Regulation vs supervision: what’s the best response to climate risk?

Programming note: Apologies to our regular readers for the late posting of this edition. Yours truly was disrupted by an airport-related mishap. I hope this piece makes up for the inconvenience.

“Regulation” and “supervision” are not the same thing.  Sure, in the financial realm the terms are often used interchangeably (I’m guilty of this as much as anyone), but as Mark Levonian’s recent paper suggests, they refer to “two distinct and complementary elements” of bank oversight.

Is one “better” than the other when it comes to climate risk management?  Here, I think Levonian and I disagree.

In Levonian’s lexicon, “regulation” relates to bright-line rules “that must be obeyed.” Compliance with regulations is binary: an institution is either in line, or out of line.  Conversely, “supervision” encompasses “a less formal process”, one that evokes the image of men in gray suits talking in smoke-filled rooms. 

Levonian doesn’t quite put it that way, of course.  He quotes Federal Reserve Vice Chair for Supervision Michael Barr, who says the goal of supervision is: “to help bank managers and boards focus their attention on weaknesses in their risk measurement and management practices, compliance with law, and the sufficiency of the bank’s capital and liquidity resources given its risk profile.”

Levonian claims that when it comes to climate risk management “the supervisory process is likely to generate more rapid movement toward desired outcomes than approaches that lean more heavily on regulation for a solution.”