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Designing a System of Financial Designing a System of Financial RegulationRegulation
Howard Davies
Director - London School of Economics
Executive Public Policy Training ProgrammeBeijing
20 June, 2006
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Five Steps to Reform
1. Assess the strengths and weaknesses of the financial system
2. Determine the desired future shape of the system
how flexible?
how open?
3. Assess compliance with international standards
4. Review the structural options
5. Map them against local market conditions
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1. The Strengths and Weaknesses of the Financial System
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Global Financial Stock 2004 (%)Global Financial Stock 2004 (%)China is becoming a significant part of the global system
Source: McKinsey Global Institute, 2006
23
16.5
4.5
156
EurozoneUKJapan ChinaRest of World
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Financial Depth – Financial Stock as % Financial Depth – Financial Stock as % of GDP 2004of GDP 2004China’s financial system is already well-developed
Source: McKinsey Global Institute, 2006
0
50
100
150
200
250
300
350
400
450
Japan US UK Eurozone China India
(%)
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Bank Deposits as % of Financial StockBank Deposits as % of Financial StockBut it is very heavily dependent on banks
Source: McKinsey Global Institute, 2006
0
10
20
30
40
50
60
70
US Eurozone India China
Per
cent (%
)
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Chinese Share of Global Financial Stock Chinese Share of Global Financial Stock (%) 2004(%) 2004And the capital markets are relatively small
Source: McKinsey Global Institute, 2006
0
2
4
6
8
10
Private Debt GovernmentDebt
Equities Bank Deposits
Per
cent
(%
)
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2. The Desired Future Shape of the System• Meet WTO commitments• Strengthen competitive pressures: greater
flexibility• Expand capital markets as a source of finance for
growth» equities
» private sector bonds
• Improve financial services for lower income families, and in remote areas
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3. Compliance with International Standards
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G7
Finance Ministers
International Monetary
Fund
World Bank
Global Financial Stability Report
Financial Stability Forum
ADB IADB EBRD etcICFC
The International Financial Architecture
Financial Sector Assessment Programmes
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A. Banking Supervision
Bank of International Settlements
G10 Governors + Heads of Supervision
Basel Committee
Basel Capital Accord
G10 + Spain, LuxembourgECECBCentral Banks and Supervisors
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B. Securities Regulation
IOSCO- Core Principles
Multilateral MOU
C. Insurance Regulation
IAIS - Solvency Standards
D. International Accounting Standards
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4. Review the Structural Options
Four main models in operation elsewhere• ‘3 pillars’: banking, securities and insurance
separately regulated• ‘Twin Peaks’: separation of prudential and
conduct of business regulation• ‘Hybrid’: where two or more sectors are
regulated together• ‘Integrated’: a single regulator covering most
or all of the financial sector.
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There is no clear consensus about which model is ‘best’.
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Structure of Supervision in 77 Countries, 2002 Agency supervising two types of financial intermediaries
Indicator Single supervisor for Banks and Banks and Securities firms Multiple
the financial system securities firms insurers and insurers supervisors
Countries Austria, Bahrain, Dominican Austria, Belgium, Bolivia, Chile Argentina, Bahamas,
Bermuda, Cayman Republic, Finland, Canada, Colombia Egypt, Mauritius, Barbados, Botswana,
Islands, Denmark, Luxembourg, Ecuador, El Slovakia, South Brazil, Bulgaria, China,
Estonia, Germany, Mexico, Salvador, Africa, Ukraine Cyprus, Egypt, France,
Gibraltar, Hungary, Switzerland, Guatemala, Greece, Hong Kong
Iceland, Ireland, Uruguay Kazakhstan, (China), India,
Japan, Latvia, Malaysia, Peru Indonesia, Israel, Italy,
Maldives, Malta, Venezuela Jordan, Lithuania,
Nicaragua, Norway, Netherlands, New
Singapore, Rep. of Zealand, Panama,
Korea, Sweden, Philippines, Poland,
United Arab Emirates Portugal, Russia,
United Kingdom Slovenia, Sri Lanka,
Spain, Thailand, Turkey, United States
% of
counties 29 8 13 9 38
in the
sampleSource: Luna Martinez and Rose (2003)
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There is a trend towards integrated regulation for a number of reasons
- growth of financial supermarkets
- risk transfer between sectors
- attractions of ‘one-stop shopping’
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Main Reasons for Adopting Integrated Supervision (agencies indicating any one of the following reasons
Reasons Number of Agencies
Percentage of all agencies
Improve the supervision of a financial system moving towards universal banking
14 93
Maximise economies of scale and scope 12 80
Solve problems resulting from poor communication and lack of cooperation among existing supervisory agencies
4 27
Minimise gaps in the regulation and supervision of financial intermediaries
3 20
Facilitate operational restructuring of regulatory agencies (in particular, after a financial crisis)
3 20
Overcome other weaknesses in the overall quality of financial regulation and supervision
2 13
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But there are also important variations between integrated regulators
- scale
- scope
- powers
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Powers of the Integrated Supervisory Agencies over BanksRegulatory and supervisory agencies Number of
agencies% of all agencies
Conduct on-site examinations 15 100
Conduct off-site examinations and surveillance 15 100
Impose sanctions and fines for non-compliance with rules and regulations
15 100
Set prudential regulation on market, credit, operational, and liquidity risks
12 80
Set accounting rules and information disclosure requirements
11 73
Set rules on the composition of capital 11 73
Approve and revoke a license to a financial intermediary 11 73
Set minimum capital requirements 10 66
Set licensing requirements 9 60
Consumer protection (assist to resolve claims for abuses against users of financial services)
9 60
Source: Luna Martinez and Rose (2003)
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How the Centres Rank in Terms of their Regulatory Environment
Market participants tend to favour integrated regulation
02468
101214161820
London New York Paris Frankfurt
Average Score
Source: Z/Yen, 2005
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5. Map options against local market conditions
China now operates a ‘3 pillar’ model, butwith banking supervision outside the centralbank• suitable where there is little ‘cross-sectoral’
activity• also where a single agency might be seen to be
‘too powerful’• and where sheer scale makes effective
management difficult.
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Regulatory Reform in China is under way
- - 3 commissions: CBRC, CSRC, CIRC
- International Advisory Councils
- - Training
- Culture of challenge
- Overarching body to resolve inconsistencies and promote co-operation
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An integrated regulator might be more appropriate if
• banks are allowed to undertake other activities: universal banking
• derivatives markets develop, allowing risks to be transferred between sectors
• multi-functional overseas firms enter the markets on a large scale
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Designing a System of Financial Designing a System of Financial RegulationRegulation
Howard Davies
Director - London School of Economics
Executive Public Policy Training ProgrammeBeijing
20 June, 2005