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Regulatory Framework

Regulatory Framework. Jeff Carmichael Chairman Australian Prudential Regulation Authority. Topics for The Session. Contributions & risks from NBFIs Effective regulation: Powers Rules & Regulations Internal Practices & Procedures Regulatory Structure. Financial Services.

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Regulatory Framework

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  1. Regulatory Framework Jeff Carmichael Chairman Australian Prudential Regulation Authority

  2. Topics for The Session • Contributions & risks from NBFIs • Effective regulation: • Powers • Rules & Regulations • Internal Practices & Procedures • Regulatory Structure

  3. Financial Services • Payments services • Liquidity • Divisibility • Store of value • Information efficiencies • Risk pooling

  4. NBFI Roles • Broaden spectrum of risks • Encourage savings and investment • Foster risk management • Enhance systemic resilience • Fill the gaps • Provide competition for banks

  5. Empirical Evidence Growing evidence that: • Financial development contributes to economic development • Contribution is increased where NBFIs are involved

  6. Sources of Risk from NBFIs • NBFIs can circumvent the intention of banking regulation, eg Asian experience • Thai finance companies • Hire purchase in Malaysia • Korean Merchant Banks & ITCs Plus: • Pseudo-banks in Latin America

  7. Sources of Risk from NBFIs • NBFI associations with banks through conglomerates, eg Asians again • Korea and Indonesia • State banks in Australia • Latin America also

  8. Community Expectations • Market conduct: • Policemen role • Severity of penalties less important that likelihood of being caught • Prudential: • Doctor role • Prevention rather than prosecution

  9. Characteristics of Prudential Regulation • Intervention is graduated: • Breaches are a warning • Process involves cooperation • Regulators are not infallible: • The process increases risk • No regulator can guarantee no failures

  10. The Road to Effectiveness • Stronger powers • Stronger policies • Stronger internal practices and processes

  11. Powers - Conduct & Prudential • Licensing • Information • Examinations • Investigations • Standards/regulations • Administrative sanctions • Directions • Prosecution

  12. Prudential Powers • Ownership & Control • Appoint experts • “Whistleblower” provisions • Statutory management/inspector • Transfers of business • Liquidation

  13. Australia - Prudential Powers

  14. Solvency Vs Risk Australian Insurance Act 1973 – Capital set at greater of: • $2 million • 15% of OCP • 20% of Premium Income New framework (2002) requires: • More capital for higher risks • Capital for asset risks

  15. Dangers of Over-Prescription US Vs International Accounting standards Same issue in Prudential Regulation Prescription leads to: • Legalistic responses • Questions of who is responsible • Inflexibility

  16. Australian Changes • New risk-rating system • Escalation procedures • Wide circulation of high-risk assessments • Dealing with informants • Greater enforcement orientation

  17. Priorities • Start with internal practices and processes • Push your laws to the limit • Never miss an opportunity to push reform • Learn from failures and from each other

  18. Objectives of Regulation Regulatory Actions • Anti trust • Anti collusion • Disclosure • Education • Financial law enforcement • Governance • Licensing • Capital adequacy • Liquidity • Risk management • Failure management • Macro economic policy • Payment system Market Failures • Anti-competitive behaviour • Market misconduct • Information asymmetry • Systemic contagion Ultimate Goals • Efficiency • Fairness • Safety • Stability

  19. Approaches to Structure • Industry: Separate agencies for each industry group • Pure form: One agency for each group but responsible for all 4 market failures • Objectives: Separate agencies for each market failure • Pure form: One agency for failure but responsible for all institutions • Reality: Nearly all are hybrid

  20. The Traditional Industry Approach Pressure from: • Convergence in financial markets and the emergence of financial conglomerates • The need for greater regulatory neutrality • Better use of scarce regulatory skills and resources

  21. Rationale for Integration • Aligns the regulatory structure with the industry structure • Resource efficiencies • Maximize regulatory neutrality • Integrated regulation is objectives-based

  22. Choosing Among Structures There is no single regulatory structure that is ideal for all countries and for all points in time Ultimately a matter of judgement

  23. The Pure Objectives-based Model • Case for: • Maximizes regulatory focus • Minimizes cultural clashes • Reduces confusion about safety nets • Case against: • Still requires inter-agency cooperation • Resolution of conflicts can be a problem • Responses: • Resolution mechanisms • Clear demarcations • Higher level of aggregation of objectives

  24. Combining Prudential & Conduct • Case for combining: • One umbrella regulator for all parts of conglomerates • Bigger and more powerful agency • Can resolve regulatory conflicts internally • Case for separation: • Cultural clashes • Loss of focus - from multiple objectives • Potential misperceptions about the safety net • Failure in one area can erode credibility in others No definitive answer but most so far have elected to combine

  25. Combining Prudential & Systemic • Case for combining: • Synergies in systemic stability regulation • Last resort lending needs knowledge of banks • Avoids crisis management by committee • C banks are more independent and better staffed • Case for separation: • C bank with 2 objectives - loss of focus • Supervisory staff not always equal C banks • C banks lack the expertise for NBFI regulation • Cultural clashes Most have elected not to combine so far

  26. Latin American Structures

  27. What Does IR Really Offer? • Integrated regulation does not: Automatically correct regulatory failures (though it can contribute) • Integrated regulation does: • Help with conglomerates • Reduce regulatory arbitrage • Make better use of scarce resources

  28. Regulatory Neutrality • Simply putting different regulators together is not enough • ‘Integration’ needs: • An integrated staff structure • A harmonized set of powers and Laws • A common approach to standards • A common approach to analysis and inspection

  29. Regulation by Risk 5 Fundamental Risk Types: • Credit risk • Market risk • Insurance risk • Liquidity risk • Governance (operational) risk

  30. Conglomerate Regulation • Integration eliminates “turf” wars • Single set of definitions (controllers, affiliates etc) • Consistent set of powers across industry groups

  31. Summary • NBFIs offer risks and rewards • Risks need sound regulation • NBFI regulation in the region is underdeveloped • Areas for improvement: • Powers • Policies • Practices & procedures • Extracting the benefits from integration is a big challenge

  32. Regulatory Framework Jeff Carmichael Chairman Australian Prudential Regulation Authority

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