Risk, Discretion, and Bank Supervision

This article argues that bank supervision sits at the center of two foundational tensions in the governance of American finance. The first is the extent to which the financial system is controlled by public actors (i.e., the government) or private actors (i.e., the banks). The second is the extent to which the contest for that control occurs through bright-line rules or through the exercise of regulatory discretion. On the first tension, this article argues that supervision is the public and private participation in financial risk management such that public actors cannot relinquish control of residual risk while private actors do not relinquish control of frontline risk management. Risk management in that sense is shared, but not shared equally: bank supervisors represent a government that has essentially guaranteed the resilience of the financial system through formal and informal commitments to a variety of private actors, including the banks themselves. Supervision is the part of the government that is created and evolves, however imperfectly, to manage those relationships, those guarantees, and those commitments, each evolving in turn. The second tension, between rules and discretion in managing those commitments, represents the defining ethos of bank supervision. The process of supervision is therefore importantly distinct from the laws promulgated by Congress or the regulations written by the banking agencies themselves. Nor is bank supervision the verification of compliance with either laws or regulations, but is instead about the flexible use of discretion, within a system whose boundaries are defined by rules that are intentionally broad and vague. Using the rich history of supervision in the United States from the antebellum period to the present, this article presents a theoretical conception of supervision as the space where bankers and the government engage each other in sometimes cooperative, sometimes contentious disputes with substantial influence on the direction of financial and economic policy