Global banking regulator compares banking with aviation suggesting regulators want to 'reduce the risk of flying in unsafe planes where the pilot is the only one with a parachute'

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By Gareth Vaughan

Bankers would do well to think more like pilots when it comes to risk aversion, a leading international banking regulator suggests, noting that risk management in both industries ought to be paramount.

Wayne Byres, the Secretary General of the Switzerland-based Basel Committee on Banking Supervision, part of the Bank for International Settlements, made the comparison between bankers and pilots in a speech given in Portugal entitled Regulatory reforms – incentives matter (can we make bankers more like pilots?)

"Pilots want to land safely," Byres said. "Bankers do not necessarily have the same natural incentive towards risk aversion. So bank regulation needs to pay particular attention to the incentives it creates for those 'flying the plane'."

In diverse and complex organisations like modern banks, ensuring incentives work in the right direction was easier said than done, Byres said. Effective regulation and supervision of banks was about helping to ensure incentives are appropriately aligned, for the benefit not just of the bank but  for society as a whole.

"This is no easy task. To illustrate this challenge, let me draw some parallels with the aviation industry," said Byres.

"As time has gone by, air travel has become commonplace. The skies are more crowded, and more and more air miles are flown. Planes, like banks, have developed in size, speed, sophistication and complexity, allowing more people to travel further, faster, and at less cost. But at its core, flying is still a risky business."

"Airlines, of course, are commercial businesses seeking to maximise profit by, among other things, minimising costs. An entire framework of air safety rules and regulations has therefore grown up to ensure that the incentives to minimise costs and maximise profits do not jeopardise the safety of passengers. As in banking, risk management must be paramount," Byres said.

Over time airline safety rules, and the supervisory practices of air traffic controllers, have become more detailed and sophisticated. Although, unfortunately, accidents still happen with devastating results at times, overall the airline industry has become safer when measured against passenger numbers or distances flown.

"The trade-off between increasing complexity and the costs associated with air safety is deemed worthwhile, even though ultimately we all pay those costs in one form or another," Byres said.

"Banking regulation is designed to make banks safer, just as aviation regulation is designed to make planes safer. But there is one advantage that airline safety regulators have that banking regulators do not: that is, the passengers of planes can take comfort that their desire for a safe flight is highly aligned with that of their pilots. Pilots have little incentive to take off in an unsound plane, or to perform aerial manoeuvres that provide a short-term thrill but could stress the plane beyond its limits."

He went on to defend the Basel III global banking reforms. Developed by the Basel Committee on Banking Supervision but adapted to individual countries by their regulators such as the Reserve Bank of New Zealand, Basel III is a set of reform measures designed to strengthen the regulation, supervision and risk management of the banking sector in the wake of the Global Financial Crisis. It aims to improve the banking sector's ability to absorb shocks arising from financial and economic stress, improve risk management and governance, and strengthen banks' transparency and disclosures

"Basel III is not just a set of minimum requirements, but it also creates a set of incentives," Byres said.

"When examining the merits of regulatory reform, it is important to look at both the minimum requirements imposed at a given point in time, and the incentives they create for the future. We believe that Basel III creates the right type of framework for safe banking. Getting this right is difficult, and requires a great deal of analysis, careful thought, and a good dose of common sense. But our goal is rather simple: to reduce the risk of flying in unsafe planes where the pilot is the only one with a parachute. On that, I am sure we all agree."

New Zealand banks must start meeting the Reserve Bank's Basel III rules from next year, which increase their minimum capital requirements. See more on this here.