In this article we suggest some ways in which financial supervisors working in an integrated environment can organize their activities to more effectively focus on the importance of corporate governance. For the purposes of this note we consider institutional risk management to be a subset of the broader field of corporate governance.

Integrated supervision is becoming a more frequently adopted form of organizational structure in countries around the world for a number of important reasons:

• Earlier Identification of Important Trends: In a globalized environment where ownership structures often include a number of different types of financial institutions, an integrated structure helps to minimize the risk that the significance of important cross sector transactions and trends will not be recognized until it is too late to react. There are many cases where fragmented supervisory agencies within a country failed to recognize critical risk developments for the financial sector as a whole because each agency was seeing only one part of the entire picture.
• Consistency of Supervisory Policy: The broad range of financial products offered by modern financial institutions means that what in the past would have been regarded as quite distinct institutions, such as banks and life insurers, now frequently sell similar products. Clearly there should be a high degree of consistency in the policies for supervising what are essentially the same products. Consistency will generally be easier to achieve when policies are being developed by one supervisory organization.
• Public Transparency: It is confusing for ordinary consumers when they must deal with different agencies overseeing different types of financial institutions. A single, integrated financial supervisor facilitates communication with the public and this can provide important input to the supervisory process.
• Employee Development: A broadly integrated organization offers a similarly broad perspective for employees over time. The opportunity to learn about the entire financial sector during a career in financial supervision provides an additional challenge and the potential for greater job satisfaction than will typically be the case in a single business supervisory agency.

The foregoing points are not to suggest that integrated supervision will in every case be the optimal way to address the issue of supervisory organization. Indeed, excellent communication and coordination between independent supervisory agencies such as banking and insurance can lead to highly satisfactory results. Nevertheless, in today’s world, and other things being equal, our experience is that more and more frequently the benefits of integrated supervision are being seen to carry the day.

In observing integrated organizations in a number of countries we have noted that it is difficult to maintain a truly integrated structure at the working level. When it comes to the “front lines” of supervision, it takes an experienced bank inspector to assess the quality of credit decisions in the bank’s loan department, but it’s quite unlikely that a bank inspector will be able to adequately assess the quality of a general insurance company’s reinsurance arrangements. Therefore it is typically necessary to maintain groups of specialist employees for securities supervision, banking supervision, insurance supervision and so on.

The main point of this article, however, is to suggest that in the area of corporate governance and corporate risk management we have an excellent opportunity to put in place a truly integrated team of specialists who are in a position to provide a desirable service to every one of the other institutional areas. International standards for the supervision of securities, banking and insurance all emphasize the critical importance of good corporate governance and risk management in meeting supervisory objectives. Effective corporate governance is increasingly being recognized as one of the most important attributes of a well managed institution.

A well trained team that is able to assess the quality of an institution’s corporate governance, including the effectiveness of board oversight, financial controls and risk management, will be an invaluable asset to the integrated supervisory agency. Unlike lending policies and reinsurance arrangements, corporate governance is virtually independent of the institutional “type”.

A well documented difficulty in establishing a successful integrated supervisory organization involves the problem of building a real team rather than a number of essentially independent groups that happen to work under the same roof. Whether supervision is fragmented across a series of independent government agencies, or across a series of organizational silos within a single agency, the ostensible benefits of integrated supervision, mentioned above, will not be realized.

This issue can be at least partly addressed by the existence of a corporate governance team within the integrated organization. Corporate governance is an area where true integration on a day to day basis can be a reality. The existence of a team that works with all the specialized supervisory groups will help to establish a common thread of experience across the organization, leading to greater cohesion and teamwork.

A reason for the existence within organizations of internal, non-communicating silos, is that generally silo members do not have to communicate with each other to carry out their day to day responsibilities. The use of a corporate governance team means that as a matter of course, all groups will at least be working with the corporate governance team, and this gives rise to an on-going basis for staff interaction and discussion. As an additional team building device the corporate governance team could organize cross sector meetings (i.e. including specialists in banking, insurance, securities, etc.) for the purpose of highlighting key corporate governance themes that should be of interest to all personnel.

Using insurance as an example, when the insurance specialist unit is planning an on-site inspection of an insurer, the corporate governance team should be brought into the picture at an early stage. The team that actually visits the insurer would be comprised of technical specialists from the insurance unit as well as one or more members of the corporate governance group. In this way the insurance unit will benefit from the presence of seasoned inspectors who have in depth experience in assessing the quality of an institution’s corporate governance and risk management practices.

Most of the risk areas that will be reviewed during an on-site inspection will involve two components. First there is a technical component where the supervisor will want to assess the degree of risk to which the institution is exposed. For example, in the investment area of a life insurer, there will be a need to assess the qualities of the investment portfolio in terms of its match with the company’s liability structure. In the claims department of a general insurer there will be a need to analyze the adequacy of past provisions in the light of actual payouts in order to determine whether there has been any historical patter of under or over provisioning. The assessment of asset/liability matching in the life insurer and of liability estimating in the general insurer, are activities that clearly require specialist knowledge.

The second component of the on-site work involves the extent to which the institution is able to control and mitigate the risks that exist. Here, the quality of risk management policies and processes become at least as important as the technical analysis. In evaluating this part of the company’s situation, the corporate governance experts and the technical specialists will need to combine their skills to meaningfully assess the real, or net risk to the institution. With input from the technical specialists, corporate governance team members will consider the extent to which the board has put in place meaningful policies designed to control risk. They will consider matters such as the quality and degree of management oversight, the comprehensiveness of the policies and procedures, the quality of internal controls, the reliability of data sources, the degree to which the policies have actually been implemented and constitute a part of the institution’s corporate culture and so on. Thus the on-site inspection becomes the arena in which corporate governance experts and technical specialists work together to assess risk areas and to look for steps to reduce risk where necessary.

It is also true that some supervisory personnel will always be most comfortable working in technically specialized areas. They will not be comfortable with, or good at, assessing board performance and corporate governance. The existence of a corporate governance team permits these individuals to restrict their activities to the areas of their real interest, such as actuarial liabilities in life insurance, quality of disclosure in securities regulation and so on.

The benefits will not flow only in one direction, i.e. to the specialist units such as banking and insurance. Our experience is that exposing staff to a broad variety of situations and challenges builds job satisfaction and makes for higher staff morale. Thus we think members of the corporate governance team will enjoy having the opportunity to make a contribution to the agency’s goals in, for example, insurance supervision. Over time some may actually decide that they would like to be members of the insurance team.

All in all, we suggest that a team of specially trained experts in corporate governance will be able to assist an agency to realize the theoretical benefits of integrated supervision and in general, to maximize the efficiency and effectiveness of supervisory efforts.

The foregoing comments may be more directly applicable in the context of emerging market supervisory agencies than in developed countries. In the latter environment supervisors typically have significant resources, including more staff, and they can frequently afford to train a substantial number of specialists and other staff members to assess the quality of institutional corporate governance.