European Economies
Single Financial Regulators Are the Future
Clive Briault
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Why have some countries chosen to create a single national financial services regulator? Four reasons predominate:
First, market developments - say, the increasing number of financial conglomerates and the blurring of boundaries between financial products - make sector-based regulation increasingly less viable. Most countries see cross-sector mergers and acquisitions in the financial services industry; and financial services firms expand through internal growth into new business sectors.
Indeed, groups that include some combination of banking, insurance, securities and fund management activities are increasingly common. Moreover, complex products that enable firms to unbundle, repackage and trade risks in ways that blur the boundaries between formerly distinct sectors are introduced consistently.
The UK was not the first country to favor a single regulator capable of regulating these conglomerates as groups, and understanding the cross-sector nature of their business. Norway, Denmark and Sweden led the way here, but many others soon followed, or announced an intention to do so.
Second, economies of scale and scope are available to an integrated regulator. The UK's Financial Services Authority (rather the many regulated firms who meet its costs) benefits from the economies of scale that arise from the move to a single set of central support services; unified management; and a unified approach to standard_setting, authorization, supervision, enforcement, consumer education and tackling financial crime. This is reflected in the FSA costing less, in real terms, than the sum of its individual predecessor regulatory bodies.
Economies of scope arise because a single regulator can tackle cross_sector issues more efficiently and effectively than a multiplicity of regulators. Consistent and coherent standards can be set for regulated firms, differentiating between sectors only when it is appropriate to do so, and so reducing incentives for regulatory arbitrage. Prudence and conduct of business regulation can be brought together, because both depend on the quality of a firm's senior management and high-level systems and controls.
A risk-based approach supervising individual firms can be adopted by a single regulator, with resources allocated not only across firms but also across sectors on the basis of the likelihood of problems arising and of the impact on consumers and on market confidence if problems emerge. A single regulator can assess the real and potential impact, on all sectors, of industry and market-wide issues such as turbulence in markets and economies, the development of e-commerce, the shift to low inflation, the implications of demographic changes, and risk transfers between banks and insurance firms.
Third, there are benefits in setting single, clear and consistent objectives and responsibilities, and to resolving trade_offs among these within a single agency. The FSA's four statutory objectives are to maintain confidence in the financial system; to promote public understanding of the financial system; to secure the appropriate degree of protection for consumers; and to reduce as far as possible the chances of a financial services firm being used for criminal purposes.
In pursuing these objectives, the FSA pays keen attention to seven ``principles of good regulation:''
· the efficient, economic use of its resources;
· the responsibilities of those who manage the affairs of authorized persons;
· the principle that a burden or restriction imposed on a regulated firm should be proportionate to the benefits;
· the desirability of facilitation of innovation in connection with regulated activities;
· the international character of financial services and markets and the desirability of maintaining the UK's competitive position;
· the need to minimize adverse effects on competition from the FSA's discharge of its general functions;
· the desirability of facilitating competition between firms regulated by the FSA.
Fourth, there are advantages for the regulatory regime, for the costs of regulation, and in preventing regulatory failures in making a single regulator clearly accountable against its statutory objectives. The buck cannot be passed from one regulator to another if a regulatory failure occurs.
Although independent of government, the FSA can be called to account by government and parliament, and recognises the interests of all of its stakeholders. It must publish an annual report describing how it has met its statutory objectives and carried out its functions. It must also consult publicly - including a cost benefit analysis - on proposed rules and regulatory guidance before issuing them; and must take account of the views of both a consumer panel and a practitioner panel established on a statutory basis.
What does the approach of a single regulator imply for innovation and new ideas? The experience here suggests that the outcome is positive. Internally, bringing together different regulatory agencies to create a new integrated approach enhances innovation, because rather than simply follow the old practices of any predecessor agency, the best ideas are chosen. As new issues arise the need and the ability to adopt a cross-sector perspective generates novel regulatory responses.
Meanwhile, constant and considerable innovation in the firms and markets the FSA regulates; the obligation on the FSA to be an open, transparent and consultative regulator, and to pay careful attention to the impact of its actions on competition and innovation; and participation in international discussions and negotiations all contribute to the FSA's development of a new, efficient, risk-based and innovative regulatory regime.
The importance of giving clear incentives, so that regulators are innovative and facilitate innovation in financial services, must not be underestimated. Regulators must be held to account for doing so.
Clive Briault is Director of Prudential Standards, UK Financial Services Authority.
Copyright: Project Syndicate, April 2002
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