Financial regulators’ global variety show
By Howard Davies
Former Chairman of Britain's Financial Services Authority, Deputy
Governor of the Bank of England, and Director of the London School
of Economics, is a professor at Sciences Po in Paris.
In the early phases of the financial crisis, it was fashionable
to argue that the United States' system of regulation needed a
fundamental structural overhaul. Differences of opinion between the
Securities and Exchange Commission (SEC) and the Commodity Futures
Trading Commission (CFTC) had obstructed effective oversight of
investment banks and derivatives trading (only the US believes that
it makes sense to regulate securities and derivatives
separately).
Indeed, the plethora of separate banking regulators had created
opportunities for banks to arbitrage the system in search of a more
indulgent approach to capital. Likewise, the lack of a federal
insurance regulator had left AIG regulated by the Office of Thrift
Supervision (OTS) and the New York State Insurance Department,
which proved to be a wholly inadequate arrangement.
Little has come of these arguments. The Dodd-Frank Act did succeed
in putting the OTS out of its misery, but jealous congressional
oversight committees have prevented a merger of the SEC and CFTC,
and nothing has been done to rationalize banking supervision. So
the American system looks remarkably similar to the one that turned
a collective blind eye to the rise of fatal tensions in the early
2000's.
One factor that contributed to institutional stasis was the absence
of a persuasive alternative. In the decade or so leading up to the
meltdown of 2007-2008, the global trend was toward regulatory
integration. Almost 40 countries had introduced single regulators,
merging all types of oversight into a single all-powerful entity.
The movement began in Scandinavia in the early 1990's, but the most
dramatic change came in 1997, when the United Kingdom introduced
its Financial Services Authority (I was its first chairman).
Other countries adopted slightly different models. A fashionable
approach was known as "twin peaks," whereby one regulator handled
prudential regulation - setting capital requirements - while
another oversaw adherence to business rules. But twin peaks itself
was further subdivided.
The Dutch model brigaded the prudential regulators inside the
central bank, while the Australian version was built on a separate
institution. These integrated structures seemed to offer many
advantages. There were economies of scale and scope, and financial
firms typically like the idea of a one-stop (or, at worst, a
two-stop) shop. A single regulator might also be expected to
develop a more coherent view of trends in the financial sector as a
whole.
Unfortunately, these benefits did not materialize, or at least not
everywhere. It is hard to argue that the British system performed
any more effectively than the American, so the single-regulator
movement has suffered reputational damage. And the continuing
travails of the Dutch banking system - another bank was
nationalized last month - suggest that it is easy to fall into the
gap between twin peaks.
The truth is that it is hard to identify any correlation between
regulatory structure and success in heading off or responding to
the financial crisis. Among the single-regulator countries,
Singapore and the Scandinavians were successful in dodging most of
the fatal bullets, while the UK evidently was not. Among the twin
peak exponents, the Dutch system performed very poorly indeed,
while Australian financial regulation may be considered a
success.
Does it matter whether the central bank is directly involved? Many
central bankers maintain that the central bank is uniquely placed
to deal with systemic risks, and that it is essential to carry out
monetary and financial policies in the same institution. Again, it
is hard to find strong empirical support for that argument.
The Dutch and American central banks, with direct oversight of
their banking systems, were no more effective in identifying
potentially dangerous systemic issues than were non-central bank
regulators elsewhere. Canada is often cited as a country that
steered its banks away from trouble, even though they sit
uncomfortably close to US markets. But the Bank of Canada is not
now, and has never been, a hands-on institutional supervisor. So
perhaps the US Congress has been right to conclude that changing
the structure of regulatory bodies is less important than getting
the content of regulation right.
Elsewhere, though, a lot of structural change is under way. In the
UK, every financial disturbance leads to calls to revamp the
system. There were major overhauls in 1986, and again in 1997, when
the Bank of England lost its banking supervision responsibilities
as a delayed response to the collapse of Barings. Next month, it
gets them back - and more.
For the first time, the Bank of England will supervise insurance
companies as well. A similar change has been introduced in France,
where a new Prudential Control Authority has been created. The
British and French rarely agree on anything; one is tempted to say
that when they do, they are highly likely to be wrong.
It is difficult now to discern a coherent pattern. Certainly, the
trend toward full-service single regulators outside the central
bank has slowed to a crawl (though Indonesia is consolidating
regulators at present). There is no consensus on the role of the
central bank: in around a third of countries, it is the dominant
player, in another third it has responsibilities for banks only,
while in the remaining third it is a system overseer only.
We could see this as a controlled experiment to try to identify a
preferred model. After all, financial systems are not so different
from one another, particularly in OECD countries. But there is no
sign of a considered assessment being prepared, which might at
least help countries to make better-informed choices, even if it
did not conclude that one model was unambiguously best. The G-20,
under its current Russian presidency, is now in search of a role.
Here is a useful practical task it might take on.
Copyrights: Project Syndicate