Evaluating the Single Financial Services Regulator Question
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ISBN 978-1-932795-66-0
Evaluating the Single
Financial Services
Regulator Question
Single Financial Services Regulator
George A. Hofheimer
Chief Research Officer
Filene Research Institute
Foreword by
William E. Jackson III, PhD
ideas grow here
Professor of Finance
PO Box 2998 Professor of Management
Madison, WI 53701-2998
The Smith Foundation Endowed Chair of Business Integrity
Phone (608) 231-8550
PUBLICATION #187 (5/09)
Culverhouse College of Commerce
www.filene.org ISBN 978-1-932795-66-0 University of Alabama
Evaluating the Single Financial Services Regulator Question George A. Hofheimer Chief Research Officer Filene Research Institute Foreword by William E. Jackson III, PhD Professor of Finance Professor of Management The Smith Foundation Endowed Chair of Business Integrity Culverhouse College of Commerce University of Alabama
Copyright © 2009 by Filene Research Institute. All rights reserved. ISBN 978-1-932795-66-0 Printed in U.S.A.
Filene Research Institute
Deeply embedded in the credit union tradition is an ongoing
search for better ways to understand and serve credit union
members. Open inquiry, the free flow of ideas, and debate are
essential parts of the true democratic process.
The Filene Research Institute is a 501(c)(3) not-for-profit
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Through independent research and innovation programs the
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priority consumer, public policy, and credit union competitive
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encouraging credit union development.
Since its founding in 1989, the Institute has worked with over
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iiiAcknowledgments
• Matt Bland, Association of British Credit Unions Limited, Man-
chester, England, UK
• Martin Cihak, International Monetary Fund, Washington, DC
• Diana Dykstra, San Francisco Fire Credit Union, San Francisco,
CA
• Rob Folsom, USA FCU, San Diego, CA
• David Grace, World Council of Credit Unions, Madison, WI
• William E. Jackson, III, University of Alabama, Tuscaloosa, AL
• Louise Petschler, Mark Degotardi, and Luke Lawler, Association
of Building Societies and Credit Unions, Sydney, Australia
• David Snodgrass, Affinity FCU, Basking Ridge, NJ
• James Wilcox, University of California–Berkeley, Berkeley, CA
vTable of Contents
Foreword ix
Executive Summary and Commentary xi
About the Author xiii
Chapter 1 Introduction 1
Chapter 2 Benefits and Drawbacks of a Single Financial
Services Regulator 11
Chapter 3 Is There a “Best” Financial Regulatory System? 21
Chapter 4 An Agenda for Reform and Regulatory
Consolidation 27
Chapter 5 Implications for Credit Unions 35
Appendix 1 A Brief History of U.S. Financial Services
Regulation 43
Appendix 2 Types of Credit Union Regulatory Structures
in G-20 Countries 45
Endnotes 47
References 49
Additional Reading 53
viiForeword
By William E. Jackson III, PhD, “The world has changed. The world is changing. The world will
University of Alabama continue to change.” This is an old saying that is especially relevant
for our current dynamic financial system. Whether we like it or not,
the U.S. financial system has changed. For example, who would have
imagined that in the year 2009 there would not be even one major
American investment bank—that they all would either go bankrupt
or merge with a bank holding company or change their charter and
become a bank holding company? Our financial system is changing,
and it will continue to change. Because of these dramatic changes, it
is imperative that the regulatory system and the structures that guide
our financial system also change. And, changes to our financial regu-
latory system are coming. This fact is apparent given the announce-
ments and activities of Congress and the Obama administration.
For example, consider the recent remarks of President Obama on
April 14, 2009, at Georgetown University’s Gaston Hall:
The first step we will take to build this foundation is to reform the
outdated rules and regulations that allowed this [financial] crisis to
happen in the first place. It is time to lay down tough new rules of the
road for Wall Street to ensure that we never find ourselves here again.
Just as after the Great Depression new rules were designed for banks
to avoid the kind of reckless speculation that helped to create the
depression, so we’ve got to make adaptations to our current set of rules:
create rules that punish shortcuts and abuse; rules that tie someone’s
pay to their actual job performance—a novel concept; rules that pro-
tect typical American families when they buy a home, get a credit card
or invest in a 401(k). So we’ve already begun to work with Congress
to shape this comprehensive new regulatory framework—and I expect
a bill to arrive on my desk for my signature before the year is out.
The fact that major changes to our current financial regulatory sys-
tem are coming raises at least three questions for credit unions:
• What major changes are likely to occur?
• How will these changes affect credit unions?
• What should credit unions do to prepare for these changes or to
become involved in the policymaking process that leads to these
changes?
These are very timely and very important questions. Fortunately,
these are also the exact questions that Filene Chief Research Offi-
cer George Hofheimer addresses in this excellent report. With this
report, Hofheimer has done a great service for the credit unions of
America. This report provides value in every chapter—from an excel-
lent summary of our current “fragmented” regulatory system to well-
reasoned suggestions for what credit unions should do in the face of
ixpotential major changes to the current regulatory framework. What
about the question, What major changes are likely to occur? The
answers are in this report. And the question, How will these changes
affect credit unions? Hofheimer provides very intelligent scenarios to
address this question. And finally the question, What should credit
unions do to prepare for these changes or to become involved in the
policymaking process that leads to these changes? The answers to this
question provide perhaps the most valuable and thoughtful analysis
in the report. The answers are so good that I cannot help but give a
little preview here.
In 2009, it is commonplace to hear policymakers and financial
researchers speak about how our regulatory system has failed us. I
agree; it has. But, we must also recognize that we have failed our
regulatory system. We are currently in a major financial crisis. Who
has the moral authority to lead the United States out of this critical
situation? Certainly it is not the big banks, insurance companies,
investment companies, or mortgage brokers. Credit unions may be
the only major financial institutions that continue to have reputa-
tions for honesty, integrity, and fairness. As such, credit unions have
a unique opportunity to help lead the political process that results
in a new financial regulatory system for the United States. How
should credit unions prepare for this role of leadership? Read George
Hofheimer’s excellent report to find out.
xExecutive Summary and Commentary
This report explores the forthcoming reregulation of the financial
services sector in the United States with a special focus on the impact
a single financial services regulator may have on the credit union sys-
tem. I examine this specific topic because a variety of political, eco-
nomic, and social trends foreshadow its creation, and credit unions
stand against the creation of such an entity. My analysis is based on
an extensive and independent review of existing academic and policy
research on this topic.
I report the following:
• Financial regulation is a constantly shifting standard due to new
innovations and marketplace realities.
• The U.S. financial regulatory system is viewed as “fractured” and
“archaic” and full of regulatory gaps that don’t effectively police
the complexities of the financial system.
• The current economic crisis is viewed, in part, as a failure of
financial services regulation, and therefore a major overhaul of the
regulatory system is necessary.
• The worldwide trend in financial services regulation has been
toward a more consolidated structure.
• The benefits and drawbacks of a single financial services regulator
are well documented.
• The academic literature is inconclusive and scant about the link
between financial regulatory structure and financial sector safety,
soundness, and/or performance.
• New frameworks, structures, and processes have been introduced
and considered by key policymakers as the potential road map for
a single financial services regulator.
Implications for credit unions:
• Beware the tide: Public and political opinion seems to be push-
ing for a major overhaul in the financial regulatory structure. In
normal times, such proposals would end up in the trash heap
of previous modernization proposals, but these are not normal
times. While I don’t expect credit unions to wither up and accept
a new regulatory structure, it may be wise to prepare for a single
regulator scenario.
• Getting to yes: If the tide of change is indeed too strong, credit
unions should be proactive in getting what they want. The
experiences of UK and Australian credit unions may be beneficial
models to study and understand.
xi• Be helpful: Influential policymakers have extolled credit unions’
behaviors leading up to and during the current economic crisis.
Credit unions have the unique opportunity to influence the new
public policy structure to benefit “simple” banking organizations
like themselves. Paradoxically, credit unions may have the oppor-
tunity to benefit in a new, more limited regulatory structure.
The days, months, and years ahead portend a financial services
regulatory structure that looks very different from the current model.
While it is foolish to predict what the exact regulatory structure will
look like, the probability of a more consolidated structure is quite
high. My aim with this report is to present an independent view
of this topic so that your credit union may traverse the future a bit
more confidently.
xiiAbout the Author
George A. Hofheimer
George A. Hofheimer is the chief research officer for the Filene
Research Institute, where he oversees a large pipeline of economic,
behavioral, and policy research related to the consumer finance
industry. He is the current vice chairman of the board of directors at
the Williamson Street Grocery Cooperative, a $17 million natural
foods store. He earned a BBA and an MBA from the University of
Wisconsin–Madison.
xiiiChapter 1
Introduction
The current U.S. financial services regulatory
environment was recently described as “out-
dated,” “ill-suited to meet the nation’s needs,”
and “fragmented and complex” by an indepen-
dent study. The desire for a change to the finan-
cial regulatory system is not new. Regulatory
restructuring has been going on for more than
a century. Academics and practitioners have
offered dozens of serious reform proposals.What Is the Purpose of Regulation?
In sports, referees, or umpires, play a critical role over the course of a
match. The best referees are barely noticed. They toil in the back-
ground by vigilantly applying a set of well-understood rules evenly
to both teams. At the end of a well-played match, the team that puts
forth the best effort, gets the
luckiest bounce, or has the most
talent usually prevails. Arguably, the ultimate test of a well-functioning
Much like in sports, many regulatory framework is whether it contributes to
businesses are bound by a set of the financial system’s intermediation capacity, while
rules that define what is per- decreasing the likelihood and costs of systematic
missible and what is forbidden financial crises.
on their playing field. In most —Martin Cihak and Alexander Tieman (2008, 4)
cases these regulations emanate
from legislative bodies and are
“refereed” by administrative groups like the Environmental Protec-
tion Agency, the Food and Drug Administration, and the National
Credit Union Administration. As each business operates under its
specific set of rules, the most innovative, most customer-centric, or
most flexible generally thrives and grows.
It is the regrettable moment when the referee becomes the central
focus of any endeavor—sporting, business, or otherwise. Sometimes,
due to close calls (however accurate), when much is at stake, referees
are unavoidably and even usefully visible. Other times, regulators
become prominent if they have “bad rules” or incorrectly enforce
“good rules.” One person’s estimation of a bad rule may be another
person’s permissible rule. Organizations may have different opinions
than regulators of what constitutes “risky behavior,” partly because
of their differing assessments of risk and partly because of how wide
their relevant purviews are.
These tensions are a natural, and likely constant, element of regu-
lated markets. This friction is captured in the following observations
2from leading experts in financial regulation and helps get us closer to
an understanding of the purpose of regulation:
• “Government regulation helps to promote general financial
stability and to protect investors and consumers against fraud.
. . . [Regulation] must weigh the social costs and benefits of the
contemplated intervention” (Bernanke 2007).
• “Getting financial market regulation right is a difficult, painstak-
ing job. . . . The ‘less’ vs. ‘more’ argument is not helpful. We don’t
need more or less regulation; we need smarter regulation” (Rivlin
2008).
• “On the one hand, we may want to encourage welfare-improving
innovations by limiting the extent of regulation. On the other
hand, because of possible systemic concerns, some policymak-
ers may want to regulate innovative instruments and institutions
even as they are developing” (Ferguson 2005).
• “The regulation of credit unions (as with other depository institu-
tions) should provide as much consumer choice as possible by
promoting a competitive and innovative financial marketplace
that recognizes the unique cooperative nature of credit unions,
while insuring a safe and sound financial system” (W. Jackson
2003, 104).
• “I believe we, as the regulator, have the responsibility to ensure
credit unions can respond to today’s challenges and are not
restrained by burdensome and unnecessary regulations” (Hood
2006).
• “The National Credit Union Administration has the following
stated goals: To ensure the safety and soundness of the credit union
system; To foster cooperation between credit unions and NCUA
(the regulator/insurer); To improve the efficiency and
Figure 1: Innovation vs. Safety the effectiveness of NCUA’s supervision including
reducing the regulatory burden; To ensure fair and
equal access of financial services for all Americans”
(National Credit Union Administration 2006, 8).
I
n Regulation, therefore, is best visualized as a seesaw,
n
o with “innovation” on one side and “safety” on the
v other side. In the middle is a precarious “regulatory”
a S
t a fulcrum about which these competing interests are
i f balanced. Move too far toward safety via heavy-
o e
n t handed regulation, and innovation is squelched; shift
y too much toward innovation via laissez-faire oversight,
and safety is endangered. Further complicating the
issue of regulatory balance is that the external world
is not constant. New technologies, changing con-
sumer demands, macroeconomic events, and new
3competitors can move the fulcrum as innovations and risks materi-
ally shift from year to year and even month to month. Such is the
nature of our dynamic financial markets.
The Current U.S. Financial Services
Regulatory Environment
The U.S. financial services regulatory system was recently described
as “outdated,” “ill-suited to meet the nation’s needs,” and “frag-
mented and complex” by an independent study undertaken by the
Government Accountability Office (GAO; Dodaro 2009). It is fair
to say that no one deliberately set out to design the system that has
evolved. Recent Senate testimony on the adequacy of the current
U.S. financial regulatory system by several experts went right to the
jugular, describing the current system as “archaic” (Davidoff 2009)
and “inefficient . . . redundant . . . wasteful” (H. Jackson 2008).
With these ringing endorsements, it is perhaps instructive to under-
stand the general organization of the current system so that we have
a common frame of reference for the remainder of this report.
• Federal Reserve System: The “Fed” is the central bank of the
United States. In addition to its considerable role in regulating
banking companies and activities, it has other responsibilities:
■■ Its board of governors guides monetary policy.
■■ Its Federal Open Market Committee works in conjunction
with other internal parties to set the federal funds rate.
■■ Reserve banks are regional arms of the central bank that
help coordinate monetary policy on a local basis. Addition-
ally, reserve banks regulate the operations of all national
banks and also oversee state-chartered banks that are part of
the Federal Reserve System.
• Department of the Treasury: The Treasury’s main function is to
manage the government’s revenues. Financial regulatory duties are
conducted by two subagencies:
■■ The Office of Thrift Supervision (OTS) charters, regulates,
and supervises federal savings and loans (S&Ls) and federal
savings banks.
■■ The Office of the Comptroller of the Currency (OCC)
charters, regulates, and supervises all national banks (banks
that have “National” in their name or the letters “N.A.”
after their name) and the federal branches and agencies of
foreign banks in the United States.
4• Federal Deposit Insurance
How Is the U.S. Financial System Different from the Finan- Corporation (FDIC): The
cial Systems of Other Countries? FDIC insures consumer
• Size and importance of U.S. capital markets are unmatched. deposits at member banks
• Importance of investment banks in credit intermediation up to $250,000. The FDIC
process. examines and supervises
some banks to ensure the
• Regionalized and localized nature of deposit-based banking
health and stability of the
institutions.
Bank Insurance Fund (BIF).
• No national-level insurance regulation.
• National Credit Union
• Government’s role in promoting home ownership and home Administration (NCUA):
financing. The NCUA supervises
——Group of 30 (2009) and charters federal credit
unions and insures savings
in federally chartered and
most state-chartered credit unions across the country through the
National Credit Union Share Insurance Fund (NCUSIF).
• State banking regulators: In addition to federally chartered finan-
cial depositories, the U.S. banking system permits state-chartered
institutions. State-chartered institutions can theoretically be
regulated by multiple parties: states and either the Federal Reserve
or the FDIC or NCUA.1
• Federal Financial Institutions Examination Council (FFIEC): The
FFIEC is a formal interagency body of the U.S. government
empowered to prescribe uniform principles, standards, and report
forms for the federal examination of financial institutions by the
Fed, FDIC, NCUA, OCC, and OTS, and to make recommen-
dations to promote uniformity in the supervision of financial
institutions.2
• Securities and Exchange Commission (SEC): The SEC regulates the
U.S. securities markets, enforces securities law, and monitors the
nation’s stocks and options exchanges along with other electronic
securities markets.
• Financial Industry Regulatory Authority (FINRA): FINRA is the
largest independent regulator for all securities firms doing busi-
ness in the United States. It oversees nearly 5,000 brokerage
firms, 173,000 branch offices, and 659,000 registered securities
representatives. Its chief role is to protect investors by maintaining
the fairness of the U.S. capital markets.
• Commodities Futures Trading Commission (CFTC): The CFTC
protects market users and the public from fraud, manipula-
tion, and abusive practices related to the sale of commodity and
financial futures and options, and fosters open, competitive, and
financially sound futures and options markets.
5• Insurance regulators: The insurance industry is regulated on a
state-by-state basis by an insurance commissioner. Each state
insurance commissioner has different rules and regulations.
• Consumer protection: Each regulatory body has some form of
consumer protection capabilities; however, the main body to
deal with this topic is the Federal Trade Commission (FTC). It is
important to note that the FTC monitors all consumer protection
topics—or in the words of its Web site, it “deals with issues that
touch the economic life of every American.”
This alphabet soup of financial services regulators is, to any objective
eye, a complex web of interrelated but uncoordinated organizations.
Adding to this complexity are the increasingly influential un-
regulated financial firms and products such as hedge funds, private
equity, and credit default swaps. If you were to sketch out the cur-
rent regulatory landscape, you would probably need more than two
dimensions to get your point across, and you would probably end
up with something akin to a Rube Goldberg contraption. Figure 2
attempts to capture the complexity of this regulatory landscape.
For the current financial services players (banks, credit unions,
insurance firms, investment managers, etc.), the regulatory environ-
ment is a complex and sometimes vexing structure to operate within.
Time and again the industry has called for deregulation to make the
players’ jobs less complex, and until recently, the referees have largely
acquiesced. Since 2008, however, the issue has not been about more
or less regulation, but about wholesale reregulation. Or more specifi-
cally, the reach or coverage of regulations is very likely to be broad-
ened so that functions rather than charters are the defining sphere of
regulations.
Why Reregulation?
The demands for reform of the regulation of our financial system are
ongoing and will become more insistent. Demands for regulatory
restructuring have been going on for more than a century. Academ-
ics, practitioners, Congress, and regulators have advanced dozens of
serious reform proposals since the 1930s. A 2005 paper published by
the FDIC documents many of these proposals. The study concludes:
The dynamic tension created by the presence not only of state regula-
tors but also of multiple federal regulators has led many banking
commentators to observe that nothing will change the regulatory
structure of the financial services industry unless the politics of the
current system are taken into consideration. Unlike citizens of other
countries, who may not worry about concentrations of power, U.S.
citizens have demonstrated a clear preference for decentralization.
Further, it is commonly said that regulatory reform in the United
6Figure 2: Simplified Framework of U.S. Financial Services Regulatory Structure
7States will be very hard to achieve without a big event to propel it
forward. Although some tinkering around the edges may be possible,
wholesale change—which would require congressional action—is not
likely in the absence of a crisis that would minimize battles over turf
and unite the entrenched constituencies. (Kushmeider 2005, 18)
Since then, a tsunami has rolled over our financial markets, damag-
ing them and the global economy. While it is beyond the scope of
this report, many experts agree this tailspin is primarily attributed
to the activities of the U.S. financial sector. Some of the most well-
documented examples include extension of risky loans to unqualified
borrowers, the securitization of these loans into collateralized debt
obligations, the emergence of credit default swaps, and the meteoric
growth of a highly leveraged (and unregulated) shadow banking sec-
tor. The regulatory system largely missed the boat on these activities.
As a result, the demand for change is loud and growing louder.
A proposal put forth by former Treasury Secretary Henry Paulson
(2008), entitled Blueprint for a Modernized Financial Regulatory
Structure, could have been relegated to the historical trash heap if
not for the current economic environment. While it is unlikely the
Blueprint proposal will be implemented as originally proposed, the
paper enabled serious discussion and debate on the topic of regula-
tory restructuring.
Recently President Obama (2009) stated in a speech to his economic
advisory team, “The choice we face is not between some oppressive
government-run economy or a chaotic and unforgiving capitalism.
Rather, strong financial markets require clear rules of the road, not to
hinder financial institutions, but to protect consumers and inves-
tors and ultimately to keep those financial institutions strong.” This
sentiment is largely shared by legislators, who will be tasked with
developing a new framework to overcome what Kushmeider calls
“the entrenched constituencies.” These legislators—represented by
the current chairs of the Senate Committee on Banking, Housing
and Urban Affairs and the House Committee on Financial Services
(Senator Dodd and Representative Frank, respectively)—are fairly
clear in their exhortations for regulatory consolidation. Frank states,
“While we will continue to work with the Obama Administration on
stabilization, it is now essential that we continue work on our reform
agenda and address the need for financial regulatory restructuring
to diminish systemic risk and to enhance market integrity.”3 Dodd
adds, “While we must ensure we do not unduly cramp innovation
and creativity, for me the need for stronger protections for ordinary
Americans is not negotiable. It is the key to restoring confidence in
our financial system and, as such, must be the bedrock foundation
upon which we build our new regulatory architecture.”4
8Research Methodology
The remainder of this report explores the pros and cons of a new
regulatory structure in the United States. The focus is squarely on the
notion of a single financial services regulator for a variety of reasons.
First, the executive and legislative branches are calling for a consoli-
dation of financial regulators as part of the restructuring process.
Second, worldwide, the trend has been toward financial regula-
tory consolidation in such developed markets as South Korea, the
United Kingdom, Germany, and Australia. Third, the Credit Union
National Association (CUNA) lists financial services regulatory
restructuring as its number one legislative issue in 2009.5 My analysis
is based on a review of existing research on this topic.
9Chapter 2
Benefits and Drawbacks of a Single
Financial Ser vices Regulator
While there is no consensus regarding the ideal
structure of financial regulation around the
world, the trend toward a more consolidated
regulatory structure is evident. Still, there is a
great deal of debate in policy, academic, and
practitioner circles about the effectiveness of
each approach.Before we examine the benefits and drawbacks of a single financial
services regulator, it is important to define what a single financial
services regulator actually means in today’s interconnected economy.
A single “prudential” regulator6 regulates the safety, soundness,
and activities of banks, nonbank financial institutions (e.g., credit
unions), insurance firms, and securities markets. Whether a single
regulator would have others under its aegis, such as finance compa-
nies, is an open issue. As stated earlier, the United States currently
has multiple regulators for each major financial services sector.
Figures 3 and 4 provide a simplistic overview of two major single
Figure 3: Simplified Structure of South Korea’s Single Financial Regulatory
Structure
Governor
Supervisory service Financial investment
Deputy governor
division division
Corporate disclosure
Strategic planning
services
Capital markets
Consumer protection Banking services
investigations
Nonbanking Accounting
services services
Insurance services
Mutual savings
Cooperative finance
(credit unions)
Full version available at www.fsc.go.kr/eng/ab/img/organization_img02.gif.
12Figure 4: Simplified Structure of the United Kingdom’s Single Financial Regulatory
Structure
Chairman
Wholesale and
Retail markets
institutional markets
Cross-sector industry leaders: Banking, insurance, retail and mortgage, asset management
Cross-sector thematic leaders: Auditing/Accounting, capital markets, financial stability
Major retail groups Wholesale firms
Retail firms Markets
Small firms Prudential risk
Insurance
Retail policy and Wholesale and
conduct prudential policy
Investments
Financial crime and
Insurance
intelligence
Mortgages and credit
unions
Full version available at www.fsa.gov.uk/pages/About/Who/PDF/orgchart.pdf.
regulator countries and where credit unions fall in the supervisory
structure. The common theme of all single regulatory structures is
prudential supervision of all financial firms; the organizational charts
and details of this supervision vary by locality.
While there is no consensus regarding the ideal structure of financial
regulation around the world, the trend toward a more consolidated
regulatory structure is evident in Figure 5.
Still, there is a great deal of debate (and a little research) in policy,
academic, and practitioner circles about the qualities of each
approach. The following is a summary of the benefits and drawbacks
of such a single regulator structure.
13Figure 5: Number of Fully Integrated Supervisory Agencies, 1985–2006
35
30
25
No. of agencies
20
15
10
5
0
1985 1990 1995 2000 2005
Source: Author’s calculations, based on data in Central Banking Publications (2005), information in the International Monetary Fund’s Article IV reports, and Web
sites of the regulatory agencies; Cihak and Podpiera (2006, 4). Data are through October 2006.
What Is “Prudential” and “Non-Prudential” Regulation?
Regulation is prudential when it is aimed operations and do not ultimately aim
specifically at protecting the financial to protect the solvency of the financial
system as a whole as well as protecting system. These rules tend to be easier to
the safety of deposits (and perhaps other administer because government authori-
liabilities) in individual institutions. When a ties do not have to take responsibility for
deposit-taking institution becomes insol- the financial soundness of the organiza-
vent, it cannot repay its depositors. If it is tion. These issues include, among others,
a large institution, its failure can undermine consumer protection; fraud and financial
confidence enough so that the banking crimes prevention; credit information
system suffers a run on deposits. There- services; interest rate policies; limita-
fore, in prudential regulation, the govern- tions on foreign ownership, management,
ment attempts to protect the financial and sources of capital; tax and account-
soundness and solvency of the regulated ing issues; and a variety of cross-cutting
institutions. issues surrounding transformations from
one institutional type to another.
Non-prudential rules encompass regu-
lations about the institution’s business Source: CGAP/World Bank.
14What Are the Benefits of a Single
Financial Services Regulator?
The following high-level benefits have been widely acknowledged
in various academic and independent studies and are based on the
experiences of policymakers here and around the world.
Consolidated View
The financial services marketplace has become more complex (see
sidebar on pages 16–17). Deregulation and financial innovation have
been rapid and extensive over the past few decades. For the handful
of mega-sized financial institutions, the lines between banking, secu-
rities, and insurance are so blurred that it is often difficult to clas-
sify these organizations into a neat taxonomy. With the emergence
of such conglomerates as AIG, Citigroup, UBS, HSBC, and Bank
of America, the argument for a single financial services regulator
“is advantageous because it mirrors the nature of modern financial
markets” (Ferran 2003, 13). For example, in the United States, Citi-
group’s various business units have been supervised (sufficiently or
not) by multiple regulators according to each unit’s function. How-
ever, no one regulator had authority over the entire conglomerate’s
activities and resolution. It is thought that a single regulator could
effectively fill the regulatory gaps, take a consolidated view, and
effectively assess and mitigate groupwide risks (Cihak and Podpiera
2006, 9). Filling the regulatory gaps is important because “experience
has shown that, while firms generally claim to have financial firewalls
between their various operations, they are often proven to be largely
illusory when serious difficulties arise” (Abrams and Taylor 2000,
10). One only has to consider the experience of AIG to understand
the importance of this observation.
Economies of Scale
Much like individual credit unions, each U.S. financial services regu-
lator conducts a variety of overlapping activities. For example, each
regulatory body has costly operational functions like information
technology, facilities, and personnel. The following list provides esti-
mates of the number of employees at the major regulatory agencies:
• FDIC: ~5,000
• OCC: ~3,000
• OTS: ~1,000
• NCUA: ~1,000
• Federal Reserve System: ~24,0007
• SEC: ~4,000
• FINRA: ~3,000
• CFTC: ~500
15The Changing Face of Financial Services
Financial services are much more com- doing business is a powerful example of
plex today mostly due to regulatory this new complexity.
changes over the past several decades
Source: Correspondence with William
(see Appendix 1). The list of activities now
E. Jackson, III, professor of finance,
permissible and executed by “new” finan-
University of Alabama, March 2009.
cial firms contrasted with the “old” way of
Figure 6: The Old World Order of Financial Services
Financial Commercial Investment Insurance Finance P. Equity
service bank bank company S&L company V. Cap. Other
Start-up capital XXX
Checking XXX XXX
account
Growth capital XXX
Plant XXX XXX
expansion
Asset-based XXX XXX XXX
loan
Insurance on XXX
equipment
IPO stock XXX
Credit cards XXX
Brokerage XXX
needs
Mortgages XXX
Real estate
IPO debt XXX
Risk XXX XXX XXX
management
Seasoned XXX
equity
16The Changing Face of Financial Services (continued)
Figure 6: The New World Order of Financial Services
Financial Commercial Investment Insurance Finance P. Equity
service bank bank company S&L company V. Cap. Other
Start-up capital XXX XXX XXX XXX XXX
Checking XXX XXX XXX XXX
account
Growth capital XXX XXX XXX XXX XXX XXX XXX
Plant XXX XXX XXX XXX XXX
expansion
Asset-based XXX XXX XXX XXX XXX
loan
Insurance on XXX XXX XXX XXX XXX
equipment
IPO stock XXX XXX XXX XXX XXX XXX XXX
Credit cards XXX XXX XXX XXX XXX XXX
Brokerage XXX XXX XXX XXX XXX
needs
Mortgages XXX XXX XXX XXX XXX XXX
Real estate
IPO debt XXX XXX XXX XXX XXX XXX XXX
Risk XXX XXX XXX XXX XXX XXX XXX
management
Seasoned XXX XXX XXX XXX XXX
equity
17A single regulator should theoretically be able to rationalize a
number of overlapping functions and activities to deliver a more Benefits of a Single Regulator
efficient regulatory regime under a single management structure, • Consolidated view.
saving firms and the government money. • Economies of scale.
• Economies of scope.
Economies of Scope
• Consistent objectives.
Similar to the economies of scale argument, a single regulator
may be able to deliver a greater scope of services than regulators • Accountability.
could individually. The scope of these services could include the • Flexibility.
following:
• Standards setting (prudential and non-prudential) for the
entire financial services industry.
• More comprehensive supervision of individual firms.
• Development of a high-powered staff.
• Ability to address financial services-wide risk issues.
Consistent Objectives
A single regulator would provide a consistent regulatory framework
simply because it is the only game in town. This regulatory con-
sistency would eliminate turf wars between competing regulatory
bodies over the interpretation of rules or attraction of specific entities
under their charter specifically because they have different regula-
tions.8 Additionally, consistency would eliminate the regulatory, or
jurisdictional, arbitrage many financial firms use to their advantage
regarding a particular product or market niche. Finally, consistent
objectives and practices would create a level playing field of rules and
regulations each player would have to abide by.
Accountability
Who is responsible for the current financial crisis? Various reports,
congressional testimony, and media coverage put the onus on
consumers, speculators, the SEC, the Community Reinvestment
Act, Fannie Mae, Freddie Mac, George W. Bush, Bill Clinton, Phil
Gramm, Democrats, Republicans, and greed. With a single regula-
tor, one of the primary goals of granting it statutory authority is to
allow it to protect the safety and soundness of the financial system.
In other words, the buck stops here. In the current patchwork of
regulatory bodies, the tendency for a “blame disbursement strategy”
is present (Abrams and Taylor 2000, 15).
Flexibility
Because of the “coherence and clarity of its mandate” (Ferran 2003,
21), a single regulator may be more flexible in dealing with the
emergence of new innovations in the marketplace. As with any
18organization, the better defined its mandate, the more likely it is to
deal with exigencies not specifically stated in its specific charter.
What Are the Drawbacks of a
Financial Services Regulator?
The following high-level drawbacks are sourced from a variety of aca-
demic papers, independent research, and experience of policymakers
around the globe. Many of these drawbacks focus on the difficulties
inherent in a major change process since most single regulator struc-
tures evolve from a legacy structure that embeds differing objectives,
personnel, traditions, and skills.
Unclear Objectives
Developing a single regulator structure involves drafting specialized
legislation to define the purpose and charter of a new regulatory
organization. The legislative process, often referred to as “sausage
making,” may result in an ambiguous mission and an unclear set of
objectives. If the objectives are unclear, the risk of a single regula-
tor “can give rise to problems of holding the regulatory agency to
account for its activities. Vague objectives may also provide little
guidance for when (as inevitably will be the case) its different objec-
tives come into conflict” (Abrams and Taylor 2000, 17).
Change Process
Drawbacks of a Single Regulator
Even if the single regulator’s objectives are clearly stated, the
• Unclear objective.
enormous risk of change management remains. Imagine for
• Change process. a moment the difficulties of consolidating different agencies’
• Unrealized synergies. cultures, IT systems, and personnel. The addition of com-
• Too large to be effective. pletely new regulatory duties (e.g., shadow banking sector
activities) will need to be integrated with established regula-
• Moral hazard.
tory bodies. This is not a trivial issue.
Unrealized Synergies
The main bet for any organizational merger is that the whole is
greater than the sum of its parts. The risk is that the economies of
scale and scope synergies imagined in the section above may fail to
materialize. These unrealized synergies are likely to happen because
of conflicting cultures and insufficient change management programs
among the various insurance, banking, and securities regulators.
Too Large to Be Effective
As stated above, consolidating regulatory agencies may create gener-
ous economies of scale, but the flip side is that a single regulator
may also become too big to be effective. The regulatory monopoly
19enjoyed by a single regulator necessarily creates a large bureaucracy
that may lead to slowness and rigidity. An additional hazard can be
what Abrams and Taylor (2000, 10) term the “Christmas-tree effect.”
This situation results in the piling on of noncore, nonstatutory regu-
latory responsibilities, such as real estate broker regulation, to the
sole financial services regulator.
Moral Hazard
If a certain party perceives it is insulated from risk, it may behave
differently than if it were fully exposed to the risk. The most com-
mon example of moral hazard is a person who buys fire insurance
for his or her home and then is more negligent than before about
risky activities such as smoking in bed or replacing batteries in the
fire detector. In a single financial services regulator model, moral
hazard refers to the assumption “that all creditors of all institutions
supervised by an integrated supervisor will receive the same protec-
tion” (Cihak and Podpiera 2006, 11). For example, bank investors
may assume they have the same protection as bank depositors. This
so-called moral hazard may cause regulated firms to act in an overtly
risky manner.
Conclusion
This chapter outlined the major benefits and drawbacks of a single
financial services regulator as sourced from various academic papers,
independent researchers, and policymakers from around the world.
In the next chapter I will examine whether the consolidation of
financial services regulation into a unified body has benefited
selected financial systems. Again I access the most relevant research
available on the topic.
20Chapter 3
Is There a “Best” Financial
Regulatory System?
Thirty-three percent of countries have imple-
mented a single regulator structure as of 2007.
An additional 26% have so-called semi-
integrated, or “twin peak,” regulation, where a
single entity supervises two of the three major
financial services sectors (banking, securities,
and insurance). Finally, an additional 41% of
countries, preferring a decentralized regulatory
environment, employ a model similar to the
U.S. model.As stated in Figure 7, 33% of the countries have implemented a
single regulator structure as of 2007. An additional 26% of countries
have so-called semi-integrated, or “twin peak,” regulation, where
a single entity supervises two of the three major financial services
sectors (banking, securities, and insurance). Finally, an additional
41% of countries, preferring a decentralized regulatory environment,
employ a model similar to the U.S. model.9 Given this diverse set
of structures, which approach is most effective? True to the age-
old economists’ maxim, “It depends.” Unfortunately there is scarce
research about the impact of regulatory form vis-à-vis financial insti-
tution performance and/or overall financial sector safety and sound-
ness. This chapter reviews the few studies that address this important
topic.
The benefits of financial regulation are multi-faceted and likely vary across jurisdictions.
Even once specified, many of these benefits are difficult to measure. . . . Thus, the task of
comparing marginal costs to marginal benefits in the field of financial regulation may be
fundamentally intractable, and international comparisons of the sort . . . may be highly
problematic.
— Howell Jackson (2007, 255)
In “Is One Watchdog Better than Three?” International Monetary
Fund (IMF) economists Martin Cihak and Richard Podpiera (2006)
review international experience with different forms of financial
regulation and supervision. They conclude integrated financial
regulators are characterized by more consistent and higher-quality
supervision, although a significant amount of these advantages can
be explained by the comparatively high level of economic develop-
ment in single regulator countries. For example, the higher quality of
regulation in Denmark is attributable to both the economic develop-
ment10 of the country and the structure of financial regulation. They
also discover that the presence of a single regulator does not necessar-
ily create noticeable economies of scale, refuting one of the benefits
listed in Chapter 2.
22Figure 7: Jurisdictions with Single, Semi-Integrated, and Sectoral Prudential Supervisory
Agencies, 2006
Agency supervising two types of financial
intermediaries
Single prudential supervisor for Multiple sectoral supervisors (at least
the financial system (year of Banks and Banks and Securities firms one for banks, one for securities firms,
establishment) securities firms insurers and insurers and one for insurers)
Australia (1998) Kazakhstan* Finland Canada Bolivia Albania* Italy*
(1998)
Austria (2002) Korea (1997) Luxembourg Colombia Bulgaria* Argentina* Jordan*
Bahrain* (2002) Latvia (1998) Mexico Ecuador Chile Bahamas* Lithuania*
Belgium (2004) Maldives* (1998) Switzerland El Salvador Egypt* Barbados* New Zealand*
Bermuda* (2002) Malta* (2002) Uruguay Guatemala Jamaica* Botswana* Panama
Cayman Isl.* Netherlands * Malaysia* Mauritius* Brazil* Philippines*
(1997) (2004)
Czech Rep. (2007)* Nicaragua * (1999) Peru Ukraine* China (Mainland) Portugal*
Denmark (1988) Norway (1986) Venezuela Croatia* Russia*
Estonia (1999) Poland (2007) Cyprus* Slovenia*
Germany (2002) Singapore* (1984) Dominican Rep* Sri Lanka*
Gibraltar (1989) Slovak Rep.* Egypt* Spain*
(2007)
Guernsey (1988) South Africa * France* Thailand*
(1990)
Hungary (2000) Sweden (1991) Greece* Tunisia*
Iceland (1988) UAE* (2000) Hong Kong Turkey
(China)*
Ireland* (2003) UK (1997) India* Uganda*
Japan (2001) Indonesia* USA*
Israel*
As share of all countries in the sample (percentage)
33 6 11 9 41
Note: The table focuses on prudential supervision, not on business supervision (which can be carried out by the same agencies or by separate agencies, even in the integrated model). Also, we do
not consider deposit insurers here, even though they play an important role in banking supervision in a number of countries and can do so under any regulatory model.
* Banking supervision is conducted by the central bank.
Source: Author’s calculations, based on data in Central Banking Publications (2004) and on Web sites of supervisory agencies.
In “Bank Safety and Soundness and the Structure of Bank Supervi-
sion” (Barth, Dopico, Nolle, and Wilcox 2002), a group of academ-
ics study whether supervision structure impacts bank safety and
soundness. The research team concludes, “Countries with multiple
authorities tend to have lower bank capital ratios and to have higher
liquidity risk. Thus, the results indicated that having multiple
banks supervisors (rather than one supervisor) is consistent with a
‘competition in laxity’. This finding that multiple supervisors tend
to reduce equity capital ratios and increase liquidity risk comports
with the hypothesis that having multiple bank supervisors weakens
corporate governance of banks.11 We also find that, when a coun-
try’s central bank also supervises banks, its banks tend to have more
23non‑performing loans. Our finding that non-performing loans
are higher when the central bank supervises banks supports the
hypothesis that a more focused bank supervisor might strengthen
the monitoring and control of banks” (185). Their conclusions,
therefore, hint that the regulatory structure currently present in the
United States may be more lax and risky than a single regulator or a
similarly structured regulatory regime in another part of the world. It
is important to note that one of the drawbacks of a single regulatory
structure mentioned earlier, moral hazard, appears to rear its head in
the fragmented regulatory structure as well.
In “Quality of Financial Sector Regulation and Supervision around
the World,” IMF Economists Martin Cihak and Alexander Tieman
(2008) attempt the Herculean task of measuring and comparing the
quality of the world’s financial regulatory regimes. They state, “The
main finding of this paper is a confirmation that there are significant
differences in the quality of regulation and supervisory frameworks
across countries, and that the level of economic development is an
important explanatory factor. . . . On balance, therefore, our research
cautions that despite the higher grades obtained by high-income
countries, the supervisory knowledge about the financial strength of
their institutions may not be higher than that for low- or middle-
income countries. Indeed, the developments in the global financial
system in late 2007 and early 2008 suggest that the higher quality
of supervisory systems in high-income countries may not have been
sufficient given the complexity of their financial systems” (20). In
short, the authors offer little in the way of a definitive answer to the
question of whether regulatory structure impacts supervisory quality.
“A Cross-Country Analysis of the Bank Supervisory Framework and
Bank Performance,” by James Barth, Daniel Nolle, Triphon Phu-
miwasana, and Glenn Yago (2002), attempts to provide a system-
atic and empirical analysis linking supervisory structure and bank
performance. They conclude, “Our results indicate, at most, a weak
influence for the structure of supervision on bank performance . . .
given the dearth of empirical evidence on the issues, advocates of one
form or another of supervisory structure have asserted that a particu-
lar change is likely to affect (favorably or adversely, as the advocate
sees fit) the performance of banks. Our results provide little support
at best to the belief that any particular bank supervisory structure
will greatly affect bank performance” (1). So, this group of research-
ers can’t find a link either.
“A Pragmatic Approach to the Phased Consolidation of Financial
Regulation in the United States,” by Harvard law Professor Howell
Jackson (2008), reports a much more definitive view, “Consolidated
oversight as implemented in leading jurisdictions around the world
offers a demonstrably superior model of supervision for the modern
24financial services industry.” Jackson goes on to expound on the
benefits of a single regulator model, including, “consistent regulatory
requirements across different sectors . . . capacity to attract and retain
higher quality staff . . . develop[ment] of broadly-based consumer
financial education programs . . . accountability have been hardwired
into many modern supervisory structures” (3–4). Jackson also raises
questions about the current U.S. financial regulatory system: “The
emergence of a near consensus among other jurisdictions regarding
the desirability of a more consolidated financial regulatory oversight
Formation of the UK Financial Services Authority
The first stage of the reform of financial infancy, although there are certainly many
services regulation in the United King- possible signs, in particular the emphasis
dom was completed in June 1998, when on an integrated approach to regulation
responsibility for banking supervision across all parts of the financial services
was transferred to the Financial Services industry” (28). Much has been written
Authority (FSA) from the Bank of England. about the United Kingdom’s experience in
In May 2000 the FSA took over the role of the development of the FSA, but there is
UK Listing Authority from the London Stock a dearth of analysis on its effectiveness.
Exchange. The Financial Services and Mar- A recent report, though, slams the FSA’s
kets Act, which received approval in June supervisory role in the recent run on North-
2000 and was implemented in December ern Rock, a large UK bank. This report is a
2001, transferred to the FSA the respon- black eye to the idea of the world’s most
sibilities of several other organizations, integrated regulator and one that has many
including the regulation of financial institu- similarities to the U.S. financial system.
tions, securities, and insurance firms. The Additionally, in 2008 the UK Financial Ser-
legislation also gives the FSA some new vices Compensation Scheme (FSCS; similar
responsibilities—in particular, taking action to FDIC) paid out £20 billion to consum-
to prevent market abuse and mortgage ers who had money in financial services
regulation. firms since September 2008. According
to David Hall, the chairman of this orga-
Cambridge University law Professor Ellis
nization, “Between December 2001 and
Ferran (2003) reflects on the lessons other
September 2008, the FSCS paid about
countries can learn from the United King-
£1bn in compensation” (5). (www.fscs.org.
dom’s experience in adopting the single
uk/industry/latest_industry_news/2009/feb/
regulator structure. He states, “Political
FSCS_Plan_and_Budget_2009_10/)
support for change [to a single regulator]
will be greater where the existing system Source: Adapted from www.fsa.gov.uk/
is, or is perceived to be, malfunctioning. Pages/About/Who/History/index.shtml.
. . . It is impossible to draw firm conclu-
sions because the new regime is still in its
25should at least raise questions as to whether our [U.S.] national resis-
tance to regulatory consolidation is well-founded” (15).
This “under-researched” (Abrams and Taylor 2000) topic does not
allow us to make sweeping conclusions about the “best” or “right”
regulatory structure for the U.S. financial system. The papers
referenced are inconclusive: Some report significant benefits of a
single regulator structure, while others fail to correlate structure
to financial industry safety and soundness. Also important to note
is all the research studies quoted above were performed before the
current financial crisis. If the authors were to replicate their studies
today, they might get materially different findings. A recent paper
by Cihak and Podpiera (2006, 24) provides a sufficiently balanced
perspective on this topic by stating, “Integrated supervision may be
associated with substantial benefits, particularly in terms of increased
supervisory consistency and quality. This strengthens the case in
favor of integrated supervision in the medium-to-long term. Country
authorities considering whether to integrate their supervisory frame-
work need to compare the likely medium- and long-term benefits
with the short-term challenges and risk involved in the integration
process and in the chosen model.”
Given the political and economic climate in the United States, it is
likely that policymakers will view short-term dislocations as a neces-
sary means to the medium- and long-term ends of a more consistent
and higher-quality regulatory system. Therefore, the final chapter
explores a number of serious reform proposals for the creation of a
single financial services regulator in the United States.
Figure 8: A Summary of Major Research on the Impact of
Financial System Regulatory Structure
Title Conclusion
“Is One Watchdog Better than Three?” Structure is important, but economic
(2006) development of a country may be more
important
“Bank Safety and Soundness and the Countries with multiple regulators and central
Structure of Bank Supervision” (2002) banks as regulator may be more lax and risky
for banks
“Quality of Financial Sector Regulation and Higher-income countries have better
Supervision around the World” (2008) supervision and regulation than low-income
countries, but complexity of higher-income
countries’ financial systems may negate this
advantage
“A Cross-Country Analysis of the Bank Supervisory structure does not impact bank
Supervisory Framework and Bank performance to any statistically significant
Performance” (2002) manner
“A Pragmatic Approach to the Phased Consolidated supervision is a superior
Consolidation of Financial Regulation in the model for a variety of reasons and should be
United States” (2008) implemented in the United States
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