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

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

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

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

The ‘Big 8’ Issues 1.Role of the Central Bank 2.Cultural conflicts 3.Objective conflicts 4.Co-operation and co-ordination 5.Size 6.Regulatory arbitrage 7.Financial conglomerates 8.Political dynamics

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Risk Mitigation – Canadian Model Co-ordination: Council of regulators Cross-board memberships Concentration of power – legislate strong governance and accountability

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

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

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

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

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

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

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

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

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

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

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