Regulators Come Up With Own Plan to Coordinate Bank Supervision

David Zaring is associate professor of legal studies at the Wharton School at the University of Pennsylvania.

The problems caused by the failure of Lehman Brothers during the financial crisis were worsened by the lack of a coordinated response by its many regulators around the world.

Lehman was not the only one. Dexia, the Belgian-French bank that was the first bank in Europe to receive a bailout, also surprised its regulators when it informed them that it was insolvent. After the American International Group required a costly bailout, no one was certain who ought to have been in charge of making sure that A.I.G. had not written too much credit insurance before the crisis. Was it the regulator in London, where the company did its insurance deals? Was it the insurance supervisor in New York, where the company has its headquarters? Or was it the Office of Thrift Supervision in Washington?

These complications — which all added to the difficulties of domestic regulators in overseeing global financial institutions that do much of their business outside the regulators’ jurisdiction — have made the effort to create an international process to “resolve,” or quickly take over failing financial firms, a high priority for representatives of the Group of 20 major economies. But progress toward creating a coherent global resolution process has been slow.

The world’s banking regulators have, therefore, decided to take matters into their own hands. Those regulators recently issued a revised set of principles outlining an alternative method of supervising global banks: the so-called college of supervisors.

The idea is to create a team of regulators for globally important banks. That team would share information fluidly enough to make the supervision of these institutions on a country-by-country basis manageable. The college would be led by the “home” supervisor, or the supervisor in the country in which the bank is based, and joined by those countries where the bank has branches.

Moreover, each college would include a “crisis management group,” which would be responsible for dealing with the sorts of emergencies faced by Lehman, Dexia and A.I.G. This group, the bank regulators have said, would be responsible for “detailed crisis management and resolution planning.”

Can a supervisory college work in lieu of a vibrant global resolution authority regime? The problem with these colleges is not that they are implausible, but that they have not really been tried in a crisis. The best-known supervisory college outside of the European Union was created in 1987 to monitor the Luxembourg-based, but international, Bank of Credit and Commerce International. Rumors of widespread fraud in the management of the bank were plentiful, but the collegiate approach did not mean that these problems were nipped in the bud. Although coordinated supervision led regulators to close many of bank’s branches at once after the bank’s accountant resigned and its insolvency became obvious, it is not clear whether Bank of Credit and Commerce International is a college success story or cautionary tale.

There are other reasons to worry about relying on colleges. The collegiate approach is meant to encourage communication more than action. Colleges operate as peers, convened by the home banking regulator, without the sort of hierarchy of decision-making and direction that leads to coordinated action.

Nonetheless, the new commitment by bank supervisors to the college format is interesting. It suggests that banking supervisors are unwilling to wait for an organized resolution authority regime to be created.

It also shows just how coordinated bank supervision has become since the financial crisis, and yet how informal the product of that coordination is. The supervisory college proposals have not been debated at the United Nations or created by a treaty. No court will review the decision of American bank regulators to rely on the college instead of some other means to monitor multinational institutions. The collegiate approach has not been ratified by Congress or authorized by an executive order of the president.

Instead, this approach was devised by the world’s bank regulators, acting on their own. It illustrates their belief that their own strong informal relationships, enhanced since the financial crisis, can do the job when more formal solutions to the problem of multinational banking risk have not yet borne fruit.