Maintaining effective culture, in risk and other management contexts, has long been a concern of regulators and the organizations they supervise. Now the supervisors and their processes are coming under scrutiny..
The 2023 collapse of Silicon Valley Bank (SVB) turned a spotlight on the performance and practices of supervisors and how they relate to the banking system’s safety and soundness.
“Culture is not only a matter for the supervised; it is a matter also for supervisors,” wrote Randal Quarles and Stephen Scott in the opening letter of Supervisors on Supervision, a report released in April by Starling Insights. Quarles, the Federal Reserve Board’s vice chair for supervision from 2017 to 2021, is the study chair. Scott is founder and CEO of Starling.
Randal Quarles
Supervisory culture “was repeatedly implicated in failures of oversight,” they asserted, adding, “Culture-driven weaknesses can threaten safety and soundness. They can impair the supervisory function . . . But there is a still broader point that must not be lost: Supervision is an exercise of public authority, and where that authority cannot explain how it sees, judges and acts, confidence in the supervisory enterprise erodes.”
As former Treasury Secretary and Federal Reserve Chair Janet Yellen put it in a June speech at the Brookings Institution, “Financial stability demands rapid, forceful responses to runs – but the deeper imperative is a supervisory culture willing to confront risks before they become crises.”
The Starling report, a year in the making, took into account input from prominent past and present supervisory and financial services professionals from around the world.
“The culture question has crossed a threshold: from ‘soft concern’ to legitimate supervisory terrain,” Scott told GARP Risk Insights via email. “For years, the argument had stalled at questions like, ‘Is culture simply too vague, too subjective, too values-laden, too hard to measure, too prone to supervisory overreach?’”
“The question,” he highlights, “is no longer whether supervisors may consider culture. The question is whether they can do so intelligibly, proportionately, consistently, and on the basis of reliable evidence.”
“Unstructured supervisory judgment is no longer defensible,” Scott contends. “Culture cannot be supervised by checklist, but neither can supervisors rely on instinct, impressions, or after-the fact rationalizations. The task is to make supervisory judgment disciplined enough to be explained, challenged and trusted.”
If supervisors and those they oversee are not on the same page and speaking a common language, then that clearly needs to change.
William Dudley, who while president and CEO of the Federal Reserve Bank of New York from 2009 to 2018 championed cultural reform, shares, “If you don’t understand what the other side is trying to accomplish, it makes it harder to find appropriate solutions. My own experience is that each side doesn’t understand well the other side’s perspective.
“I think this could be addressed by greater dialogue to define more clearly where the objectives align…or don’t.”
Scott believes supervisors need to be seen as “acting predictably, not arbitrarily.
“Firms need to understand the supervisory ‘rules of the road’: what kinds of cultural signals matter, why they matter, what evidence supports supervisory concerns, and what consequences may follow. Otherwise, culture supervision looks like ‘values,’ ideology, or supervisory overreach.”
Stephen Scott
Addressing culture in supervisory context is a consequential but complicated next step.
“There has been no sufficiently concerted effort across jurisdictions to define the terms on which culture can be discussed as an object of governance and supervision,” said the Quarles-Scott letter.
“Where there is no common evidentiary basis, concern too easily drifts into anecdote, impression, or abstraction,” they elaborated. “Under those conditions, practical interests go unmeasured, and supervisory judgments become harder to explain, compare and contest.”
A sticking point that Starling surfaced: Whether to focus on “risk culture” – “the norms and behaviors that shape risk-taking and control effectiveness” – or “culture risk,” because “culture is seen to shape customer treatment, leadership behavior, business-model discipline and the ability of institutions to preserve trust.”
Such “definitional ambiguity” is considered a “supervisory risk.”
“Ambiguity makes supervision harder to execute and defend,” Scott argues. “If supervisors do not mean the same thing by ‘culture,’ then exam teams look for different things; firms do not know what standard they are being held to; findings become harder to compare across firms or jurisdictions; escalation becomes easier to delay; supervisory judgment looks subjective, arbitrary or ideological.”
How best to begin? Home in and get a handle on culture, one that can be backed up and understood.
“Define culture functionally,” Scott suggests. “Do not start with values. Start with behavior: the norms, incentives, silences, escalation habits, and decision patterns that determine whether governance works in practice.”
Dudley underscores incentives: “Culture is about shared social norms. But how are those norms formed? This is where incentives come in. If the incentives are consistent with the behaviors you desire, then those behaviors collectively form the basis for a good culture.”
“Distinguish ownership,” Scott offers. “Boards and management own firm culture. Supervisors own the question: ‘When do cultural patterns create material risk, and how should that be evidenced, escalated, and remediated?’”
He also recommends building “a common grammar,” using “shared language to define: incentives, challenge, escalation, accountability, risk appetite adherence, remediation pace, board information flow, and supervisory responsiveness,” and creating “a common evidentiary basis by which to render and assess decisions, rather than some inert scorecard.”
The report revealed resistance to “the idea of a single global doctrine for culture supervision.”
Elizabeth McCaul, who has served as New York State banking superintendent and a European Central Bank Supervisory Board member, comments that culture “needs to be understood in context, not forced into a single mold. It lives inside legal systems, governance structures, and supervisory mandates that differ too much for one global doctrine to work.”
“Coherence matters more than conformity,” McCaul states.
In Yellen’s view, “Sound supervision is mostly invisible: It is the crisis that does not happen, the institution that does not fail, the vulnerability addressed before it becomes systemic. Those successes do not hold press conferences. That makes the culture of supervision – the willingness to push back, to escalate, to act in a timely way, to accept the discomfort of being unpopular with the supervised – all the more important.
“The Fed’s own post-mortem on SVB identified a supervisory culture in which the burden of proof for escalating concerns had drifted too high, in which examiners were reluctant to act against rapidly growing institutions, and in which formal findings did not reflect the actual risks being observed.”
“Timely supervision is rarely about seeing risks. It is about acting on them,” reasons McCaul. “The real constraint is not detection but hesitation driven by a mix of factors including uncertainty, institutional incentives and, at times, concern about legal challenge. When supervisors prioritize defensibility over judgment, they reduce legal risk but increase supervisory risk, delaying intervention and defaulting to checklist supervision that misses emerging threats.”
“Legitimacy depends not only on being right,” she insists, “but on being understandably right.”
L.A. Winokur is a veteran business journalist based in the San Francisco Bay Area.