Alternative Approaches to Regulatory Structure

1. Alternative Approaches to Regulatory Structure Jeff Carmichael Chairman Carmichael Consulting Pty Ltd

2. 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

3. Some Definitions • Regulation Vs Supervision • Regulatory structure • Institutional structure • Unified structure • ‘Mega’ regulators/‘Super’ regulators/ ‘Integrated’ regulators

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

11. 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

12. 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

15. 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

16. Risk Mitigation – Institutional Model • Co-ordination: • Council of regulators • Lead regulator • Cross-board memberships • Gaps – power to deem institutions to require regulation

17. 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

18. 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

20. 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

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

25. 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

26. Risk Mitigation – Singaporean Model • Moral hazard - need to educate public about safety nets • Power – needs very strong governance and accountability (rare in CBs)

27. 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

28. 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

29. 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

30. 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

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

32. 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

33. Alternative Approaches to Regulatory Structure Jeff Carmichael Chairman Carmichael Consulting Pty Ltd