Risk-based supervision is one of the most important changes in modern banking supervision. It is important not because it creates new rules, but because it changes how supervisors think and work. In the past, supervisors treated most banks in the same way. They depended mainly on periodic inspections and compliance checks. Risk-based supervision changes this approach. It focuses attention on areas where risks are higher and where problems can threaten financial stability.
At the heart of risk-based supervision lies supervisory judgment. Supervisory judgment is the professional and evidence-based assessment used by supervisors. It helps them interpret information, assess governance and controls, and decide when and how to act. It is not intuition. It is not personal opinion. When applied correctly, it is a structured process. It combines data, qualitative assessment, experience, and forward-looking thinking.
The idea of supervisory judgment did not appear suddenly. It developed as banking systems became more complex. Traditional supervision slowly showed its limits. In earlier years, supervision was mainly compliance-based. Supervisors checked laws, rules, ratios, and reports. The basic belief was simple. If banks followed the rules, they would be safe. Experience proved this belief wrong.Many banks that later failed or faced serious problems looked compliant shortly before the crisis. Their real problems were hidden. Weak governance, excessive risk-taking, poor internal controls, and wrong incentives were often the true causes. These problems did not always appear in regulatory ratios or legal violations. Because of this, supervisors across the world began to change their focus. They moved from checking past compliance to understanding current risks and future vulnerabilities.
In developed countries, supervisory judgment works within strong and disciplined frameworks. These systems use common risk categories and clear assessment methods. Rating systems are defined in advance. Supervisors follow agreed processes. Specialist teams support them in areas such as credit risk, market risk, operational risk, technology risk, cyber security, and financial crime. Peer review is common. Supervisory decisions are challenged internally. Data analysis and comparison across banks help identify trends and unusual behaviour. Clear rules define when supervision becomes stricter. In these systems, judgment does not mean freedom from discipline. It means making informed decisions within a clear structure.
Even in advanced systems, subjectivity remains a concern. Banks sometimes ask why similar banks receive different treatment. Supervisors must therefore explain their decisions clearly. Documentation becomes very important. Supervisory credibility depends not only on making correct decisions, but also on showing how and why those decisions were made.
In developing countries, supervisory judgment is more difficult to apply. Banking systems are often diverse. Some banks are strong. Others are weak. Governance standards differ widely. Risk management practices are uneven. Data quality is often weak. Reporting systems may not be integrated. Supervisory resources are limited. Experts in areas such as cyber risk, digital banking, or complex risk models may be few. Legal, political, and market pressures can make early action difficult.
Bangladesh's move toward risk-based supervision is an important transition. It reflects recognition that compliance-focused supervision is no longer enough. The banking system is becoming more complex. Technology is changing fast. Financial connections are deeper. Under risk-based supervision, supervisory effort is allocated based on each bank's risk profile, governance quality, and systemic importance. The goal is to detect problems early, push for timely correction, and protect financial stability.
The framework in Bangladesh focuses on structured assessment of key risks. These include credit risk, market risk, operational risk, strategic risk, legal and regulatory risk, technology risk, and financial crime risk. These risks are assessed together with governance quality, internal controls, and risk management practices. While the framework provides structure, supervisors still carry large responsibility. They must interpret information, judge qualitative issues, and form forward-looking views. Supervisory judgment therefore plays a central role.
Another major change is the move from periodic inspection to continuous supervision. Supervisors are expected to maintain regular contact with banks. Off-site monitoring is combined with focused on-site reviews. This allows supervisors to track developments over time. Problems can be identified earlier. However, this also increases liance on judgment. Supervisors must decide which signals matter and which trends are dangerous. They must judge when discussion is enough and when formal action is needed.
Clear supervisory accountability improves consistency and communication. Designated lead supervisors give banks a clear contact point and reduce mixed messages. However, too much reliance on one supervisor can create bias or over-familiarity. Without peer review and rotation, judgment may become personal rather than institutional. Risk-based supervision therefore requires teamwork, internal challenge, and proper oversight to keep decisions balanced andcredible.
Data quality is essential for supervisory judgment. Risk-based supervision depends on reliable data. If data is late, incomplete, or wrong, judgment becomes weak. Supervisors may become overly cautious or falsely confident. The framework therefore emphasizes standard reporting, data consolidation, and accountability for data accuracy. Persistent data problems are treated as governance failures, not technical errors. This sends a strong message. Data governance is a core part of sound banking.
Despite careful design, many challenges remain. One challenge is consistency across supervisory teams. If similar banks receive very different risk assessments, trust declines. Consistency does not mean identical outcomes. It means similar logic and similar standards. Bias is another challenge. Frequent contact with banks improves understanding, but may weaken professional distance. Documentation, peer review, and supervisory committees are essential controls.
Internal capacity and mindset change at Bangladesh Bank are therefore critical. Risk-based supervision cannot work with an old compliance mindset. Supervisors must move from rule checking to outcome assessment. They must be comfortable making forward-looking judgments. They must also be able to defend those judgments with evidence. This requires training and support. Technical skills alone are not enough. Supervisors need analytical skills, communication skills, and confidence.
Internal quality assurance is equally important. Regular review of supervisory decisions, calibration across teams, and structured challenge processes must become routine. Without these, judgment will vary widely and lose credibility. Investment in supervisory technology and data analytics is also necessary. Tools can support judgment and reduce reliance on intuition.
Currently, the banking industry in Bangladesh is in a phase of critical challenge. Risk management culture remains uneven. Many banks still focus mainly on compliance. Risk management functions may exist, but lack authority. Boards may approve policies without understanding real risks. Data systems may not support timely risk reporting. Incentives may encourage short-term growth instead of long-term stability. Under risk-based supervision, these weaknesses will become more visible and costlier.
Banks must strengthen risk culture at all levels. Boards must understand risk appetite and stress results. Senior management must own risk outcomes. Risk management, compliance, and internal audit must be independent and effective. Data integrity must be treated as a strategic issue. Banks that fail to adapt may face stronger supervision and earlier intervention.
When supervisory judgment is applied well, the benefits are clear. Supervisory resources are used better. Risks are identified earlier. Governance improves. Banks invest in stronger systems. Financial stability improves. Public confidence grows. When judgment is poorly structured, the opposite happens. Decisions become inconsistent. Expectations become unclear. Action is delayed. Discipline weakens.
Supervisory judgment is not the weakness of risk-based supervision. Weak structure is. When judgment is disciplined, documented, and consistent, it becomes the key tool for modern supervision. Bangladesh's move toward risk-based supervision shows this understanding. The real test now is execution. Internal capacity, mindset change, and commitment from both supervisors and banks will determine whether risk-based supervision delivers real improvement or remains only a framework on paper.
The writer is Professor at Bangladesh Institute of Bank Management (BIBM), Dhaka. ahsan@bibm.org.bd