Risk-based Supervision in the Banking Sector: Its Impact on Bank Stability and Profitability

Abstract

This study aims to examine the opportunities to enhance bank stability and profitability following the implementation of the risk-based supervision (RBS), which is a regulatory approach that prioritizes allocating oversight resources based on each bank’s risk profile, applying a structured, process‐driven methodology to identify and quantify not only the risks faced by a bank but also the quality of its risk management and internal controls. This study adopts both qualitative and quantitative approaches. Qualitative data from expert interviews, focus group discussions, and stakeholder interviews are used to project financial indicators for individual banks, prioritizing their historical trends and considering RBS intervention. We conducted the panel data analysis of the historical and projected data for Bangladesh's commercial banks to examine the impact of RBS on bank stability and profitability. We incorporate both fixed and random effects in analysing data. Our analysis of historical and projected data for Bangladesh's commercial banks reveals evidence of enhanced bank stability as an impact of RBS. Effective supervision will ensure proactive measures to maintain asset quality, prevent capital erosion, reduce non-performing loans, and ultimately ensure bank stability. However, RBS adversely affects banks' profitability due to the costs of developing IT infrastructure, implementing enhanced management control systems, and hiring skilled, well-trained employees. This study contributes to the banking literature by quantifying the impact of risk-based over rule-based bank supervision. Its findings will facilitate policymakers, regulators, and bank management in strategic decision-making to achieve the maximum output from RBS implementation.