Financial Sector Assessment

Importance of Institutional Structure

The institutional structure of supervisory agencies is not simply an administrative matter; it is important to meet the objectives of financial supervision for several reasons. The
objectives of financial supervision are to promote efficiency and competition,2 to main­tain market confidence, to protect depositors or consumers (as appropriate), and to foster systemic stability. Supervisory capacity and the supervisory process itself are the critical elements in attaining those goals. Above all other considerations, institutional structure may have an effect on supervisory capacity and process and, hence, on the overall effec­tiveness of regulation and supervision, because of the expertise, experience, and culture that develop within particular regulatory agencies and with the approaches they adopt.

One school of thought argues that focused, rather than diversified or conglomerate, regulators are more effective simply because their mandates are clearly defined, which allows the buildup of expertise. There is a danger (although this risk is by no means inevitable) that expertise, collective memory, and experience can be lost when changes are made. Others argue that regulation is more likely to be effective if a single agency is responsible for all aspects of regulation and supervision.

Closely related to effectiveness is the clarity of responsibility for particular aspects or objectives of regulation. This clarity, in turn, raises the question of interagency rivalry and disputes and of the effectiveness of needed information exchange and coordination. Seldom does regulation have a single objective; when multiple objectives are set, conflicts can arise between them. Although this potential for conflict is true irrespective of insti­tutional structure, different structures may be more or less efficient at handling conflicts and facilitating information exchange and cooperation. Specific country circumstances dictate whether conflicts could be better handled or whether cooperation could become easier within a single agency or between agencies if responsibilities for particular objec­tives are more clearly defined. It becomes a question of whether transaction costs are lower when conflicts are resolved internally (e. g., between different divisions of a single agency) rather than externally between different agencies.

Different structures have implications for the costs of regulation. On the one hand, if there are economies of scale and scope in regulation, there should be advantages to hav­ing a small number of agencies or even a single authority. On the other hand, if a single regulator (encompassing a wide variety of financial institutions) adopts an inappropriate regulatory regime (perhaps because its remit is too wide and unfocused), then the compli­ance and structural costs of regulation would rise—even though the purely institutional costs of regulatory agencies (i. e., the costs of running supervisory agencies) might be lower. The following considerations are relevant for the costs of regulation:

• A major issue relates to overlap and underlap and to whether a particular structure causes an unnecessary duplication of regulatory activity and, hence, places unnec­essary costs on firms; it also relates to whether some aspects of business or some institutions fall through the net altogether.

• A multiple-agency regime, especially if it allows regulated institutions an element of choice, creates the potential for regulatory arbitrage and inconsistent regulation between different institutions conducting the same type of business.

• Public perceptions and credibility also may be a significant issue in that, with mul­tiple agencies, it may not be clear to the consumer which agency is responsible for a particular issue of regulation or to whom complaints should be addressed.

Any change in supervisory architecture must take into account the likely effect on the governance of the agency or agencies concerned. There are four prerequisites for good reg­ulatory governance in regulatory and supervisory agencies: accountability, independence, integrity, and transparency. Each may be affected by a structural change in the supervisory process.3 The importance of corporate governance arrangements arises from several fac­tors: (a) they determine the effectiveness and efficiency of the agencies’ operations; (b) they have a powerful effect on the agency’s credibility, authority, and public standing; and (c) they have an important effect on the authority and credibility of agency’s attempt to encourage and to require effective corporate governance arrangements within regulated firms.

For all those reasons, the institutional structure of regulatory agencies is an issue of some significance. However, the importance should not be exaggerated. A crucial point is that institutional structure does not, in itself, guarantee what really matters: the effec­tiveness of regulation in achieving its objectives in an efficient and cost-effective manner. The arguments in favor of and against various supervisory structures can best be drawn out by considering the case for and against a fully unified prudential agency.