Microprudential

Microprudential supervision is a field of financial regulation focused on the safety and soundness of individual financial institutions. It aims to ensure that banks and other financial firms hold sufficient capital, controls, and liquidity, and that their risk-management, governance, and internal processes are robust enough to withstand idiosyncratic shocks without threatening financial stability.

Regulators use a suite of tools to assess and enforce standards, including capital adequacy requirements (such as Basel III), liquidity standards (like the liquidity coverage ratio and net stable funding ratio), leverage limits, and large-exposure rules. Supervisory review processes, on-site examinations, and off-site monitoring accompany stress testing, recovery and resolution planning, and requirements for risk reporting and disclosure. Firms may use internal models subject to supervisory validation and governance expectations.

Microprudential policy covers banks, insurers, and other regulated financial intermediaries. The framework is commonly organized around the Basel II/III construct with Pillars: Pillar 1 sets minimum capital and risk weights; Pillar 2 addresses supervisory review and the strength of internal controls; Pillar 3 emphasizes market discipline through disclosure. While its emphasis is on individual entities, it interacts with macroprudential aims to reduce systemic risk.

Critics note that microprudential focus can contribute to procyclicality or compliance burdens, and that regulation may incentivize regulatory arbitrage or risk shifting. Effective microprudential policy requires coordination with macroprudential tools, resolution planning, and cross-border supervision to prevent single-firm problems from escalating into broader financial instability.