Changing power balance: banks & regulators

Risk-based supervision reshapes the relationship between banks and regulators. Under compliance-based supervision, power was largely mechanical. Banks were assessed against ratios, exposure limits, and reporting standards. If these thresholds were met, supervisory intervention was limited. Action usually followed breaches, losses, or visible deterioration. It offered banks predictability and a degree of protection. When the numbers were within limits, supervisory pressure was restrained.Risk-based supervision weakens this protection. Supervisory authority is no longer anchored in confirmation of past compliance. It rests on assessments of future vulnerability. Regulators can intervene earlier, based on emerging risks rather than confirmed failures. This produces a structural rebalancing of power.

For banks, this shift is practical, not theoretical. Supervisors no longer need to wait for capital erosion, liquidity stress, or regulatory breaches. They can challenge strategy, governance, and risk trends even when headline indicators appear stable. This creates an inherent asymmetry. Regulators see the system. They compare peers, observe common exposures, and track interconnected risks. Individual banks see their own balance sheets, funding plans, and internal metrics. Decisions that appear reasonable in isolation may look risky at system level. When supervisory judgment is supported by peer comparison and macro analysis, regulators gain authority to question decisions that would previously have been shielded by compliance.

The basis of supervisory engagement therefore changes. Discussions move away from confirming minimum compliance and toward evaluating sustainability. The key question becomes whether a bank’s strategy, governance, and risk profile can withstand stress over time. Numbers still matter. Explanations matter just as much. Adequate capital and stable earnings do not guarantee supervisory comfort if risk escalation is weak, internal challenge is limited, or information is unreliable. Conversely, a bank under short-term pressure may receive a measured response if risks are clearly identified, governance functions are effective, and corrective actions are credible. Under risk-based supervision, credibility increasingly outweighs technical defence.

Disagreement also changes in nature. In compliance-based systems, disputes focused on rule interpretation and technical definitions. Banks defended positions by citing regulations or precedent. Under risk-based supervision, disagreements centre on judgment, assumptions, and behaviour. These are harder to resolve through formal argument. Weak governance, delayed recognition of problems, selective disclosure, or optimistic projections are difficult to defend over time. Influence depends less on citing rules and more on demonstrated conduct. Banks that acknowledge issues early, act decisively, and follow through consistently tend to build supervisory confidence. Banks that delay action or rely on best-case narratives invite earlier and stronger intervention.

In developed supervisory systems, this reallocation of authority has stabilised within structured frameworks. Risk-based supervision operates through defined methodologies, common risk taxonomies, peer benchmarking, and formal review processes. Supervisory judgment is documented, internally challenged, and supported by specialist input. Authority is strong, but it is constrained by institutional discipline and accountability. Over time, banks in these systems have adapted. They invest heavily in board effectiveness, risk governance, data quality, and internal challenge. While power has shifted toward regulators, expectations are predictable. Banks understand which behaviours build supervisory confidence and which trigger concern, even during periods of stress.

In developing and emerging markets, the same shift is taking place under more fragile conditions. Banking systems are often uneven in size and sophistication. Governance standards vary widely. Risk management practices are inconsistent. Data quality is frequently weak, delayed, or fragmented. Supervisory resources and specialist expertise are limited relative to the complexity of risks. Legal, political, and institutional constraints can affect the timing and intensity of supervisory action. Risk-based supervision still expands supervisory authority, but without all the safeguards found in advanced systems. Judgment becomes more central and more exposed. Consistency across supervisory teams is harder to maintain. Peer comparison is less reliable when transparency differs sharply across institutions. The main risk is not excessive authority, but uneven authority. If judgment is unclear or inconsistently applied, trust erodes and supervision loses effectiveness.

Bangladesh’s current risk management and compliance culture shows many of these challenges. In many banks, compliance is still treated as a checklist exercise that looks mainly at past events. Regulatory requirements are often seen as reporting tasks rather than as tools to understand risk. Risk management functions are in place, but their independence, authority, and analytical strength differ widely across banks. In some institutions, risk is still viewed as a control or support function instead of a core part of business strategy. Weak data aggregation and poor data quality remain ongoing problems. Early warning signals are often late or incomplete. Board-level oversight is improving in some banks, but in others it is limited by skill gaps, concentration of decision-making, and weak risk culture. These structural weaknesses make the move to true risk-based supervision more difficult.

Bangladesh’s move toward risk-based supervision reflects these realities clearly. Credit concentration, pressure on asset quality, weak governance, and operational risks are now more visible across the banking system. Rapid use of technology and closer financial links have also created new risks. Under risk-based supervision, Bangladesh Bank is expected to look ahead rather than only review past results. Supervisory effort is adjusted based on each bank’s risk level and systemic importance. Intervention is expected to happen earlier, before problems become severe. Ongoing supervision is gradually replacing occasional inspections. Understanding risk trends is now as important as checking reported figures.

Banks also have a direct role. Moving successfully onto the risk-based supervision path requires a shift away from defensive compliance toward genuine risk ownership. Stronger board oversight, empowered and independent risk functions, improved data integrity, and integration of risk into strategic decisions are no longer optional. Banks that adapt tend to experience more stable supervisory relationships and earlier resolution of emerging issues. Banks that do not face rising pressure as supervisory tolerance for weak governance narrows.

This reallocation of authority is not punitive by intent. It reflects how banking problems actually develop. Failures rarely begin with clear rule breaches. They begin with weak incentives, ignored warnings, limited challenge, and delayed action. By the time ratios deteriorate, options are fewer and costs are higher. Risk-based supervision gives supervisors authority to act when warning signs first appear. This is uncomfortable for banks accustomed to defending themselves through compliance.

Risk-based supervision does not remove friction between banks and regulators. It changes how that friction is expressed. Power moves away from fixed rules toward judgment, from reacting to problems toward anticipating them, and from formal compliance toward real risk management. In Bangladesh, the framework is now in place and the balance of authority has already shifted. Whether this change leads to a stronger and more stable banking system, or to ongoing strain, will depend on institutional discipline, consistent supervision, and how quickly banks move from defending compliance to taking ownership of risk as a core responsibility.

The writer is professor at Bangladesh Institute of Bank Management (BIBM), Dhaka. ahsan@bibm.org.bd