Regulatory Framework

Jeff Carmichael

Topics for The Session

Contributions & risks from NBFIs

Objectives of regulation

Different types of regulation

Regulatory structure

Financial Services

• Payments services• Liquidity• Divisibility• Store of value• Information efficiencies• Risk pooling

Empirical Evidence

Growing evidence that:

• Financial development contributes to economic development

• Contribution is increased where NBFIs are involved

Sources of Risk from NBFIs

1. NBFIs can circumvent the intention of banking regulation, eg Asian experience

• Thai finance companies

• Hire purchase in Malaysia

• Korean Merchant Banks & ITCs

Sources of Risk from NBFIs

2. NBFI associations with banks through conglomerates, eg Asians again

• Korea and Indonesia

• State banks in Australia

Not so much an issue in Africa

NBFI Risks in Africa?

3. Concentration of risksSize of institutionsIndustry concentrationDominant commercial companiesUnderdeveloped regulation

Philosophical Foundations

Regulation rests on market failure and the impact of that failure on: efficiency, safety, and fairness

Sources of market failure:

Anti-competitive Behaviour

Market Misconduct

Information Asymmetry

Systemic Instability

Anti-Competitive Behaviour

Regulatory Measures include:• Rules covering industry structure;

• Rules to prevent anti-competitive behaviour; and

• Rules to ensure contestability

Market Misconduct

Common problem areas:• Unfair & fraudulent conduct;• Inadequate disclosure

Regulatory Measures include:• Disclosure standards;• Conduct rules:• Entry restrictions;• Governance requirements; and• Minimal financial strength requirements

Asymmetric Information

Arises from inherent complexity of products and institutions

Regulatory Measures include:• Entry requirements;• Capital requirements;• Liquidity requirements;• Governance requirements; and• Customer support schemes

Systemic Instability

Confidence is fundamental to the financial system

Regulatory Measures include:• Monetary and fiscal policy;• Lender of last resort; and• Payments system regulation

The Road to Effectiveness

• Better structures• Stronger laws• Stronger policies• Stronger internal practices and processes to improve enforcement

Models of Regulatory Structure

• Separate Regulators: Separate agencies for each industry group (31)

• Mexican: Banking and Capital Markets (9)• South African: All NBFIs together (3)• Canadian: Banking and Insurance together (13)• UK: Unified Regulator outside Central Bank (10)• Singaporean: Unified Regulator inside Central Bank

(3)

Separate Regulators

Pros: • Easiest to implement• “Tailored” supervisionCons: • Lack of scale• No synergies• Duplication of infrastructure• Doesn’t cope well with Conglomerates• Potential for Arbitrage• Potential for Capture

Mexican Model

Pros: • Better scale• Consistency across securities dealersCons: • Synergies are limited• Clash of cultures• Possible loss of focus• Central bank issues• Conglomerates and arbitrage still a danger• Some duplication of infrastructure• Capture of those that remain outside

South African Model

Pros: • Some scale economies efficiency of resource use• Better synergies than Mexican • Leave central bank to focus on monetary policy and doesn’t

impair banking supervision by removalCons: • Synergies still limited• Cultural clashes• Possible loss of focus• Still some duplication• Need to avoid “one size fits all”• Conglomerates

Canadian Model

Pros: • Significant scale economies/resource efficiencies• Regulatory synergies• Less scope for arbitrage• Frees CB for monetary policy• In the extreme aligns with market failureCons: • Still some duplication• Possible loss of CB credibility for banking• Some conglomerates may still escape• Dominance of regulator and danger of “one size fits all”

UK Model

Pros: • Very cost effective• Maximizes synergies• Eliminates arbitrage and covers conglomerates• No central bank distractionCons: • Cultural clash• Potential loss of focus• Possible loss of CB credibility for banking• Reputational contagion• Dominant regulator and danger of “one size fits all”

Singaporean Model

Pros: • Maximum cost effectiveness and synergies• Eliminates arbitrage and covers conglomerates• Avoids loss of credibility and resources for banking• CB responsible for all systemic stabilityCons: • Extremely powerful agency• Multiple objectives and loss of focus• Cultural clashes maximised• Takes CB away from core competencies• Reputational contagion risk including monetary policy• Danger of “one size fits all”

Weighing the Issues

• No perfect model for all countries and all time

• Push towards integration driven by:– Elimination of regulatory arbitrage– Better regulation of conglomerates– Efficient use of scarce regulatory resources

Closing Thoughts

• Changing regulatory structure doesn’t fix regulatory failure

• Use reform opportunities wisely

• Beware the vested interests