Aligning Financial Regulatory Architecture with Country Needs: Lessons from International Experience

1. Aligning Financial Regulatory Architecture with Country Needs: Lessons from International Experience World Bank Conference, New Delhi, 6 June 2004 Issues in making regulatory structures effective – communicating with stakeholders Andre Bezuidenhout South African Reserve Bank

2. ISSUES IN MAKING REGULATORY STRUCTURES EFFECTIVE – COMMUNICATING WITH STAKEHOLDERS OVERVIEW • Stakeholders in Financial Stability • Importance of Coordination and Information Exchange • Does institutional structure help with Communication? • Country Specifics influencing Coordination • Rationale for an Objective Based Approach

3. STAKEHOLDERS IN FINANCIAL STABILITY WHO ARETHEY? • Government • Central Bank • Financial Regulator(s) • Deposit Insurer • Financial Firms • Consumers/Public

4. STAKEHOLDERS IN FINANCIAL STABILITY WHAT ARE THEIR INTERESTS? • Government Low social costs • Central Bank System stability • Fin. Regulator(s) Institutional soundness • Deposit Insurer Fund protection • Financial Firms Sustainable business • Consumers/Public Protection

5. STAKEHOLDERS IN FINANCIAL STABILITY WHAT ARE THEIR ROLES ? • Government Policy and legislation • Central Bank Systemic oversight • Financial Regulator(s) Supervision • Deposit Insurer Risk monitoring • Financial Firms Prudential compliance • Consumers/Public Awareness

6. STAKEHOLDERS IN FINANCIAL STABILITY WHAT ARE THEIR ROLES IN A CRISIS? • Government Capital provider • Central Bank Liquidity provider • Financial Regulator(s) Problem resolution • Deposit Insurer Reimburse small dep. • Financial Firms Responsiveness • Consumers/Public Awareness

7. IMPORTANCE OF COORDINATION AND INFORMATION EXCHANGE BETWEEN STAKEHOLDERS GOVERNMENT Example informational needs Information sources Normal times Qualitative assessments CB, FSAPs, Quantitative assessments CB, Independent analysts, Rating Agencies Crisis times Situational reports CB, Fin Regulator(s) Resolution proposals Safety Net Participants

8. IMPORTANCE OF COORDINATION AND INFORMATION EXCHANGE BETWEEN STAKEHOLDERS CENTRAL BANKS Example informational needs Information sources Normal times Macro-prudential info Various Aggregated Micro-prud data Fin Regulator(s) Crisis times System risk info Fin Regulator(s), Fin Firms Liquidity data Troubled fin. Firms Asset quality/collateral Due diligence auditors Exit policy Government

9. IMPORTANCE OF COORDINATION AND INFORMATION EXCHANGE BETWEEN STAKEHOLDERS FINANCIAL REGULATOR Example informational needs Information source Normal times Compliance assessments On-site inspections Prudential data Statutory returns Strategic and risk info Management meetings Crisis times Liquidity status Daily flow analyses Asset quality Due diligence audits Problem resolution strategies Board/s/holder meetings LOLR, Exit policy Government, CB

10. IMPORTANCE OF COORDINATION AND INFORMATION EXCHANGE BETWEEN STAKEHOLDERS CLASSES OF INFORMATION Requirement User Source Policy direction All Government Regulatory principles CB Government Prudential requirements Fin. firms Prud. Regulator(s) Conduct rules Fin. Firms Conduct regulator(s) Micro-prudential data Prudential sup. Fin. firms Macro-prudential indicators Systemic regulator Prudential sup(s) Macro-financial data Systemic regulator Exchanges Qualitative assessments All Various International macro data All Various

11. STAKEHOLDERS IN FINANCIAL STABILITY Integrated Regulator National Treasury SARB Coordinating stability responsibilities - Day-to-day supervision - Micro-prud perspective Cross directorships Legislation/MOU Coord Committee Public - Legislative responsibilities - Policy MPR FSR - Monetary stability - Financial stability

12. CAN INSTITUTIONAL STRUCTURE RESOLVE THE COMMUNICATION PROBLEM? • WAYS TO REGULATE FOR EFFECTIVE COORDINATION • Total integration? • Sound institutional design • Statutory coordinating body (Canada) • Formal MOU’s (UK) • Board cross-membership • Informal collegial arrangements • Will they stand up in a crisis?

13. CAN INSTITUTIONAL STRUCTURE RESOLVE THE COMMUNICATION PROBLEM? COMMUNICATION/COORDINATION IN A MEGA-REGULATOR? Mega regulator still only one part of safety-net system No degree of integration can resolve the need for external coordination! Other problems with internal coordination Principles based vs rules based regulation Specialist silos and cultures Perception that inter-dept communication will happen automatically

14. COUNTRY-SPECIFIC FEATURES INFLUENCING THE COORDINATION PROBLEM OPENNESS OF THE ECONOMY AND THE DEGREE OF DISCRETION OF THE SARB Small but open economy Floating currency, some remaining exchange control Large degree of independent monetary discretion Link between price and financial system stability Monetary policy executed through banks as agents SARB is banker of banks Conclusion: Strong argument for banking supervision function remaining in SARB Danger of duplication of functions if information flows not perfect

15. COUNTRY-SPECIFIC FEATURES INFLUENCING THE COORDINATIONPROBLEM CONCENTRATION OF BANKING 80% of banking assets concentrated in big four Border between micro- and macro-prudential issues becomes fuzzy Distinction between systemic and prudential regulation fades In extreme case, every bank problem is systemic in nature Acclaimed effectiveness of banking supervision High quality information currently available for financial stability policy decisions Conclusion: SARB likely to want to retain oversight of banks

16. COUNTRY-SPECIFIC FEATURES INFLUENCING THE COORDINATION PROBLEM QUALITY OF SETTLEMENT SYSTEMS AND TIME TO REACT Highly sophisticated real-time gross payment and settlement system High percentage of inter-bank transactions flow through SARB settlement system In crisis, massive funds can be switched from a bank in distress Intimate knowledge of prudential standards of banks is crucial Real-time risk information is useless if time to react is slow Conclusion: SARB likely to need such close links with banking supervisor that it would not be possible if part of another organisation

17. COUNTRY-SPECIFIC FEATURES INFLUENCING THE COORDINATIONPROBLEM THE SAFETY NET AND DEPOSIT INSURANCE SARB will remain the lender of last resort (LOR) Natural tendency to want effective oversight of banks Recent near-crisis events showed proximity of supervision function helps with rapid decision-making so crucial in a crisis No effective DIS as yet to enhance supervision and increase crisis resolution options Conclusion: It would be difficult for SARB to part with supervision function until effective statutory coordination mechanisms established between the four safety net participants

18. COUNTRY-SPECIFIC FEATURES INFLUENCING THE COORDINATION PROBLEM STATEMENT BY SARB GOVERNOR FOLLOWING RECENT NEAR-CRISIS EVENT “With the recent liquidity problems of some small banks, it was again evident that the least-cost resolution of a banking crisis would always depend on a special collegial interaction between the RoB and at least four other departments in the Bank. The policy formulation, decision-making, coordination and rapid execution of the many interventions that were necessary would have been almost inconceivable in a situation where the supervision of banks was not part of the Bank.” - Governor’s address – 27 August 2002

19. COUNTRY-SPECIFIC FEATURES INFLUENCING THE COORDINATION PROBLEM STATEMENT BY SARB GOVERNOR FOLLOWING RECENT NEAR-CRISIS EVENT “… the capacity to perform effective banking supervision is crucial to price and financial stability. After careful consideration of the issues, I am therefore convinced that it is in the best interests of the South African economy that banking supervision should remain in the Bank.” - Governor’s address – 27 August 2002

20. COUNTRY-SPECIFIC FEATURES INFLUENCING THE COORDINATIONPROBLEM EXISTENCE OF COMPLEX FINANCIAL GROUPS Universal banking structures not prevalent Banks not permitted to conduct insurance and securities business Little evidence of regulatory arbitrage But: Insurance companies tend to control the banks If conglomerates increase, this will be a compelling argument to unify prudential supervision Conclusion: Until then, effective conglomerate supervision may best be achieved if the integrated prudential regulator would be within the SARB (something like Bank of Ireland, Netherlands and Monetary Authority of Singapore?)

21. COUNTRY-SPECIFIC FEATURES INFLUENCING THE COORDINATIONPROBLEM THE ROLE OF STATE- AND FOREIGN-OWNED BANKS State-owned banks are not a feature of the SA system Also, the role of foreign-owned banks is small Hence, relatively more power for supervisor Political and bureaucratic tensions Scarce regulatory resources Conclusion: High risk of inadequate coordination and crucial information exchange if supervision removed from SARB

22. RATIONALE FOR AN OBJECTIVE-BASED APPROACH A MODEL FOR GOOD TIMES AND BAD Any model can work in good times, however, in a crisis: Availability of ready information, Depth of knowledge, intimate understanding of nuances, and Cooperation is key Formal arrangements are necessary but not sufficient Relationships and goodwill are just as important The “form” is not so important as the “substance” of: Cooperation, and Change management SA’s case is complicated by the need to maintain systemic stability yet ensure broader delivery of services