Alternative Approaches to Regulatory Structure

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Alternative Approaches to Regulatory Structure

• Jeff Carmichael
• Chairman
• Carmichael Consulting Pty Ltd

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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 doesnt guarantee good
  regulation

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Some Definitions

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

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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

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The Big 8 Issues

• Role of the Central Bank
• Cultural conflicts
• Objective conflicts
• Co-operation and co-ordination
• Size
• Regulatory arbitrage
• Financial conglomerates
• Political dynamics

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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

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Case Against CB Regulatory Role

• Case against
• Conflicts between regulatory and monetary
  policies
• Reputational risk
• On balance dont separate banking regulation
  from CB unless there are powerful other reasons
  for doing so

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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

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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

10
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

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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

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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

13
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

14
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

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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
• Doesnt deal well with conglomerates

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Risk Mitigation Institutional Model

• Co-ordination
• Council of regulators
• Lead regulator
• Cross-board memberships
• Gaps power to deem institutions to require
  regulation

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Mexican Model

• Positives
• Some economies of scale and career opportunities
• Doesnt 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

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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

19
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

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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

21
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

22
Risk Mitigation Canadian Model

• Co-ordination
• Council of regulators
• Cross-board memberships
• Concentration of power legislate strong
  governance and accountability

23
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

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Risk Mitigation UK Model

• Co-ordination
• Cross-board memberships with CB
• Power need for very strong governance and
  accountability (e.g. UK)
• Culture silos

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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

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Risk Mitigation Singaporean Model

• Moral hazard - need to educate public about
  safety nets
• Power needs very strong governance and
  accountability (rare in CBs)

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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

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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

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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

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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

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Funding

• Independence of funding is critical (independent
  but accountable)
• Adequacy of funding is critical
• Best model is industry funding

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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

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Alternative Approaches to Regulatory Structure

• Jeff Carmichael
• Chairman
• Carmichael Consulting Pty Ltd