This post is part of Notice & Comment’s symposium on Peter Conti-Brown and Sean Vanatta’s Private Finance, Public Power: A History of Bank Supervision in America. For other posts in the series, click here.

The goal of scholarship in law, in economics, or in general should be to expand our understanding of the world. Peter Conti-Brown and Sean Vanatta’s recent book, Private Finance, Public Power, explores the history of bank supervision in America, explaining how supervision has evolved and describing the interplay between private finance and public regulatory power. The work materially adds to our understanding of the theory and practice of banking in the United States.

Bank supervision is so embedded in the fabric of bank regulation that it is easy to miss its distinctive features and to conflate supervision with regulation. The laser-like focus on bank supervision in America contributes to our understanding of both banking in particular and of regulation in general by highlighting the distinctive features of supervision, explaining the interactions between bank regulation and bank supervision, and showing the profound effects of supervision on the nature and structure of the U.S. banking industry.

At a superficial level, the distinction between regulation and supervision is simple. In the context of banking, regulation is the creation and articulation of rules, laws and policies that govern the behavior of financial institutions. Regulations govern things like which activities are permissible to banks, the levels of capital and liquidity that banks are required to maintain, and how consumers are protected from misbehavior by banks. Supervision consists of monitoring of banks and dynamic enforcement of the static regulations in place at any particular point in time.

The implementation and enforcement of capital requirements illustrate the authors’ point about the symbiotic relationship between regulation and supervision in the banking industry, making an effective case that supervision plays a critical role in shaping and enforcing bank capital requirements. Since capital requirements are arguably the most important and impactful regulations affecting banks, establishing that supervision plays a pivotal role in shaping and enforcing bank capital requirements goes a very long way towards establishing the authors’ point that bank supervision is a critical determinant of bank regulation. The primary role of supervision in the context of bank capital requirements is to assess the adequacy of a bank’s capital to determine whether it is capable of absorbing losses in order to survive during periods of financial stress. While supervisors of course seek to ensure that banks comply with applicable capital requirements, this is far from all of the work they do in connection with regulating bank capital. In times of financial instability, supervisors sometimes exercise discretion to relax or to tighten capital requirements based on their judgment about what action is required to stabilize the banking system.

Also, bank supervisors play a crucial role in the all-important job of evaluating the quality of a bank’s assets and in assessing the sensitivity of those assets to risk in order to operationalize the system of risk-based capital requirements that lie at the heart of the financial system. These risk assessments, which include evaluations of management quality, influence the amount of capital considered necessary to get the bank to operate safely. Thus supervision both operationalizes regulation and injects vitality into a system that otherwise would be wooden and rigid.

It stands to reason that if there is a distinction between supervision and regulation, there also should be a distinction between supervisors and regulators. The authors, however, do not always clearly distinguish between the act of regulating and the act of supervising. But the act of supervising can be differentiated from the act of regulating. Supervising involves overseeing operations and managing to ensure compliance with the letter and the spirit of the regulations promulgated by the regulators. At a minimum, it seems clear that regulation occurs before supervision, and that regulators’ work occurs prior in time to the work of supervisors.

Commendably, the authors have a lot of interesting things to say on the important topic of the influence of special interest groups on policy—from organized industry groups like the American Bankers Association, which is described as having “waged increasingly apocalyptic campaigns” against policies they opposed, and from consumer groups, which advocated for greater disclosure and tougher enforcement of laws like the Truth-in-Lending Act (TILA) and the Community Reinvestment Act (CRA). The sharp distinction between regulation and supervision that the authors seek to make holds up well. Interest groups not only press for regulations that favor their membership, they also press to influence supervisory priorities in ways that advance their own goals. For example, the authors interestingly point out that consumer groups sometimes pressed for greater attention to enforcing Truth-in-Lending and other consumerist rules, but that supervisors pushed back favoring a traditional focus on managing risk (p. 300). Gradually, particularly due to the creation of consumer departments like the Consumer Affairs Division of the Comptroller’s Office and the Office of Saver and Consumer Affairs, supervisory agencies began to focus more on consumer issues.

The point of the book is that bank supervision historically has been and continues to play a central role both in the regulation of banks and in actually shaping contours of the U.S. financial system. Supervision, which involves active management of financial risk, discretionary decision-making, and balancing the inevitable tradeoffs between public and private interests, has evolved over time and periodically adapted and “updated” itself in response to external forces, particularly financial crises, political pressure, and changes in economic conditions.

Jonathan Macey is Sam Harris Professor of Corporate Law, Securities Law and Corporate Finance at Yale Law School.