Lars Nyberg: Issues in supervision of banks - the European experience  Speech by Mr Lars Nyberg, Deputy Governor of the Sveriges Riksbank, at the Association of Professional Bankers, Colombo, Sri Lanka, on 26 August 2000. *  *  *  Background First of all, I want to thank you for giving me this opportunity to discuss with you some questions concerning the supervision of banks. The issue, I understand, is quite timely, since Sri Lanka has embarked on an ambitious project of developing the financial sector, opening the banking system to international influence and modernising it accordingly. A sound and well functioning financial sector is a key to economic development. This statement may sound uncontroversial in your ears, but it is not always accepted by the general public and by the politicians. The contributions of the financial sector are sometimes hard to explain in simple terms and people tend to look at banks with suspicion. To create credibility and respect for the financial sector in general and most importantly for banks, a proper and well-developed supervision is essential. Bank of Sri Lanka has realised this and initiated a comprehensive upgrading of bank supervision. In my view this is exactly the right point to start developing the financial sector. Supervision, however, is developing quickly. Supervising a traditional highly regulated banking system is far different from supervising a deregulated system open to foreign competition. Furthermore, going from a state of strict regulations to one of deregulation implies risks for undermining banking stability.

In my view, in markets where banks are dominating the financial sector and where the integration with securities and insurance markets are less pronounced, keeping the supervision separate and within the central bank makes good sense. Having said this, I acknowledge that the present tendencies are for banks to merge with other financial institutions, and for financial instruments to look increasingly alike whether they are created in banks or in other institutions. These tendencies would indicate a corresponding need for supervision of different financial sectors to cooperate closer and closer and, perhaps, finally to merge. The trend is clearly seen in Europe, reinforced by the common currency, but is gradually developing also in other countries. As mentioned above, this is the way we have organised supervision in Sweden. But I do not see a need to consolidate the supervisory authorities in a specific country until the structure of its financial markets so requires. As an intermediate step, cooperation agreements between the supervisory authorities should be encouraged. A strong rationale for locating bank supervision in a central bank is that bank stability is of crucial importance for the conduct of monetary policy. In addition, a central bank has the powers to provide liquidity - under normal as well as exceptional circumstances - to banks, for instance as a lender of last resort. To do this, it is obvious that the central bank must have full knowledge about the financial situation of a bank. However, there are also good arguments for keeping supervision separate from the central bank.