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Designing a System of Financial Regulation

Designing a System of Financial Regulation. Howard Davies Director - London School of Economics. Executive Public Policy Training Programme Beijing 20 June, 2006. Five Steps to Reform. Assess the strengths and weaknesses of the financial system

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Designing a System of Financial Regulation

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  1. Designing a System of Financial Regulation Howard Davies Director - London School of Economics Executive Public Policy Training ProgrammeBeijing20 June, 2006

  2. Five Steps to Reform • Assess the strengths and weaknesses of the financial system • Determine the desired future shape of the system • how flexible? • how open? • 3. Assess compliance with international standards • 4. Review the structural options • 5. Map them against local market conditions

  3. 1. The Strengths and Weaknesses of the Financial System

  4. Global Financial Stock 2004 (%)China is becoming a significant part of the global system Source: McKinsey Global Institute, 2006

  5. Financial Depth – Financial Stock as % of GDP 2004China’s financial system is already well-developed (%) Source: McKinsey Global Institute, 2006

  6. Bank Deposits as % of Financial StockBut it is very heavily dependent on banks Source: McKinsey Global Institute, 2006

  7. Chinese Share of Global Financial Stock (%) 2004And the capital markets are relatively small Source: McKinsey Global Institute, 2006

  8. 2. The Desired Future Shape of the System • Meet WTO commitments • Strengthen competitive pressures: greater flexibility • Expand capital markets as a source of finance for growth • equities • private sector bonds • Improve financial services for lower income families, and in remote areas

  9. 3. Compliance with International Standards

  10. The International Financial Architecture G7 Finance Ministers International Monetary Fund World Bank Financial Sector Assessment Programmes ADB IADB EBRD etc ICFC Financial Stability Forum Global Financial Stability Report

  11. A. Banking Supervision G10 Governors + Heads of Supervision Bank of International Settlements Basel Committee G10 + Spain, Luxembourg EC ECB Central Banks and Supervisors Basel Capital Accord

  12. B. Securities Regulation IOSCO- Core Principles Multilateral MOU C. Insurance Regulation IAIS - Solvency Standards D. International Accounting Standards

  13. 4. Review the Structural Options Four main models in operation elsewhere • ‘3 pillars’: banking, securities and insurance separately regulated • ‘Twin Peaks’: separation of prudential and conduct of business regulation • ‘Hybrid’: where two or more sectors are regulated together • ‘Integrated’: a single regulator covering most or all of the financial sector.

  14. There is no clear consensus about which model is ‘best’.

  15. Structure of Supervision in 77 Countries, 2002 Agency supervising two types of financial intermediaries Indicator Single supervisor for Banks and Banks and Securities firms Multiple the financial system securities firms insurers and insurers supervisors Countries Austria, Bahrain, Dominican Austria, Belgium, Bolivia, Chile Argentina, Bahamas, Bermuda, Cayman Republic, Finland, Canada, Colombia Egypt, Mauritius, Barbados, Botswana, Islands, Denmark, Luxembourg, Ecuador, El Slovakia, South Brazil, Bulgaria, China, Estonia, Germany, Mexico, Salvador, Africa, Ukraine Cyprus, Egypt, France, Gibraltar, Hungary, Switzerland, Guatemala, Greece, Hong Kong Iceland, Ireland, Uruguay Kazakhstan, (China), India, Japan, Latvia, Malaysia, Peru Indonesia, Israel, Italy, Maldives, Malta, Venezuela Jordan, Lithuania, Nicaragua, Norway, Netherlands, New Singapore, Rep. of Zealand, Panama, Korea, Sweden, Philippines, Poland, United Arab Emirates Portugal, Russia, United Kingdom Slovenia, Sri Lanka, Spain, Thailand, Turkey, United States % of counties 29 8 13 9 38 in the sample Source: Luna Martinez and Rose (2003)

  16. There is a trend towards integrated regulation for a number of reasons - growth of financial supermarkets - risk transfer between sectors - attractions of ‘one-stop shopping’

  17. Main Reasons for Adopting Integrated Supervision (agencies indicating any one of the following reasons

  18. But there are also important variations between integrated regulators - scale - scope - powers

  19. Powers of the Integrated Supervisory Agencies over Banks Source: Luna Martinez and Rose (2003)

  20. How the Centres Rank in Terms of their Regulatory Environment Market participants tend to favour integrated regulation Source: Z/Yen, 2005

  21. 5. Map options against local market conditions China now operates a ‘3 pillar’ model, but with banking supervision outside the central bank • suitable where there is little ‘cross-sectoral’ activity • also where a single agency might be seen to be ‘too powerful’ • and where sheer scale makes effective management difficult.

  22. Regulatory Reform in China is under way - 3 commissions: CBRC, CSRC, CIRC • International Advisory Councils - Training • Cultureof challenge • Overarching body to resolve inconsistencies • and promote co-operation

  23. An integrated regulator might be more appropriate if • banks are allowed to undertake other activities: universal banking • derivatives markets develop, allowing risks to be transferred between sectors • multi-functional overseas firms enter the markets on a large scale

  24. Designing a System of Financial Regulation Howard Davies Director - London School of Economics Executive Public Policy Training ProgrammeBeijing20 June, 2005

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