, as a complementary tool to capital requirements and other substantive
measures, it is important for prudential regulation to address the processes of risk-taking of
nancial institutions.
In particular, Supervisory Authorities show a growing interest in the risk cultures of banks
(Financial Stability Board, 2014) in the belief that a sound, shared and effective risk culture is an
essential tool for risk management policies oriented to value creation in the banks.
Indeed, the risk culture may represent a guide for proper organizational and individual
risk-taking behaviours and for an effective internal control system. Weaknesses in risk
culture can lead to a requirement of higher capital ratios to individual banks (Fahlanbrach
et al., 2012;Ellul and Yerramilli, 2013).
To enhance supervisory effectiveness, Supervisory Authorities should be trained to catch
this aspect, consistently with the qualitative nature of the risk culture itself and in a manner
as uniform as possible in the various contexts of reference.
JEL classication – G28, G38
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1358-1988.htm
Risk culture
and banking
209
Journalof Financial Regulation
andCompliance
Vol.25 No. 2, 2017
pp.209-226
©Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-03-2016-0019
Despite this fact, the European Union (EU) Supervisory Authorities have quite different
styles of supervision, which are only partially addressed in the European Central Bank (ECB)
approach to supervision (Carretta et al., 2015). Masciandaro et al. (2011) nd a relatively
complex EU supervision framework with, at the bottom layer, a large and heterogeneous
group of national supervisory authorities, with a wide variety of architectures, governance
arrangements, supervisory cultures and regulatory frameworks.
The recent Comprehensive Assessment exercise carried out by the ECB in close
collaboration with the European Banking Authority represented, de facto, the rst
opportunity for the comparison of the risk cultures of supervised entities and supervisors.
This work is aimed to assess the risk culture of a sample of Central Banks and
Supervisory Authorities in Europe as well as of the ECB. The main assumptions are:
the existence of a signicant degree of differentiation of the risk cultures among
supervisors, which also reects the country-specic factors (Mihet, 2012); and
the presence of a “distance” between these cultures and the risk culture of the ECB.
In this perspective, the paper points out that these diversities, especially in presence of credit
markets still characterized by poor integration, could create unwanted distortion effects
during the initial stages of the Banking Union.
This paper has important policy implications. In fact, if it is true that supervisory risk
cultures are quite different among EU countries, the establishment of a Banking Union could
require a severe “tness effort” from ECB, to properly manage the relationship with the
different cultures of EU national supervisors.
The rest of the paper is structured as follows. Section 2 presents the main literature; Section 3
describes the methods; Section 4 presents the results and conclusions are drawn in Section 5.
Literature
Supervisory style can be dened as the behaviour that supervisors adopt in supervision,
according to different mixes of tools, resources and available information. When analysing
supervisory styles, it is possible to move between two extremes, thus determining an ample
set of possible supervisory interventions’ congurations (Carretta et al., 2009;Caprio, 2012;
Carretta et al., 2013).
On the one hand, there is a more formal style characterized by vertical relationships
between supervisors and supervised nancial intermediaries; the emphasis is on general,
prescriptive rules of conduct; on-going supervision is prevailing and it is based on frequent
and detailed reporting; sanctions are imposed mostly because of formal and technical
failures; the focus on the enhancement of internal governance of supervised banks is weak.
On the other hand, there is a more result-oriented supervisory style characterized by
horizontal relationships between supervisors and supervised nancial intermediaries; the
emphasis is on comprehension and sharing of best practices; inspections are prevailing;
supervisors are geographically close to supervised entities; sanctions are mostly imposed
because of failures in internal organization and control; the focus on the enhancement of
corporate and internal governance of supervised banks is strong.
Might differences in supervisory styles affect supervisory performance? In principle,
given the two goals of stability and efciency of the nancial system, some supervisory
styles could have positive effects on one goal but not, to the same extent, on the other one;
they could reach their objectives either in the short run or in the long run. A style that shows
to be very demanding in terms of formal compliance could increase compliance costs, thus
reducing the efciency of the supervised banks. Alternatively, a style that appears more
oriented towards cooperation and proximity, by stimulating a learning process on safe and
JFRC
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