Regulatory Framework

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Regulatory Framework

• Jeff Carmichael
• Chairman
• Australian Prudential Regulation Authority

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Topics for The Session

• Contributions risks from NBFIs
• Effective regulation
• Powers
• Rules Regulations
• Internal Practices Procedures
• Regulatory Structure

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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

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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
• Plus
• Pseudo-banks in Latin America

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Sources of Risk from NBFIs

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

• Korea and Indonesia
• State banks in Australia
• Latin America also

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Community Expectations

• Market conduct
• Policemen role
• Severity of penalties less important that
  likelihood of being caught

• Prudential
• Doctor role
• Prevention rather than prosecution

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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

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The Road to Effectiveness

• Stronger powers
• Stronger policies
• Stronger internal practices and processes

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Powers - Conduct Prudential

• Licensing
• Information
• Examinations
• Investigations
• Standards/regulations
• Administrative sanctions
• Directions
• Prosecution

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Prudential Powers

• Ownership Control
• Appoint experts
• Whistleblower provisions
• Statutory management/inspector
• Transfers of business
• Liquidation

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Australia - Prudential Powers
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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

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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

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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

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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

• Ultimate Goals
• Efficiency
• Fairness
• Safety
• Stability

• Market Failures
• Anti-competitive behaviour
• Market misconduct
• Information asymmetry
• Systemic contagion

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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

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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

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Rationale for Integration

• Aligns the regulatory structure with the industry
  structure

• Resource efficiencies

• Maximize regulatory neutrality

• Integrated regulation is objectives-based

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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

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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

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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

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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

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Latin American Structures
COUNTRY Structure Structure No.
ARGENTINA Institutional Institutional 7
BAHAMAS Institutional Integrated 5
BARBADOS Institutional FSA 4
BOLIVIA FSA NBFI 2
BRAZIL Institutional Other 1
CHILE NBFI Total 19
COLOMBIA Integrated
COSTA RICA FSA
ECUADOR Integrated
EL SALVADOR Integrated
GUATEMALA Integrated
HONDURAS FSA
JAMAICA NBFI
MEXICO Banks Securities
NICARAGUA FSA
PANAMA Institutional
PERU Integrated
TRINIDAD AND TOBAGO Institutional
VENEZUELA Institutional
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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

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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

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Regulation by Risk

• 5 Fundamental Risk Types
• Credit risk
• Market risk
• Insurance risk
• Liquidity risk
• Governance (operational) risk

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Conglomerate Regulation

• Integration eliminates turf wars
• Single set of definitions (controllers,
  affiliates etc)
• Consistent set of powers across industry groups

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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

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Regulatory Framework

• Jeff Carmichael
• Chairman
• Australian Prudential Regulation Authority