Increasing the intensity and effectiveness of supervision is a key component of the Financial Stability Board's (FSB's) efforts to reduce the moral hazard posed by systemically important financial institutions (the "SIFI framework"), along with requiring added capital loss absorbency and facilitating the orderly resolution of firms. On November 1, 2010 the FSB, in consultation with the International Monetary Fund (IMF), released a report on Intensity and Effectiveness of SIFI Supervision (the SIE report). The SIE report observed that prior to the crisis, risk management processes at SIFIs were generally judged to be acceptable, but the crisis indicated otherwise. The report noted that supervisory work was often not geared toward "outcomes" but more focused on process, and said that supervisory expectations for SIFIs in particular needed to increase. The SIE report did not set out new supervisory rules and policies for SIFIs but set out 32 recommendations for making the supervision of financial institutions more intense, effective and reliable.

Members of the FSB Supervisory Intensity and Effectiveness group (SIE) met on several occasions to review progress in implementing the recommendations set out in the SIE report. Examples of supervisory practices that get to the essence of financial institutions' risk and how it is being managed were discussed as well as actions being taken to strengthen controls at SIFIs. Underpinning some of the discussion among SIE members were the outcomes from a questionnaire sent to members of the BCBS-SIG and a self-assessment conducted by FSB members against certain Basel Core Principles. These exercises were useful in identifying recent improvements and remaining challenges in supervisory practices at SIFIs.

Supervisors are making headway in addressing many of the issues identified in the SIE report (e.g. model risk management, enhanced scrutiny of boards and senior management, more emphasis on adoption of strong controls by SIFIs, deep dives and horizontal reviews, stress testing, supervisory colleges, macro prudential surveillance, and examination of risks associated with business models). To ensure changes to supervisory practices endure, supervisors will be held to higher standards. The Basel Core Principles (BCPs) on Effective Supervision - the global standards against which supervisors are assessed as part of the IMFWorld Bank Financial Sector Assessment Program (FSAP) - are being revamped, and the bar is being raised, including with respect to resources and independence. Further, the FSB urges that the IMF and World Bank resources for FSAPs be increased to provide assessors the capacity to drill down to form more robust opinions on the effectiveness of supervision. Continue reading