From Documentation to Diagnosis - Bank Supervision’s Clinical Turn

While the terms ‘regulator’ and ‘supervisor’ are often used interchangeably in the literature and academic discourse, as both regulate or oversee the activities and functioning of another entity, the terms ‘regulation’ and ‘supervision’ should not be used so loosely. Regulation is the framing of a set of rules for an entity to function appropriately, with the objective of reducing the probability of insolvency. 

Accordingly, such rules need to be dynamic, in sync with the continuing needs of the entity, the economic conditions and, at times, in response to the changing requirements of the stakeholders — depositors and investors. But supervision not only looks at adherence to the regulatory guidelines and the law/rules of the land, but also at any matter that is perceived to be detrimental to the interests of the depositors or investors.

Supervision is therefore all-pervasive and carries “markedly broad powers: to grant or revoke firms’ licenses to operate, to require firms to provide them with information or act to ensure their safety and soundness, to fine firms, and to approve or remove firms’ management and board members. They have also been equipped to monitor firms closely. In the case of larger banks, supervisors typically maintain a close watch over firms’ activities, reviewing business plans, risk frameworks, governance, corporate structures and financial performance”, as Sam Woods, Deputy Governor for Prudential Regulation at the Bank of England and Chief Executive Officer of the Prudential Regulation Authority, noted in the Henry Thornton Lecture at Bayes Business School, published on 12 May.

The techniques and tools of supervision have to be portfolio- and bank-specific, since risks to safety and soundness are entity-specific. Identifying bank-specific risks — some before they appear and others after they surface — is the central task and challenge of supervision. Vulnerabilities in a bank are not always easy for bank management to identify; they are even harder for supervisors to detect. 

This requires supervision to: 

• Carry a ‘third eye’ to undertake this task.

• Form creative judgements beyond formulaic metrics or criteria.

• Deliver credible supervisory conclusions free from influential vested interests or even political pressures. 

Added to this is the public expectation that supervisors should inculcate in bank management the ability to identify and mitigate emerging entity-specific risks on their own and at an early stage.

Hence, supervision needs to be ‘clinical’, as Sam Woods calls it. The bilateral relationship between the supervisor and the supervised is akin to that between the doctor and the patient. Trust cements this relationship. The doctor starts working on the patient by closely looking at the health check-up reports and discussing any troubling symptoms with the patient. The appropriate course of treatment is patient-specific; so are the medicines prescribed. The supervisor’s role, however, does not remain confined to curing the sickness of the supervised entity under review; it must also ensure that individual ill-health is not allowed to spill over to other entities, giving rise to system-wide financial distress and adversely affecting the financial health of the public at large, given the severe economic and fiscal costs of a financial crisis. Research suggests that the average net present value cost of a financial crisis, even if well managed, is around 43% of GDP — a finding that underscores the need to keep enhancing supervisory rigour.

The supervisor not only seeks to fix a point of ‘instability’, as the doctor treats the ailment of the patient at hand, but also does so in a manner that reduces the likelihood of the identified problem recurring. The supervisory approach is an ‘intense expertise-based’ one, much like that of a doctor, but remains ‘forward-looking and judgement-based’, identifying and mitigating financial health issues while keeping the health of the wider ecosystem in view.

Like Medicine
As Woods argues, supervision could be recognised more formally as a ‘profession’, akin to ‘medicine’. The demands of the role of a supervisor are no less demanding than those of a doctor — technical proficiency in understanding the nuances of capital, liquidity and the balance sheet is only the minimum. 

What is also required is a deep understanding of 

• The running of financial entities

• The kind of risks they face in relation to their risk appetite and tolerance.

• The psychology of organisations and their individuals.

• The mindset of the board towards keeping the entity resilient to distress. 

Indeed, each of these, as a stream of learning, is no less rigorous than understanding the complexities of the heartbeat or the workings of cells in the brain — the learning points in the study of medicine.

In her remarks delivered at the 2026 Banking Outlook Conference in Atlanta on February 19, Michelle Bowman, Vice Chair for Supervision at the US Federal Reserve Board, echoed a similar view. Reviewing possible areas where supervision has “drifted into procedural compliance over material risk assessment” and processes that “rarely predict institutional failure”, she suggested that supervisors should move from asking “Is this documented?” to “What scenarios could cause your strategy to fail, and are you prepared for them?” 

Similarly, in India, supervisors have for some years now started asking questions like: “Do you have a system to identify vulnerabilities well in advance in various business areas? And have you been able to set up mechanisms to resolve such issues before they crystallise?” 

Further, such clinical supervision would require, in a changing environment, monitoring of granular, high-frequency activity — from derivatives and securities financing to algorithmic trading. Expectations will be tighter on timeliness, proportionality, and legal defensibility of supervisory viewpoints.

This transformation is not easy to achieve without a commensurate increase in specialist capacity. New tools and methods will require new competencies, organisational structures, and supervisory cultures.

In the interim, better use of existing data should be pursued, as this would reduce the need for bespoke, episodic data requests and free up supervisory time from routine diagnostic work. Shared data architecture between home- and host-country supervisors would lower the costs of cross-border supervision, while strengthening the visibility of system-wide vulnerabilities. While quantitative indicators would help in detection, screening, and prioritisation of supervisory action points, there should also be techniques and tools to capture and assess qualitative factors — governance culture, strategic intent, and management competence — that critically influence risk. Clinical Supervision would place heightened emphasis on such an optimal hybrid model. 

It requires, however, a steep change in approach to bank supervision and substantial new learning on the part of both the supervisors and the supervised.