Frank Elderson: Supervisory risk appetite, efficiency and effectiveness

In the evolving landscape of banking, supervisors face a complex and interconnected risk environment. Effective supervision requires a strategic approach that focuses on prioritising risks, streamlining processes, and accepting a certain level of residual risk. The European Banking Authority has adopted a three-pillar approach to achieve this: sharper risk prioritisation, simpler and more efficient supervision, and timely remediation.

The first pillar involves sharper risk prioritisation, which recognises that supervisors cannot monitor every risk in every bank. Instead, they must focus on material risks, including those related to capital, liquidity, governance, and structural risk drivers like climate and geopolitical factors. The European Banking Authority has increased its supervisory risk tolerance through its dedicated risk tolerance framework (RTF), which clarifies how much residual supervisory risk can be accepted when certain areas are reviewed less intensively. This approach allows supervisors to become more focused on the most significant risks.

The second pillar of effective supervision is greater efficiency. By streamlining processes, regulators can reduce complexity and free up capacity for more targeted assessments of material risks. This includes simplifying supervisory guidance, reducing processing times for securitisation transactions, and accelerating fit-and-proper assessments through the use of digital tools. The aim is to maintain the same level of safety and soundness while simplifying the framework for both banks and supervisors.

The third pillar focuses on timely remediation, ensuring that identified risks are addressed promptly. This requires a culture shift within banks, encouraging them to accept a greater degree of supervisory risk-taking and to apply the law based on materiality rather than seeking continuous guidance.

In summary, effective banking supervision in a complex environment requires a balanced approach that combines strategic risk prioritisation, process efficiency, and timely remediation. By adopting this approach, supervisors can remain effective and impactful while maintaining the safety and soundness of the banking system.