subject: What Risk Based Supervision is All About [print this page] Risk Based Supervision is a process which regulators use to:
Identify the main risks to achieving their statutory objectives
Assess the impact on their objectives if the risk materializes
Analyze the probability of the risk occurring at all
Allocate and prioritise the regulated entities into risk categories
Apply the appropriate regulatory tool to mitigate the risks to their objectives.
The purpose of this approach is to achieve a more consistent form of regulation, and a more cost effective allocation of resources.
Identify the regulators statutory objective
Identify the statutory objectives set out in the empowering law. The basic question is what developments, events or issues are going to pose a threat to achieving those objectives successfully, and how will resources be allocated to focus on the risks that seem to matter most?
Identify risk to the objectives
Examples of risk to objectives are the financial collapse of regulated entities, significant market malfunction, inadequate general financial literacy of the public, or inadequate understanding by consumers of specific products and services, misconduct by, or mismanagement of institutions, failure to control sales forces, financial crime, market abuse, fraud or dishonesty. The main sources of risk to objectives are the external environment, consumer and industry wide, regulated entities.
Assess the impact on the objective and probability that the risk will materialize
The priority given to a particular risk depends on the impact on the regulator's objectives if a particular risk actually materializes, and the probability that a particular risk will actually occur in the first place. This can be determined by the regulator's judgments and its existing knowledge of particular sectors and institutions and by any other general data available.
Regulated entities are them allocated intoimpact bands high, medium one, medium two and low, using a number of measures to identify the impact. Such measures includes total assets and liabilities, the number of depositors policyholders, clients amount of deposits, funds under management, volume and value of daily trade.
Then the regulator will assess the likelihood or probability that a risk will actually occur. Risk from entities would be credit risk, market risk, operational systems and control risk and the framework involved in building up a risk profile of each institution looking at the entities financial strength; and quality of management among other things. An overall risk score for each entity is then set e.g. "high impact and high probability"
Categorise the entities to know regulatory tools to apply
This impact and probability exercise will allow the regulator to produce a prioritised list of the risks to its objectives and to allocate resources accordingly by allocating the appropriate regulatory tools most suited to each situation. Four types of tool are:
Diagnostic those tools that are designed to identify, assess and measure risks. An example of that would be a routine visit by an inspection team, or the use of experts from outside.
Monitoring tools, those which track the development of particular risks, for example a desk-based review of returns provided by an institution would be one example of that kind of tool.
Preventative tools those which are designed to limit or reduce identified risks. We would use for example comparative information for consumers as a preventative tool in this way.
Remedial tools those that respond to risks when they have crystallised, delivery of restitution or compensation to consumers would be one example of that kind of tool.
Outcome
The outcome of risk based supervision is that some regulated entities who carry out prompt and effective remedial action will have reduced intensity of their regulatory relationship with regulators and those which represent a low risk to the regulator's objectives will only get short, rare visits and desk based monitoring rather than routine visits but will have contact points from which clear regulatory guidance can be obtained, and the regulator will continue to deal with issues as they develop or crystallise.
