Supervising the New Normal: Long-term implications of the pandemic for supervisory judgement
Tuesday, Jan 12, 2021

Supervising the New Normal: Long-term implications of the pandemic for supervisory judgement

Speakers:

Elsie Addo Awadzi – Second Deputy Governor, Bank of Ghana

Martin Moloney – Director General, Jersey Financial Services Commission

Lyndon Nelson – Deputy CEO and Executive Director, Prudential Regulation Authority, United Kingdom

Moderator:

Clive Briault, Chair, Banking Advisory Board, Toronto Centre

Listen to the podcast:

 

Read the full transcript:

Clive Briault:                   

Well, hello, everyone. Good morning, good afternoon, or good evening depending on where you are. Welcome to another episode of Toronto Centre's virtual webinars series on supervision after COVID-19. We have today 130 registered attendees of this webinar from 31 countries. My name is Clive Briault and I'm the chair of Toronto Centre's Banking Advisory Board. But more importantly, our distinguished panelists today are Elsie Addo Awadzi, the deputy governor of Bank of Ghana, Martin Maloney, the director general of the Jersey Financial Services Commission, and Lyndon Nelson, deputy chief executive of the Prudential Regulation Authority in the UK. We've already circulated their biographies with the program material.

So welcome to Elsie, Martin, and Lyndon. It's very, very good to have you with us today. Managing through the pandemic and adjusting to the new normal has not been easy for financial supervisors. And as its contribution to this effort in late September, the Toronto Centre published the most comprehensive, practical, and cross-sectoral guide to supervision in the COVID-19 world with input from a wide range of supervisory authorities and standard setters. I do encourage you to read it and we'll be putting up a link to that publication in the chat function in just a moment.

But today, we're going to focus on the implications of COVID-19 for supervisory judgements. We've seen already how supervisors have had to make some difficult judgements in the COVID-19 world, for example, in assessing how well banks are dealing with credit risk at a time when borrowers are being supported by government assistance and payment holidays. But some of those borrowers may not survive once that assistance is withdrawn. We've seen some judgments becoming slightly more difficult to make, for example, in making assessment of senior management or boards of supervised firms on the basis of video conference interviews rather than face-to-face meetings.

Looking ahead, it's clear that supervisors will need to make judgements on how the crisis may evolve, how well supervised firms will respond to the heightened risks that they face to emerging new risks and whatever else the new normal may bring. So even if there is nothing fundamentally new in supervisors being judgmental and forward-looking within a risk-based approach to supervision, some of our parameters have shifted and the importance of being judgmental and forward-looking may have increased further.

We do intend today to leave time for your questions. So do please use the Q&A tab on your Zoom screen if you want to submit your questions. I would just like to thank the key sponsors of Toronto Centre, mainly Global Affairs Canada, Swedish Sida, the IMF, Jersey Overseas Aid, USAID, and Comic Relief. I'd also like to thank Demet Çanakçı [inaudible 00:03:24] Toronto Centre, who have worked so hard behind the scenes to bring you this quality webinar. Let's start off with the first question for our panelists today, which is what difference has COVID-19 made to the types of judgments that supervisors in your organization are required to make? And can you illustrate this with some examples? Elsie, would you like to start on that one, please?

Elsie Addo Awadzi:       

Thank you, Clive. And thank you to the Toronto Centre for this opportunity. In my view, the judgments that supervisors are having to make are not different from what they typically would have to do. What is different is just how challenging it is to arrive at a conclusion one way or the other given the uncertainties that we face as well as the fact that this is bank-wide. This is industry-wide, you're not dealing with just one institution at one time. You're dealing with a pandemic that has shocked the entire industry. So you're having to make very difficult choices than you probably would ever have to be. A few of these are, for example, the fact that most regulators have given capital liquidity reliefs to banks.           

The question is how much of this, how much of such forbearance to give and for how long? Given the fact that the duration of the pandemic is extremely uncertain, given the fact that the impacts on the real sector are evolving, so where are the trade-offs and where is that curve going to evolve, going to end up? And so these are some of the difficulties. There's also the key difficulty of the fact that most banks have moved mostly electronic in their service delivery and the operational risks that attend to these are quite high. What are the types of assessments that supervisors need to make? Moving online mostly has changed a lot of the business models that supervisors have been used to. And then overnight, they are having to struggle to understand what does this mean for the institution, what is judgment in this context?     

The other key thing is the fact that the road... I call it the road to rebuilding capital and liquidity buffers will be very long. And how are supervisors supposed to deal with this on a daily basis? Very quickly, we're going to see capital and liquidity buffers erode. Already, we've given a lot of reliefs. And the remaining buffers that are in place would very quickly be rotted in the coming year. What stands my supervisor stake were used to approaching this by the rule book and knowing when to intervene and when not to intervene. But in this context, judgment is going to be very difficult. You don't want to intervene too quickly, you don't want to intervene too late, what does that mean? So a lot of unknowns, a lot of questions, and it just makes decision-making very, very difficult in these circumstances.

Clive Briault:                   

Okay. Well, thanks so much, Elsie. Some key issues there around forbearance initially, about rebuilding capital and liquidity buffers as we move forward, and about the changing landscape out there in terms of digital delivery. So some areas there which as you say require supervisory judgment. So moving on, Martin, same question for you. What judgments have you and your authority been making during COVID-19 and how has that gone? Sorry, you're on mute, Martin.

Martin Maloney:            

The classic COVID crisis [inaudible 00:07:39], you're on mute. Anyway, just to say I'm struck immediately by the similarity between what I would say and what the deputy governor has said. It is definitely an experience that we've all shared. But I do also recall when I first became a regulator that we placed a great value on the experiences of some elder regulators, who in years gone by had been involved, let's say, in the winding up of banks or other crisis events. I think back on that in the course of the recent crisis because it was striking the difference in perception, experience of supervisors who had been through 2008 or some other crisis versus people who had become supervisors since then, because it definitely calls for a degree of creativity and lateral thinking and originality on the part of supervisors that they're not normally used to. And in that sense, the crisis situation makes you put away the rule book and try to think from scratch about what your public function is.        

So it's already been mentioned about some of the reliefs that have been given in relation to things like dividends and buffers and also on timelines. And a lot of those were exercises of judgments by regulators, where nobody could really tell you what the right answer was. And in that sense, the exercise of judgment has been critical. But also, it can suddenly require regulators to have knowledge of things that parts of the market, for example, that they wouldn't normally have knowledge of. So those who paid particular attention to the oil commodity futures market as it reacted in March, April, for example, and the whole question of physical delivery and why that was impacting on that market and tried to figure out whether we, as regulators, should be worried about that, it required you to dive down deep into an area that you might not have been very familiar with and really to pick up very quickly information.

And in that respect, I think what supervisors would normally do, which is quite interesting, is we will often reach out to our network within the industry itself, not necessarily to the firms we regulate, but to people we've worked with in the past and ex-supervisors and so on to try to pick up information on how things actually work in the market and how significant the events and the information we receive is. In that sense, it is about the exercise of judgment where there is no rule book, but it's also, I think, about using your networks and your resources to try to get new types of information that you don't necessarily normally have as a supervisor.

And the third thing I would emphasize is, and I'm sure we all do this, the support we had to give to governments with the various remote working, homeworking, whatever you want to call it, move out of the office processes that they engaged in, where at least initially that would have been deep concern as to how the financial sector would do that. As it turned out, the financial sector turned out to be pretty good at remote working, but you couldn't have known in March, April how good their compliance controls were going to be and what other areas that you might be expected as a financial regulator to get involved in. Did you get involved in who was essential staff, for example, who was defined as essential staff? So you're forced into a range of judgments there around your relationship with government, which are also quite new for regulators. I thought those were quite interesting developments.

Clive Briault:                   

Okay. Thank you very much. Martin, we'll come back a little bit later to the question about how to instill creativity and lateral thinking in supervisors. But last but not least, Lyndon, same question for you. I'm sure an avid reader of speeches made by members of the Prudential Regulation Authority in the UK would have seen the word judgments appear many times over the last decade. What's been different under COVID-19?

Lyndon Nelson:              

Well, thanks, Clive. As you say, judgment at the heart of our processes and data is of many. Because I'm going last, I'll try and feed off some of the comments from my colleagues because I very much support all the things that they said. The two key judgments, so the ones that you put in your introduction, Clive, which is the judgment about the path of the virus and the judgment about the impact of government support. And indeed as Elsie began saying this has been a sectoral problem, I would say the UK's approach has been very much characterized in that sort of macroprudential space.

So the way the judgments have changed in a way is that they've been more in combination. They've been more in a combination of somebody making a sector-wide judgment about the path of virus and the impact of government within the microprudential judgment about how does that impact my particular institution. And as Elsie and Martin have both said, we have been playing our part as part of that sectoral story in relaxing and using as much of the flexibility in Basel as we can to relax the capital constraints. So I think that's been really the key and it's been very difficult, obviously, for supervisors given the degree of uncertainty that they've had to form some of those judgements. But we've essentially been doing that by having this much more, I would say, collective process than the one that we've been encouraging in more business as usual.           

A few things I might also point out, I think we've had much more involvement with the monetary policy side with the Bank of England and most of our microprudential supervisors would have had before. We've obviously keyed a lot of our stress tests off. They're actually the macro inflation forecast, or indeed in some cases, scenarios because they were unable actually to produce a forecast in the early few months of the crisis. And also more recently, as the UK has speculated about using negative rates and the impact that that would have on business models, and as Elsie said, and actually on restoring some of these buffers and these capital positions. We are fortunate in one respect. We had two members of staff who we have seconded a couple of years earlier to help on the Ebola crisis. And in fact, therefore had actually some people who were very expert in disease transmission and other things like that. We sent one to deal with the bank's own internal preparedness, but also one who was leading for us in terms of supervisory approaches.

And the other thing I would highlight is where we've seen some of the risks and therefore key judgments is that we've seen a lot of firms and indeed ourselves actually take some decisions based on maybe the wrongful belief that things would be back to normal in a few months time and not expecting when we first went into this, which was in March in my country, that it would be nearly potentially a year before we were going back. And I think decisions taken in terms of risk appetite for a short period of time look very different when they're extended for that amount of time.

So we've definitely been sharing best practice with supervisors about what some of those decisions are. And Martin alluded to one of them, which I think is the conduct issue, which I think some firms were very prepared to take a short conduct risk for a very short space of time when they didn't have physical controls in place. But I think increasingly when they've had a choice, they've chosen to bring those conduct risks back into the office where the control environment is much more controllable. So I think that's just an observation that we've had and that's what we've been trying to pass on to the supervisors.

Clive Briault:                   

Hey, thanks a lot for that, Lyndon. And some interesting comments there, particularly I think around the greater focus on the macroprudential and wider macroeconomic position. Well, let's move on then. Let's look ahead a bit. You've all said that making judgements and taking a forward-looking approach has probably becoming even more important as a result of COVID-19. But how do you think this is going to evolve over the next two to three years? Particularly as Lyndon was saying, some people probably overestimated the speed at which the world would return to normal. Although vaccines have begun to be rolled out in some cases, it's quite possible that that process will carry on for at least the next 12 months, possibly longer. So, again, we're not going to return to full normality everywhere very quickly. So how do we think the need for supervisory judgements may evolve over the next two to three years? Martin, can we start with you this time round?

Martin Maloney:            

Okay. Well, this is a tough question in a way. And to some extent, it depends on making some assumptions about how COVID-19 itself ends up. But if we start, I guess, with the optimistic assumption that we're at the back end of this crisis hopefully, so it's about what we can see, or at least answering your questions about what we can reasonably prepare for. I think it's probably fair to say that the designers of regulatory frameworks have been urging supervisors to exercise judgment for the best part of more than 20 years actually. But supervisors are inherently, I think, reluctant to expand the sphere of their exercise of supervisory judgements. They don't particularly like to second-guess the market. They do it, but they do it maybe tentatively and carefully and with a lot of support.

I think you will see supervisors trying to increase their use of judgment carefully. But I think there are a couple of reasons why we will be forced further down that road. I was particularly struck by a recent article by Tobias Adrian of the IMF, very influential financial economist there, Low for Long was the name of the article. And he was really emphasizing the importance for central banks of taking into account the impact of the interventions they're engaging in on financial markets and the increasing fragility of financial markets. And that fragility is very hard to measure, but it forces us, I think, as supervisors, to be more actively engaged in answering the question, when is enough enough? When are precautions as sufficient? And that becomes a harder and harder question to answer in an era of deep uncertainty.

And the second factor, I think, that is widely recognized is that COVID-19 has pushed forward a lot of trends that were there, not only in the financial sector, but more broadly in the economy in terms of the impact of technology on the economy and innovation. And this speeded up a lot of processes that were happening anyway. I think that is going to have an impact on us. We're going to face more and more innovation. And if the homeworking trend becomes a series in long-term, then obviously to go back to the question Lyndon mentioned, we will have to be willing to make judgment on the adequacy of control systems that involve significant amount of homeworking.

I think there are a number of other themes that have emerged from this crisis. One obvious one is the ratcheting of cyber risk during this crisis. I suspect from a regulators point of view, that is going to mean that we're going to have to move away from what for many regulators has been the approach of just checking on the governance of cyber risk controls within entities. I think we're increasingly going to move into the space of making substantive judgements on the adequacy of those controls and make them ourselves rather than leave those entirely to the regulated entities.

I think the area of organizational resilience is going to become a hugely important theme in this period of fragility. And there's something fundamentally challenging for regulators in judging organizational resilience because you're judging the adequacy of organizational arrangements for an unknown threat. And that's a particularly difficult thing to do if you can stress test something and figure out in relation to a known threat why you are building resilience within a system, that's one thing. But if you were trying to make a judgment as to the adequacy of resilience frameworks to deal with an unknown threat, that's a very different approach. And it makes you focus on questions like single points of failure rather than adequacy in a given scenario.

I think the third area that strikes me is the global governance around financial stability. And it may be that notwithstanding that we've done quite well and the framework of relationships has done quite well in this crisis, It has set an agenda of issues for regulators to think about globally in relation to how well we govern and control financial stability across the globe and our governance arrangements for that perhaps seem a little bit weak and leave individual regulators with perhaps too much judgment to be exercised at a local level because the global frameworks could do it with a little bit more work, I suspect.

Clive Briault:                   

Okay. Thank you, Martin. Well, pleasure to keep you occupied over the next two to three years. Thank you for that. Lyndon, your views on how judgment might evolve over the next two to three years. Thank you.

Lyndon Nelson:              

Absolutely. I might just at the end key off a couple of things that Martin said, definitely a topic I care about very much so. So I would say is as many consultants are trying to spin it, we've made advancements in 10 years in the space of 10 months. But I think there's an awful lot of truth in essentially that move towards digitization. And of course, I think what that means is we're going to get a lot more business models that are going to come along to exploit that. And of course, most jurisdictions will welcome the competitive and the dynamic nature of that. But I think for supervisors, judging business models and the viability of those going forward, as Martin said, with a degree of uncertainty that we live in is very much a challenge.      

For banking, clearly, where we are in terms of credit risk as you highlighted, Clive, and where we are, and as Martin said, in Low for Long, made big challenge. But even in insurance, for example, what COVID has introduced is perhaps a greater emphasis on contract uncertainty, what sort of things are they actually writing? And indeed in terms of the UK courts, what the scope of actions might be? We may actually see something that's very common in a number of jurisdictions, so-called class action suits have been definitely developing over COVID. So I think the risk environment has definitely altered. And for supervisors, their judgments about areas of contract uncertainty and these judgements about viability will be really, I think, quite challenging.   

As Martin absolutely said, this increase in digitization means that there's a piece of Silicon at the end of that channel. And that does make industry very vulnerable, I think, to cyber attack. Our approach, Martin, so the challenge that you had about the threat is that we are threat agnostic, and essentially just assume that there will be failure and then work as you stay from that point. But I think the other thing it's done is I've noticed a very interesting change in how our supervisors, the challenge that some of our supervisors have had. If I might characterize it quite crudely, if you were a supervisor of one of the major UK globally important banks, you were very much used to having the whole of that entity under your control. It was big and a challenge to do that.

But I think when you look at technology and more and more third parties being involved, then suddenly they start to speak the language of what I might call a host supervisor of, "Well, there's something else beyond what I can see and how do I think about that?" And I think we've tried to cross-pollinate the experience of the host supervisors because the UK is quite a big host supervisor with those domestic supervisors who are very much having to learn a few new tricks about how do I piece together my view of HSBC when I've got Amazon Web Services over here and Azure over there and things like that?

So I think that's definitely a big change for them in terms of how the judgments they make about the viability of the entity that they actually are responsible for when it's got these other component parts that they don't have as much access and visibility of as they would normally. I think what you might also see, and if I might talk about domestic arrangements, I'm expecting quite a lot more segmentation of how we supervise, quite a lot more focus on the ease of exit, and also, I think, on our ways of working. We've just established a project on ways of working.

And really, there are two extremes here. There is the, well, once the virus has gone away, we'll all go back to the office as we always were. And then as many of us listened to in the International Conference of Banking Supervisors, the paper from Harvard Business School saying, "Well, once you break the connection with the office, perhaps you can just work anywhere." I think that how do we manage as a supervisory function where we have to work at what people prefer will be quite a challenge in the coming years.

Clive Briault:                   

Okay. Thank you very much, Lyndon. Thank you also for taking us into the world of insurance as well as banking and securities. Last but not least on this round, Elsie, how do you think the use of judgment may evolve in the next two to three years?

Elsie Addo Awadzi:        

Thank you. I believe, fundamentally, supervisors are going to have to adjust their risk appetite going forward because it seems to me that the perfect world where supervisors need to have a comfort of having buffers in the right places, of having governance and management and everything in the right place it's probably gone for a while. How long? We don't know. It seems to me that over the next 12 years, we'll still be in containment mode, try to contain the impact of the pandemic. And so there will tend to be still the need to forebear for a while. And so we're all going to have to adjust our risk appetite. Not only because banks will somehow still have to grant loans, even in uncertain terms, we're all bent on seeing the economic recovery. And so even with concerns around credit risk, banks are still going to have to lend.

And then you're dealing with some banks, especially in emerging markets, developing markets, having to take up a lot of government debt to support all the additional fiscal spending to help contain the virus. Many of the foreign investors in emerging markets have had to move away. And so you have in banks and insurance companies and pension funds in the local financial system picking up the slack. That is also overincreasing the banks, overexposing banks, if you will, to the fiscal. And then at the same time, you have debt sustainability concerns even for the sovereign. And so it just seems to me that we have to begin to talk about where are we going to be comfortable going forward.

And then again, you have some concepts that has started to take root, particularly again in emerging and developing markets, but not caught on completely, but are becoming very important as we talk about post-COVID recovery. These are the concepts of financial inclusion, these are the concepts of sustainable finance and banks dealing with climate-related risks. Now, these are going to be very important for supervisors to focus on. So while wanting banks to start to build resilience going forward, we're also going to have to focus on some kind of a trade-off that allows them to, like I said, grant more loans, provide more access to all economic access while thinking of how do banks use the market path to begin to promote more sustainable ways of doing business.

And all of that is very confusing for supervisors. Many supervisors don't already have these skills to help them make the appropriate judgments. And so we're going to have to spend a lot of effort also on building capacity and helping supervisors acquire skills in perhaps areas where they haven't previously had a focus, one of the issues that Lyndon talked about. And then you have the fact that, as we've all said, a lot of the banks have moved online with their services. Supervision itself is having to move online or has had to move online pretty much. We still probably won't have enough onsite examinations in the next few months.

And so there's a sense in which we have to also begin to think of how are we going to be able to do that more effectively. Supervisors are going to have to invest a little bit more in technology that allows them to do this more effectively. The whole AI suptech area is something that we need to look more closely at and see how we can get to more granular data from supervised firms that allow us to make some judgements much more than what I've had the luxury of making in the past.

And then one other point that I don't hear enough about, the cross-border cooperation conversation has to be broadened. I think it was Lyndon or Martin, I forget which one, that talked about big tech, Amazon and all of that being very much part of the equation now. Before now, cross-border supervision has really been among supervisory authorities. After the global financial crisis, we've made a big push to include other authorities, including perhaps even fiscal authorities or deposit insurance schemes, others in a financial safety net that all have a role to play in crisis management.

But the big tech regulators are very far removed from the conversations and yet having a big role to play in terms of access to supervisory data, even the operational resilience of banks. And if all of us are moving online, both the supervised firms and the supervisors, we perhaps need to begin to think of how risks are concentrating on the big tech front and what conversations we need to start having with the regulators of these big techs, if any. And so these are some of the few things I can think about in addition to what Lyndon and Martin have already said.

Clive Briault:                   

Okay. Thanks very much for that, Elsie. Well, let's turn to answering a couple of the questions which have come in from the audience. The first one, a question about whether you think that the extent of legal responsibility of the supervisor or regulator will constrain the types of decisions that can be made by the authorities, or whether perhaps there'll be a lot of litigation after the event. So they're taking lots of judgments is fine, but what happens when someone takes you to court afterwards? I think personally in that context, but Martin, do you want to take that one first because it may be particularly pertinent for supervisors with responsibilities in the security sector?

Martin Maloney:            

Yes, and I think what I'd say. There are, I think, three challenges of this type that I would point to. One is I think there are questions relating to regulatory independence. I won't talk about them. We could do a whole webinar on regulatory independence quite happily. I think, secondly, there are these issues that I already mentioned in relation to innovation and the regulatory frameworks being out of date. But public expectation on the regulators still being they will respond proportionately and promptly to the changes, even though in the world we now live in actually regulatory frameworks could be up to 10 years behind from the point you spot a problem to the point you've adjusted the regulatory framework through various international bodies and then down into local application to get it responded to.

But the third area, which is brought out in the question, I think is quite an interesting one about the potential for cases to be taken. And my observation here would be that in different parts of the world, there are different degrees of potential legal exposure for regulators. And there is a best practice here, it seems to me, which is the regulators cannot be sued in the absence of negligence or bad faith. And that is not the case in a lot of countries or in some countries at least. And it is the only way, it seems to me, to create a legal framework that prepares for the unknown.

We're all talking about the known, unknowns as being things we're supposed to prepare for. But in situations like we've just gone through where regulators have to make decisions and pass judgments in entirely anticipative circumstances, the only way you can really create an appropriate framework is through that test, which does exist in a number of countries, which provides... particularly I think in some common law jurisdictions, which provides to me the best practice standard.

And in the absence of that, I'm afraid regulators in some other jurisdictions will find themselves constrained and will not do what in their best judgment, having consulted widely and so on, they think is in the public interest and which is urgently needed to be taken. It's not unlike the problem that is sometimes discussed about weaknesses in the laws governing central bank interventions in response to crises, where sometimes political realm will try and constrain them excessively and then regret it afterwards when the crisis hits and they need them to have the flexibility.

Clive Briault:                   

Okay. Thanks a lot for that, Martin. Lyndon, I think you typed an answer to a question on credit risk. But I think technologically, once you send the answer to the person who asked it, only that person and you who have seen the question and the answer. Actually, if you could just very briefly summarize the question and what your answer [crosstalk 00:35:37].

Lyndon Nelson:              

Absolutely. I'm so sorry, Clive. I was trying to be helpful. But yeah, so this was a question which I think we've covered to some extent, which is the fiscal stimulus and the low net interest margin and the poor asset quality and what does this mean for supervisors and indeed resolution. I think it's absolutely a great question. It's not looking particularly healthy for banks at the moment, I would suggest. The way we've done it in the UK, as I said, we've done stress testing, so you can pour all of your cynicism into the scenario for that. And then obviously work out where the outliers are and discuss that with management about how those things could be remedied. And indeed, if they can't be remedied, then potentially you're looking at a resolution route.

This comes back to the heart of the debate we're having today about there's some pretty key judgments in that. And then therefore, they will come down to an appetite for both resolution and for forbearance, which of course will reflect some of the uncertainty inherent in some of the judgments we make. I know of some resolution authorities, I will speak of my own, who will be particularly cautious, I think, to resolve an institution that might on the face of it at the moment look solvent, but maybe in future, might not given all of the very difficult judgements we might make there. But my only advice really in these circumstances is to get it out in some way in discussion in terms of what you fear is the scenario. Stress test is how we would do it, and then you can debate it from that point on.

Clive Briault:                   

Okay, great. Thanks very much. Another question that's come in is what advice would you give to regulators and supervisors who are not yet looking into cyber risks, technology risks, and managing fintech risks that many of you were talking about in your introductory remarks? And perhaps on that, we can start with you Lyndon and then move on to Elsie, given the rather different ways in which these risks and fintech evolution occurs in different countries?

Lyndon Nelson:              

Thank you, Clive. That's great. It's a particular passion of mine, so I'll try and limit my comments. I do chair the G7 group. And you might say maybe part of the half's in this discussion about having quite a lot of access to quite a lot of cyber experts, and I know that can put a number of jurisdictions off. My advice always actually is to give you some facts from what we discover when we do our own penetration testing of our own UK important institutions. 90% of the failures that we find are what you would call basic housekeeping, basic hygiene, passwords patching for which you need no particular technical experience whatsoever.

And so I think in the adage that two... The old joke about two golfers walking along the woods and one of them says, "There are bears here. What would you do if a bear came after us? Do you think we could outrun it?" And the other one turns to him and says, "Well, all I have to do is outrun you." So the reality is don't make the firms be the easiest target for a hacker. I would say if jurisdictions can focus on the 90% hygiene factors, I think you're quite a long way there. After that, yes, absolutely, there is quite a curve to go up, I would say, in terms of learning about that. But then again I think work with your government authorities who will also be looking very much at these issues. We have a very close partnership with our own government authority. We could not do the work we do in terms of where the threats are and the vulnerabilities are without them. We actually have very, very, very few, what I call pure cyber experts in the bank. So we do most of ours by partnership with those authorities.

Clive Briault:                   

Okay. Thank you, Lyndon. Elsie, just to put the same question to you in terms of how you're responding to fintech and evolving cyber risk and other related risks.

Elsie Addo Awadzi:       

Luckily, two years ago, we put in place the regulatory framework for that, where we required very specific technical standards to be met by all the players in the ecosystem, as well as the governance requirements. I must say that it takes a long time for compliance to get where one would want it to be, and even for the industry, as well as the regulator to build the capacity to be able to do this right. From the onset of the pandemic, we've seen huge rise in the use of traditional financial services. And we're dealing not only with the fintechs, we're dealing with telcos because a lot of those transactions are happening on the back of mobile money wallets and then a host of fair party players in the ecosystem.

As Lyndon said, a lot of these are very simple frauds. And so we use a lot of education as well, both for the industry as well as for the public, basic education. And then we put in place technical capacity to monitor the industry and then be able to pick up threats and get the industry to do the right things. We've had a few cases of frauds haven't been successful. And then we use those as case studies to educate the industry on a forward-looking basis. And again, we also have a very close cooperation with the national authorities as well as other industry regulators in the financial system. So it's multifaceted, but I think the question had to do with what advice we have for regulators who are not doing this yet? My answer will be to stand right away.

Clive Briault:                   

Okay. That's a very good answer, Elsie. Very good advice. Okay. A different question for you, Martin. How should regulators and supervisors ensure that investors primarily and also perhaps depositors and policyholders are still protected in the midst of this health and economic crisis, considering that the information needs of investors has probably increased many times over at a time when the companies issuing debt and other securities probably faced greater uncertainty than ever before? What about this whole business of disclosure and transparency for the benefit of investors and other consumers?

Martin Maloney:            

Unfortunately, I would have a slightly pessimistic answer to this, in which is that if you haven't done the work in advance, you are unlikely to be able to resolve this question in the midst of a crisis. So your main asset management firms and your banks and various other intermediaries and so on who are the counterparts, the investors, and the depositors will need to have well-established systems and approaches well in advance of this crisis to be able to deal with those. And if they have those systems and they're reasonably well advanced, what they will show up is the gaps. So what will happen very quickly as a crisis like this develops is that you believe you have a good adequate set of information that you are giving out to people. But as a firm, you will start to get complaints in and queries in not withstanding the information flow out that you believe you have already designed and structured.

And as a supervisor, the right thing to do is to go to your largest intermediaries and actually start asking them about what the feedback is that they are getting. Because certainly in talking to a lot of asset managers during this crisis, it became quite obvious to me, for example, that a number of investors in various investment funds didn't particularly actually understand the strategy that they would invested in. And lot of queries were being generated for the companies by the surprise of the investors that the value of their investments was going in a certain direction, in the light of market events of which those investors were clearly aware and understood.

So they weren't able to add up two and two together and get four. Now, one might say that's the investor's fault for not understanding, but there is definitely also a responsibility on the provider of that investment instrument to make sure that they've done everything they can to help and facilitate the investors in understanding what's going on. So this is one we talked initially about the way supervisors actually change their behavior when the crisis hits. This is one of the areas where you change your behavior when the crisis hits and you start asking the asset manager or the bank questions you wouldn't normally ask them.

And a lot of what supervisors are really good at comes into play here, which is nudging, pushing, encouraging, reflecting back to those organizations about where those weaknesses are, being the challenger within the system for those organizations about where those weaknesses are, being the challenger within the system for those organizations to get them to move in the right direction. If you have to go further in a crisis situation, you will very quickly run up against the limitations on the systems within the various financial services firms, and you will not be able to achieve change, I would say, very quickly while the crisis will unfold quickly. So you will have a problem. It's all in the preparation for it.

Clive Briault:                   

Okay. Thanks for that, Martin. Elsie's answer start immediately. Elsie's answer should have started yesterday. [crosstalk 00:45:29]. It's a tricky one. Let me just move on to the question I wanted to come back to in response to some of the things you were saying in the earlier rounds of answers. We've talked a lot about digital delivery, cybersecurity, more general impact of technology and innovation, you've talked about the need for judgment around stress testing, financial inclusion, climate risks, cross-border cooperation.

Given that need, what have you found to be the most useful ways to encourage and help supervisors in your authority to be more judgemental and forward-looking? And in particular, where do the various components of that come in for you and your authority? You have the skill sets of your staff, whether or not management is supportive of staff taking judgements, whether or not the broader culture needs to change to accommodate this, and also perhaps whether some of those supervisory frameworks, like ways in which you do risk-based supervision, which have been in place for many years. Do they need to evolve as well in order to encourage your staff to take more and better judgements. Sorry, that's not a long question, but whichever angle that you feel most comfortable in tackling. So, Lyndon, do you want to go first on this one?

Lyndon Nelson:              

Yeah. Thanks, Clive. I'll probably tackle this sort of cultural bit, if I may. I think in a way, you have to create a safe space for judgments to develop and thrive. It's pretty bad if somebody forms a judgment and to immediately to get slapped back down. Hopefully, we do a lot of management training to try and work out how to do that and I'll come back to that in a second. The other way we've done to create safe harbors is we've done an awful lot of training. So I, for example, chair the main executive decision-making meeting in the regulator and I actually regularly carry that duty in a shadow capacity so effectively. We take the same papers where the senior people have exercised judgment and it's part of a training course, and more junior staff come along and I chair the meeting as I always would have done.

That gives them an ability to exercise some of those judgments. And of course, for some senior decision-making areas, these judgments are very, very finely balanced as indeed some of the questions we've had from the audience today highlight how do you weigh up these various things. So we definitely do that. As Elsie has already pointed out, never let a bad thing go to waste and we use quite a lot of case studies as well. We have intranet site where people post those case studies and what they've learned from there. And then we've done some training for management about how you should have managed in a judgment-based world and indeed in a more remote-based world.

I think we've actually found one of the advantages of remote working to actually be slightly more participative. Virtual rooms are infinite as this webinar is demonstrating, whereas there are very few meeting rooms in the bank which could take... What are we at now? 73 plus a few more. Actually, that's proved to be democratization of the meetings and seeing judgements in place and how people use the work that they've prepared, I think, has definitely benefited that process.

Clive Briault:                   

Thank you, Lyndon. And thank you for that practical example because I think that's a very good illustration of something which any supervisory authority could put into practice, this idea of sharing a real case with a wide range of staff and asking, "How would you have dealt with it?" And a very good way of encouraging people to take judgements, but also taking a view as to whether different people in the organization approaching that afresh would actually take different judgments and how you can finesse that. Elsie, over to you. What are you doing to help your staff become even more judgment-based?

Elsie Addo Awadzi:       

Thank you. I think the first thing is to build the capacity to be able to do that and some of that Lyndon has talked about. But I think it was Martin who talked about the need for lateral thinking. So there's a sense in which we need to build the skills in a broader range of fields than they normally they'd been used to. So a lot of skills development and the managerial aspects of decision-making. But I think in addition to that, the management support is critical because supervisors want to know that they can make decisions, they can exercise judgment. And even if they go wrong, if they have followed a certain protocol, they've exercised best efforts to arrive at those judgments, the institution will still have your back.

And so I think the role of tools like indemnities are very important. When does a supervisor indemnify by the institution if they did something that ended up to be wrong? How do you prove gross negligence? How do you prove that they did the best thing? Along the same lines, you need to also increase your ethical standards, ethics in decision-making and all of that. And in particular, the institutional culture, I think it was Lyndon who referred to that. Institutional culture is important. How does top management view decision-making, even if the right trade-offs are not made? How's the response conveyed and all of that? I think it's a slow process of building confidence really in supervisors and a variety of approaches are required.

Clive Briault:                   

Okay. Thank you very much, Elsie. And Martin, over to you on this one. I think you mentioned earlier in the webinar the way in which you're also thinking about your supervisory framework. So perhaps you could pick up on that angle of this question as well as any other angle you want to cover. Thank you.

Martin Maloney:            

Yeah. I very much agree with what both my colleagues have said, actually, in particularly the emphasis on culture. It's just so important if you wanted to get judgment to happen. But this is all I think about human nature and organizational behavior and trying to get that framework right. I like to think of this under three pillars really. One is the culture question, which has been well covered in the previous answer. I think the second, which is not as important, but is important is the actual regulatory framework itself because you need to make sure, frankly, that combative entities that don't want you to exercise judgment are not in a position to use the way your regulatory framework is written against you to suggest that you don't have the right to make judgment, but you must just follow your own rules.

And that's important to be able to push back against that kind of behavior, which you don't get from most licensed entities, but you do occasionally get and you've got to be aware of that. But the third area that I would focus on is in systems to support judgment. And that to me is critical. So an awful lot of supervisors have been wrestling for many years now and are still wrestling with the development of really effective risk systems to do good analysis of the data that gets reported into us. So that informs a supervisory judgment. And a judgment that is underpinned by data and analysis to support it, which has the authorization and the approval of the organization actually places the supervisor in a much better position to make a judgment.

And one of the areas I think a lot of us are increasingly moving into as a supplement to risk systems is the use of data analytics. So it's not a standard risk system analysis of the reported regulatory data, but a capacity of supervisors themselves to generate a particular analytics query to get an answer to a certain issue that they pose, which very often will allow them to benchmark organizations against each other to identify outliers, and in that way to rationalize or make transparent to their own organization the reasonableness of the judgments that they're exercising. And that's crucially important for supervisors that their colleagues see that they are exercising their judgment in a reasonable and thought out way.

And if you can do that with all the other things that have been said here, to which, by the way, I would however add a HR policy emphasizing inclusion is also important because you need different types of people within your organization who approach things in different way, and you need the natural dissident as well as the natural compromiser. And you need the person who is a technical expert as well as the person who is a good people leader. And you need HR policies that promote that if you're going to get challenge, but not just pointless challenge. Challenge that turns in debate and challenge the turns into the discovery of solutions is critically important for challenge not to become just an exercise in destabilization, but an exercise in the creation of good outcomes.

Clive Briault:                   

Okay. Thank you very much for that, Martin. Indeed, Elsie and Lyndon, again, some excellent practical advice to people. I think this echoes what I take to be a comment rather than a question from one of the audience saying, "The culture of judgment and decision-making needs to be developed for the supervisor to be less reactive and more proactive." I'm sure all the panelists would agree with that. Let me come back now to a different question that's come in. When it comes back to some of the things we were talking about earlier about forbearance during COVID-19 at a time of government support, payment holidays and the like, another question here about can you advise on some safeguards to avoid unintended consequences of regulatory forbearance? Is there a risk as a moral hazard problem here with the government and everyone else seems to be supporting each other, but actually at the end of the day, when all of that support is withdrawn, things don't look quite so good? Lyndon, do you want to go first on this one?

Lyndon Nelson:              

Yes. Thanks, Clive. I think Sofia has a great question. In effect, and these are my words, I would say much of that forbearance we were describing earlier on as part of a sectoral story ultimately has to be tested against what you might call as a microprudential veto. At some point, we have to say the firms can't take this. And so I think that's exactly why Sofia's question is right on the mark. The way we've done it is that when we made some of these forbearance decisions, we set up essentially a reporting template of key measures that we would look at, which essentially captured the thought process that we went through to make the forbearance judgments that we did.

We take notice of lending and all of those other things that we did. We then have measures against those and staff on a monthly basis. And this is independent to the decision-making process, essentially produce their judgment as to where we are on that scorecard using a red amber green. And every month, we look at that piece of paper. And of course, if there are reds, we discuss them. And that really, I think, is a way of keeping us honest to the original decision-making that we took and the original justification for the forbearance that we took that clearly, in some cases, we've had to move that on, and we've had to change process of back changing that.

But I think we've been very careful not to change the original risk appetite. We've kept that going, so we've got some consistency of measure. I think it's probably the best way. I think we know supervisors are often... when things go wrong, I think they're often accused of letting things drift and carry on for a bit too long and all of things. This seems to be the best where we've come out to try and safeguard that. Clearly, it hasn't been tested in the full... We haven't reversed our forbearance, put it that way. But I thought that was probably the best innovation I'd seen to combat Sofia's risk, which I think is a very real one.

Clive Briault:                   

Okay. Thank you, Lyndon. Elsie, you were mentioning in your opening remarks the judgments you've had to make around forbearance and the questions about rebuilding capital liquidity buffers in due course. Any comments you want to make about the potential unintended consequences of all that? Sorry, you're on mute.

Elsie Addo Awadzi:       

Sorry. Yes, that keeps us up at night, where we don't know what we don't know. What we've done is to keep a very close eye like Lyndon said. So we actually have a weekly reporting by the banks on what they're doing with the buffers we release to them. And we wanted to see how they were deploying those, how much of that is going to support moratoria and other reliefs to their customers, how much of that is going into New London, what are the credit underwriting processes going on there, how much of that is going into government paper for which they're making a quick buck and all of that. So we really are monitoring.

As many other regulators have done, we've also put in place restrictions from payment of dividends and payments of executive bonuses and all of that stuff, which we thought would also be very important so that any remaining buffers are not being dissipated. But I think the real question is being able to keep an eye bank to bank and seeing how this is impacting them. At some point we're going to have to pull the plug on these reliefs. And the question is when. And also, if we're going to have an extended period of this pandemic, are we going to have to do even more? That's a tricky question we don't have an answer for now. But we just continue to monitor the situation and have conversations with individual banks as needed.

Clive Briault:                   

Okay. Thank you very much. Martin, anything you just want to add quickly on that [crosstalk 01:00:16]?

Martin Maloney:            

No, I couldn't echo more Elsie's point about that challenge if this crisis were to go on, which is a huge challenge for all supervisors. But maybe just one unintended consequence to observe which is in a regulatory frameworks, we're never designed to be engineering tools for guiding economic activity. So you can release a buffer, or you can have a constraint in place, but that doesn't mean that you know how they're actually going to behave. You can release a buffer and they don't use it. And we have seen a lot of that, just as we have also seen, for example, in money market funds them keeping weekly liquid buffers in place and actually selling off less liquid assets because they don't want to mess with the regulatory constraints. So it is actually a really complicated area to try to use regulatory frameworks to guide economic activity and they were never designed for us.

Clive Briault:                   

Okay. Well, thank you very much for that. We started on time. I think it's important we finish on time. This is all part of good Zoom etiquette. So just to say thank you very much to Toronto Centre and its funders for making this webinar possible. Thank you very much indeed to the three panelists, Elsie, Lyndon, and Martin for their range of, I think, very informative views on the use of supervisory judgment in these difficult times. And last but not least, thank you, the audience, for joining this webinar and for the excellent questions which you've been submitting during this. I'm sorry, we haven't had time to answer every single question.

I can see there's a couple of questions coming in on resolution, dealing with failed institutions. The only solace I can offer you on that is that Toronto Centre did publish a number of Toronto Centre notes, which you can find on the Toronto Centre website this summer on resolution planning and exit policy. I suggest you look those up and read them and I hope they'll go some way to answer your questions. On that basis, thank you very much again for the panelists. I see someone has kindly said here... sorry, on the chat function say, "Thank you for all the great insights." I couldn't have put it better. On that basis, thank you very much. Seasonal greetings and stay safe.

Martin Maloney:            

Thank you, Clive.

Clive Briault:                   

Thank you.

Elsie Addo Awadzi:       

Thank you.