I think these goals are broadly shared by supervisors and banks alike, which suggests to me that the relationship between supervisors and banks does not always need to be adversarial. Indeed, a healthy dialogue helps this supervisory process to work well. For example, it is important that firms are proactive in revealing problems to their supervisors. And, individual institutions can certainly benefit from the horizontal perspective that supervisors bring to examinations. This perspective can highlight where the firm stands vis-à-vis best practices, or where there may be important vulnerabilities in its operations. Of course, there is an irreducible amount of tension built into this relationship, given that each party’s roles, interests, and responsibilities will not always coincide. Banks are naturally more sensitive to constraints on their profit opportunities or dividend policies and to the costs of regulation. They may also question how much protection is necessary—for example, how stringent the capital requirements or how severe stress testing assumptions should be. These are areas where I would expect perspectives to differ. Supervisors are principally focused on compliance with laws and regulations as well as issues of safety and soundness. They also bring to their work a perspective on financial stability that may not match the more narrow interests of the firm. For example, supervisors seek to address the externalities created by the failure of a systemically important firm by imposing higher capital and other requirements than the firm would likely select if left to its own devices.

After all, misaligned incentives contributed greatly to the financial crisis and continue to affect bank conduct and behavior.2 Today, I will address this issue of incentives, with emphasis on the complementary roles of regulation, supervision, and bank culture. Each of these is necessary to ensure that we have a robust and resilient financial system not just today, but also in the future. Progress since the financial crisis The financial crisis was a watershed event that exposed severe deficiencies in the financial system—including the inadequacy of bank capital and liquidity buffers, poor risk management and internal controls, and bad bank cultures. Many financial firms took on an excessive amount of risk and did not always act in ways consistent with the interests of their customers or the broader public. The crisis revealed woeful shortcomings in many of these elements, with terrible consequences for the economy and millions of people. Over the past decade, the official sector and the financial industry have made considerable progress in addressing these problems. The banking system is much sounder and more resilient as a result, in a number of ways. First, systemically important banks are much safer.3 They have much bigger liquidity and capital buffers, and the quality of capital is much improved. Moreover, the capital regime now has a forward-looking element in which annual stress tests examine banks’ ability to withstand losses under severely adverse economic conditions and constrain the amount of capital that can be returned to shareholders via dividends and share repurchases.