The quest for supervisory effectiveness
Speech by Mr Pablo Hernández de Cos, General Manager of the BIS, at the BCBS-FSI high-level meeting for European supervisors, Basel, 22 May 2026.
Ladies and gentlemen,
The banking turmoil of March 2023 revealed critical lessons. These bank failures and near failures occurred even though the banks met capital requirements and, in some cases, also liquidity requirements. The root causes were mainly qualitative weaknesses – poor governance, weak risk management and unsustainable business models. These weaknesses eventually manifested in the form of quantitative shocks, such as liquidity runs and market corrections.
The banking turmoil highlighted the importance of strong and effective supervision. Indeed, supervisory post-mortem reviews (BCBS (2023) and FINMA (2023)) identified consistent delays in addressing qualitative weaknesses, even when early warning signs were present. Why did this happen? The reasons are not simple. Institutional, legal and operational constraints often prevent timely action by supervisors.
Some of these barriers, such as inadequate legal powers or unclear mandates, are outside the control of supervisory authorities. However, many of the critical frictions lie within the supervisory process itself and are premised on the ability and will of supervisors to exercise judgment on matters that are rarely clear-cut. Improving supervisory effectiveness was therefore considered one of the key lessons. And it is in this context that the current work of the Basel Committee on Banking Supervision (BCBS) to strengthen the supervisory toolkit is particularly opportune.
More recently, while it is generally accepted that the Basel III regulatory reforms have strengthened the resilience of the banking sector, some concerns have been raised about the high complexity of the regulatory framework (Hernández de Cos (2026)). Excessive complexity can impose operational burdens on banks and supervisors, reducing transparency for market participants and weakening market discipline. Complexity also undermines the ability of a bank – including its board and senior management – and its supervisor to effectively oversee and manage its risk profile. Ultimately, this complexity can reduce the effectiveness of bank regulation in achieving core microprudential, macroprudential and resolution objectives.
Against this background, it is important to identify areas where we can reduce undue regulatory complexity and improve efficiency without diluting the resilience of the financial system. In this regard, an effective supervisory framework could help mitigate the need to develop "one size fits all" regulatory requirements. Again, supervisory effectiveness relies heavily on the ability of authorities to identify banks' relevant vulnerabilities and to act promptly. Thus, improving supervisory effectiveness becomes a key aspect of this broader discussion.
In the debate on how to improve supervisory effectiveness, the role of qualitative tools is essential. A key lesson from the 2023 episode is that a purely rules-based approach is unlikely to appropriately identify, assess and mitigate key risks to a bank's safety and soundness and broader financial stability in a timely manner. Unlike supervisory measures that are triggered only once quantitative requirements are breached, qualitative tools can address root causes before financial risks materialise (Balan et al (2025) and Dahlgren et al (2023)). These tools are forward-looking and judgment-intensive. When applied early, qualitative tools can create transformational changes in governance and risk management, which, in turn, strengthen the long-term resilience of financial institutions.
The supervisory process and potential gaps
Let us examine the supervisory process more closely.
Supervisors often have the tools they need to address weaknesses in governance, risk management and business model sustainability. However, having tools is not enough. Early action remains a significant challenge. Why is this the case? Problems rarely emerge in isolation. It is the cumulative effect of gaps and frictions across various stages of the supervisory process.
The process begins with risk scoping. This is where supervisors decide their focus areas and allocate resources accordingly. Scoping demands judgment. It involves trade-offs to prioritise critical risks. However, some fundamental issues related to governance, risk management and business model sustainability may be overlooked or at least not looked at with sufficient depth. This may happen when, for example, scoping is too narrow. In other words, if risk scoping precludes sufficient focus on key risk areas, it necessarily implies that supervisory findings in those areas will also be limited. As supervisory findings form the basis for early supervisory action, poor risk-scoping decisions are consequential and can undermine the entire supervisory review process.
The next stage is risk assessment. At this stage, weak governance and business model risks can be obscured by strong financial performance, which may be associated with benign macroeconomic conditions and rapid credit growth. These challenges are further compounded by the inherent difficulty for supervisors to provide tangible evidence of poor governance or unsustainable business models. As a result, firms with robust financial indicators but underlying governance weaknesses or unsustainable business models may be assigned a more favourable supervisory rating, which, in turn, would delay the implementation of necessary supervisory measures. If these risks are not explicitly prioritised, they may become visible only when they start to manifest as financial problems.
Once shortcomings are identified, timely and decisive action is essential. A significant challenge at this stage is the reluctance of some supervisors to pursue formal supervisory actions due to concerns about potential, including legal, challenges. As a result, informal tools such as moral suasion or supervisory observations dominate the early stages of intervention. While these measures can be effective, they have limitations. They may not be explicitly documented in supervisory inspection reports and often lack the urgency and clarity needed to drive meaningful change. Without clear timelines or consequences, banks may view informal concerns as recommendations rather than those that warrant corrective action. This perception delays action.
Therefore, clear guidance on when to use moral suasion rather than other forms of informal measures are needed to support timely supervisory actions. Proper internal procedures on when to escalate from informal tools to formal measures are equally important. Without these, necessary interventions can be delayed, identified weaknesses may continue to fester, and risks grow (Balan et al (2025)).
Supervisory judgment and risk appetite frameworks
Judgment is the foundation of supervision. It underpins every stage, from scoping to risk assessment, to escalation and closure. Judgment involves accepting certain risks. These include the risk of false positives, legal challenges or reputational scrutiny. Supervisors must strike a balance between rules and discretion. Too much prescription limits flexibility and adaptability. Too much discretion undermines consistency and credibility.
Institutional culture and risk appetite play a crucial role in enabling early action. Every supervisory authority must accept a certain level of supervisory risk. This is the risk that the authority, despite its best efforts, fails to identify, address or mitigate prudential risks in a timely and effective manner. It stems from the growing complexity of financial systems, expanding supervisory responsibilities and resource constraints, among other factors. Attempts to fully eliminate supervisory risk – for example through a "zero bank failure" policy – are neither realistic nor desirable, as they would undermine banks' ability to take informed risks and support the real economy. Therefore, all supervisory authorities need to identify and manage – rather than eradicate – their tolerance for supervisory risk.
Risk appetite frameworks can help manage this challenge. These frameworks, when adapted to the supervisory context, can help authorities articulate their tolerance for and define the boundaries of supervisory risk (Balan and Zamil (2026)). They make trade-offs explicit and institutionalise proportionality. By linking an authority's supervisory risk tolerance to tangible guidance, these frameworks provide structure and consistency to supervisory decision-making. At the same time, they preserve the flexibility needed to exercise judgment effectively, while assuming that, sometimes, judgments may turn out to be wrong ex post. Importantly, such frameworks support effective prioritisation, which is a cornerstone of a truly risk-based supervisory approach (Buch (2025)).
Strengthening the willingness to act
To strengthen their willingness to act, supervisory authorities must take practical steps.
First, they must clarify their risk appetite. Supervisors need to identify the type and level of risks they are willing to take, including risks like judgment errors or litigation. This clarity gives supervisors the confidence to act early.
Second, supervisors must strengthen the link between ratings and actions. Supervisory ratings should lead to timely actions. When banks address the issues identified by supervisors, they should see their ratings improve. This reinforces accountability.
Third, supervisors must differentiate the severity of issues. They can do this by adjusting their tone, the tools they use and the level of sign-off required. The follow-up process should also reflect the urgency or importance of the issue. This approach helps signal how critical a particular concern really is.
Fourth, supervisors must improve how they communicate to supervised firms. They should deliver clear and prioritised messages in a timely way. These messages should include specific timelines and consequences. This reduces confusion and ensures that banks understand what is expected of them.
Finally, supervisors must improve their monitoring and escalation processes. They need robust information technology systems to track findings and ensure quick resolution. If issues are not addressed, there should be clear and predictable steps for escalation. These steps must be applied consistently to maintain credibility.
Conclusion
In conclusion, early qualitative action is essential. It prevents small weaknesses from escalating into systemic failures. Delaying action transfers risk elsewhere. It leads to more disruptive interventions, burdens public balance sheets and ultimately threatens financial stability.
Acting early requires judgment, and judgment involves taking risk and making risk-based decisions. Yet judgment should in no way be confused with unconstrained discretion. The real challenge is to put in place an effective structure to properly frame judgment. This structure must contain the required combination of tools, methods and procedures to strike the right balance between flexibility and consistency. Well-designed supervisory risk appetite frameworks that are tailored for jurisdiction-specific circumstances provide a pathway to achieving this equilibrium.
In this context, developing further international guidance to improve the quality of supervision worldwide is particularly important. Such efforts are also key to mitigate unwarranted international heterogeneity in supervisory practices. The work of the BCBS to strengthen supervisory effectiveness is a critical and welcome step in this direction.
Thank you.
References
Balan, M, F Restoy and R Zamil (2025): "Act early or pay later: the role of qualitative measures in effective supervisory frameworks", FSI Insights on policy implementation, no 66, April.
Balan, M and R Zamil (2026): "Acting under uncertainty – the case for supervisory risk appetite frameworks", FSI Insights on policy implementation, no 74, May.
Basel Committee on Banking Supervision (BCBS) (2023): Report on the 2023 banking turmoil, October.
Buch, C (2025): "Evidence-based supervision: addressing evolving risks, maintaining resilience", speech at the Banking Supervision Research Conference 2025, Frankfurt am Main, 9 December.
Dahlgren S, R Himino, F Restoy and C Rogers (2023): Assessment of the European Central Bank's supervisory review and evaluation process, report by the Expert Group to the Chair of the Supervisory Board of the ECB, April.
FINMA (2023): Lessons learned from the CS Crisis, December.
Hernández de Cos, P (2026): "Streamlining financial regulation while safeguarding stability and tackling new risks", speech at the International Center for Monetary and Banking Studies, Geneva, 4 March.
