Regulatory Framework
Jeff Carmichael
Chairman
Australian Prudential Regulation Authority
Topics for The Session
 Contributions & risks from NBFIs
 Effective regulation:
 Powers
 Rules & Regulations
 Internal Practices & Procedures
 Regulatory Structure
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Financial Services
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Payments services
Liquidity
Divisibility
Store of value
Information efficiencies
Risk pooling
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NBFI Roles
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Broaden spectrum of risks
Encourage savings and investment
Foster risk management
Enhance systemic resilience
Fill the gaps
Provide competition for banks
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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
2. 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
o Market conduct:
– Policemen role
– Severity of penalties less important that likelihood
of being caught
o Prudential:
– Doctor role
– Prevention rather than prosecution
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Characteristics of Prudential
Regulation
1. Intervention is graduated:
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Breaches are a warning
Process involves cooperation
2. Regulators are not infallible:
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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
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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
Banks
Life
Insurers
General
Insurers
Pensions
Licensing
Y
Y
Y
P
Standards
Y
Y
Y
N
Appoint External Expert
N
Y
Y
N
Ownership & Control
Y
N
Y
N
Statutory Management
Y
Y
Y
Y
Directions
Y
Y
Y
N
Investigation
N
N
N
N
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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:
o Legalistic responses
o Questions of who is responsible
o Inflexibility
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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
Ultimate
Goals
• Efficiency
• Fairness
• Safety
• Stability
Market Failures
• Anticompetitive
behaviour
• Market
misconduct
• Information
asymmetry
• Systemic
contagion
Regulatory
Actions
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Anti trust
Anti collusion
Disclosure
Education
Financial law
enforcement
Governance
Licensing
Capital adequacy
Liquidity
Risk management
Failure management
Macro economic
policy
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Payment system
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
1 Aligns the regulatory structure with the
industry structure
2 Resource efficiencies
3 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:
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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:
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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:
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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
PANAMA
PERU
FSA
Institutional
Integrated
TRINIDAD AND TOBAGO
Institutional
VENEZUELA
Institutional
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What Does IR Really Offer?
o Integrated regulation does not:
Automatically correct regulatory failures
(though it can contribute)
o 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:
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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:
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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
APRA
Regulatory Framework
Jeff Carmichael
Chairman
Australian Prudential Regulation Authority