Financial Sector Assessment

Case for the Fully Unified Model

The fully unified model is particularly relevant when regulated entities are increasingly consolidating their activities and turning into conglomerates with centralized risk man­agement. Several arguments might favor the creation of a single unified agency for pru­dential regulation and supervision. Those arguments are as follows:

There may be economies of scale within regulatory agencies (particularly with respect to skill requirements and recruitment of staff members with appropriate skills and qualifications). If so, the smaller the number of agencies, the lower the institutional costs should be. A single regulator might be more efficient because of shared resources and, in particular, shared information technology systems and support services. The argument for economies of scale might apply particularly to the “small-country” case.

It is likely to be easier to achieve an optimal deployment of staff members within a unified agency than within a specialist and fragmented institutional structure. As noted, the distinction between functional and institutional regulation does not apply to a financial system made up of specialist institutions. For financial conglomerates, a unified agency enables a groupwide picture of the risks of an institution to be observed more clearly and thus to be supervised. This groupwide supervision of risks is especially important when financial conglomerates them­selves adopt a centralized approach to risk management and risk taking. In such a case, there is merit in having an institutional structure of supervision that mirrors the practice of regulated institutions. As a result, a more rapid response to emerging groupwide problems should be possible.

There is less scope for incomplete coverage, with some institutions or lines of business slipping through the regulatory and supervisory net because of confusion about which agency is responsible. There may even be damaging disputes between agencies in a multiple-agency structure.

• There might be merit in having a simple regulatory structure that is readily under­stood and recognized by regulated firms and consumers. Some of the traditional dis­tinctions between different types of institutions have become increasingly blurred, which undermines some of the traditional arguments in favor of separate regulation and supervision of different types of financial institutions.

• There might be an advantage to having a structure that mirrors the business of regulated institutions. To the extent that financial institutions have steadily diversified, traditional functional divisions have been eroded. Although there are various ways of addressing overall prudential requirements for diversified institutions, a single, conglomerate regulator might be able to monitor the full range of institutions’ business more effectively and be better able to detect potential solvency risks emanating from different parts of the business.

• Equally, the distinctions between certain types of financial products have become increasingly blurred, which raises questions about the case for regulating them dif­ferently. The potential danger of a fragmented institutional structure is that similar products (products providing the same or a similar service) are regulated differently because they are supplied by different types of financial firms. This difference in the regulation of similar products may impair competitive neutrality. It is more likely that a consistent approach to regulation and supervision of different types of institutions will emerge.

• A single agency should, in principle, avoid problems of competitive inequality, inconsistencies, duplication, overlap, and gaps that can arise with a regime that is based on several agencies. A singe regulator should make it easier for similar products offered by different types of institutions to be regulated and supervised in a consistent manner.

• A single agency also should minimize regulatory arbitrage. A potential danger with multiple agencies is that overall effectiveness may be impaired as financial firms engage in various forms of regulatory and supervisory arbitrage. This arbitrage can involve the placement of a particular financial service or product in that part of a given financial conglomerate where the supervisory costs are the lowest or where supervisory oversight is the least intrusive. It also may lead firms to design new financial institutions or to redesign existing ones strictly to minimize or avoid supervisory oversight. This regulatory arbitrage also can induce “competition in laxity,” as different agencies compete to avoid the migration of institutions to com­peting agencies.

• If expertise in regulation is in short supply, expertise might be used more effectively if it is concentrated within a single agency. Such an agency also might offer better career prospects. Accountability of regulation also might be more certain with a simple structure if for no other reason than that it would be more difficult for dif­ferent agencies to “pass the buck.”

• The costs imposed on regulated firms might be reduced to the extent that firms would need to deal with only one agency. This issue was particularly significant in the United Kingdom when, before the creation of the Financial Services Authority (a fully unified agency), a financial conglomerate might be regulated and super­vised by and required to report to nine regulatory agencies. There also can be

economies, plus greater effectiveness, when all information about financial firms is lodged within a single agency.

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