Alternative Approaches to Regulatory Structure

Jeff CarmichaelChairman

Carmichael Consulting Pty Ltd

Outline

• Main models that have emerged around the world

• Key issues for consideration

• How the various models handle the issues and mitigate the risks

• Making regulation effective

Conclusions: There is no perfect structure Structure matters – but it doesn’t guarantee good regulation

Some Definitions

• Regulation Vs Supervision• Regulatory structure• Institutional structure• Unified structure• ‘Mega’ regulators/‘Super’ regulators/ ‘Integrated’ regulators

Main Models

• Institutional (31)

• Mexican (9) – Banking and securities

• South African (3) – Non-banks

• Canadian (13) – Banking and insurance

• UK (10) – unified outside CB

• Singaporean (3) – unified within CB

The ‘Big 8’ Issues

1. Role of the Central Bank

2. Cultural conflicts

3. Objective conflicts

4. Co-operation and co-ordination

5. Size

6. Regulatory arbitrage

7. Financial conglomerates

8. Political dynamics

Role of the Central Bank

• Systemic stability role is undisputed

• Case for regulatory role:• Banks are key to systemic stability• LLR• Banks and monetary policy

• Specific Emerging Market issues:• CBs are typically more independent• CBs are typically better resourced

Case Against CB Regulatory Role

• Case against:• Conflicts between regulatory and monetary policies• Reputational risk

• On balance – don’t separate banking regulation from CB unless there are powerful other reasons for doing so

Conflicts of Culture

• Conduct (policemen) Vs Prudential (doctor)

• Different skill sets are needed

• Different approaches are needed

• There are risks in bringing them under the same roof

• But there can also be benefits from exposing the cultures to each other

Conflicts Among Objectives

Regulatory Objectives:• Systemic stability – payments and macro policy• Safety and soundness – prudential• Fairness – conduct• Efficiency – competition

Conflicts:• Prudential/conduct• Prudential/competition

Handling conflicts:• Internal Vs external

Co-operation & Co-ordination

• Co-operation and co-ordination are needed under any structure

• But some are more demanding than others:• Institutional – conglomerates• Canadian – multiple regulators• Unified – across departments

Size

• Can be the ‘deal breaker’

• Very small countries:• Shortage of regulatory skills• Economies of scale• Cost• Careers

• Very large countries:• Risk of dominance• Risk of over-regulation

Regulatory Arbitrage

• Effective regulation demands neutrality

• Arbitrages arise from gaps and overlaps

• Institutional structure is exposed

• Choice can lead to arbitrage

• Conglomerates can exploit arbitrage

• Arbitrage not limited to prudential regulation

• Higher levels of amalgamation should lower risk of arbitrage

Financial Conglomerates

• Emergence of conglomerates has challenged traditional demarcations due to:

• Complexity of structures• Intra-group exposures and lack of transparency• Contagion• Lack of information to specialist regulators

• Need to capture totality of risks

• Regulatory structure should reflect industry structure

Political Dynamics

• Change has many stakeholders

• Change needs a champion who can deliver

• Change can be a catalyst for delivering the undeliverable (powers, break up ineffective coalitions, improve conditions)

• Nevertheless, resistance is inevitable and should be anticipated

• A compromised outcome may be worse than the status quo

Institutional Model

• Positives:

• Leaves banking regulation with CB

• Separates cultures (to a point)

• Facilitates tailoring

• Avoids over-concentration of power

• Negatives:

• Can lack scale

• Potential for capture

• No real synergies

• High cost

• Reputational risk for CB

• May have conflicts of objectives

• Potential for gaps and overlaps

• Doesn’t deal well with conglomerates

Risk Mitigation – Institutional Model

• Co-ordination:• Council of regulators• Lead regulator• Cross-board memberships

• Gaps – power to deem institutions to require regulation

Mexican Model

• Positives:

• Some economies of scale and career opportunities

• Doesn’t over-concentrate power

• Less costly than institutional

• Can deal with bank/securities conglomerates

• Negatives:

• Can lack scale in insurance

• Insurance exposed to capture

• No real synergies

• Cost may still be high

• Potential cultural clashes

• Possible conflict of objectives

• Gaps and overlaps – congloms.

• Difficult to keep in CB

Risk Mitigation – Mexican Model

• Co-ordination:• Council of regulators• Lead regulator• Cross-board memberships

• Gaps – power to deem institutions to require regulation

• Cultural clash - silos

South African Model

• Positives:

• Leaves banking regulation with CB

• Economies of scale in non-bank regulation

• Better balanced than Mexican

• Power no overly-concentrated

• Deals with non-bank conglomerates

• Negatives:

• No real synergies

• Relatively high cost

• Bank/non-bank conglomerates

• Culture clashes

• May have conflicts of objectives

• Reputational risk for CB

Risk Mitigation – S.Af. Model

• Co-ordination:• Council of regulators• Lead regulator• Cross-board memberships

• Gaps – power to deem institutions to require regulation

• Cultural clashes - silos

Canadian Model

• Positives:

• Aligns structure with objectives/less cultural clash

• Economises of scale in prudential regulation

• Deals with ‘prudential’ conglomeration

• Stronger career prospects

• Reduces arbitrage opportunities

• Maximises synergies

• Negatives:

• Removes banking

• Concentrated power

• One-size-fits all

• Co-ordination still needed

• Conglomerates with securities

Risk Mitigation – Canadian Model

• Co-ordination:• Council of regulators• Cross-board memberships

• Concentration of power – legislate strong governance and accountability

UK Model

• Positives:

• Matches structure with industry – conglomerates

• Minimises arbitrage

• Very broad career prospects for staff

• Economies of scale/lower costs

• Resolve conflicts internally

• Synergies

• Negatives:

• Concentration of power

• Conflicts of objectives

• Conflicts of culture

• Banking away from CB

• Possible one-size-fits all

Risk Mitigation – UK Model

• Co-ordination:• Cross-board memberships with CB

• Power – need for very strong governance and accountability (e.g. UK)

• Culture – silos

Singaporean Model

• Positives:

• Leaves banking regulation with CB

• Very cost effective

• Good career prospects/synergies

• Maximises scale economies and synergies

• Eliminates arbitrage and deals with conglomerates

• Negatives:

• Extreme concentration of power

• Clashes of objectives

• Clashes of culture

• Moral hazard on safety net

• Reputational risk

• One-size

Risk Mitigation – Singaporean Model

• Moral hazard - need to educate public about safety nets

• Power – needs very strong governance and accountability (rare in CBs)

Choosing a Structure

• Every structure has some strengths and weaknesses

• In practice, moves towards some form of amalgamation have been prompted mainly by:

• Cost/scale• Reducing regulatory arbitrage• Conglomerates

• In practice, any structure can work if it has the right foundations and commitment

Independence and Accountability

• Independence is to ensure clarity of objectives

• Regulators need independence to:• Develop, implement and enforce policy

• Independence is determined by:• Appointment and dismissal terms• Indemnities for staff• Relationship to Government

• The greater the independence, the greater should be the accountability

Governance

• Refers to how the agency is run:• How it deals with conflicts• How it ensures it is doing its job effectively

• Requires internal structures such as:• Board• Risk Committee• Code of conduct• Delegation structure and internal controls• Dispute mechanisms

Powers

• Issue of how much ‘black letter’ law

• Ideal powers include:• Licensing/de-licensing• Regulations/standards• Reporting obligations• Monitoring and surveillance• Directions• Investigation• Enforcement

• Transfers • Statutory management• Winding up• SROs• Information sharing

Funding

• Independence of funding is critical (independent but accountable)

• Adequacy of funding is critical

• Best model is industry funding

Summary

• Regulation is a ‘hot’ topic• Regulation matters – but it is not a panacea• International trend has been to amalgamate into

one of a number of different forms• No model is perfect and requires a balancing of

issues:• Role of CB

• Cultural clashes

• Conflicting objectives

• Co-operation

• Size

• Regulatory arbitrage

• Conglomerates

• Political dynamics

Alternative Approaches to Regulatory Structure

Jeff CarmichaelChairman

Carmichael Consulting Pty Ltd