Submission to the Financial System Inquiry Appendix B: Overseas Supervisory Arrangements

69. This Appendix summarises the organisation of prudential supervision in a range of OECD and other countries.^[29] It concentrates on three main issues:
    • which countries use the ‘mega-regulator’ model;
    • the role of central banks in prudential supervision; and
    • reasons for any recent changes in supervisory arrangements.
70. Among the countries studied, the supervisory structures are organised in a variety of ways and the different national systems do not always fit conveniently into neat categories.^[30] Nonetheless, some broad generalisations can be made:
    • although there are a number of countries that combine some supervisory jurisdictions, only a small minority combine responsibility for all the main institutional groupings in a single prudential regulator;
    • most central banks are heavily involved in bank supervision, either as the sole supervisor or by sharing responsibilities with another agency. Where central banks do not have the primary formal responsibility for bank supervision they still, in most cases, devote significant resources to monitoring the financial system and maintain an interest in system stability;
    • related to this, the central bank almost always has a key role in the payments system, running settlement accounts for banks and providing some form of lender-of-last-resort facility;
    • while we are not aware of instances in recent history of the bank supervision function being taken away from a central bank, there are several examples of bank supervisory responsibilities being moved into the central bank, or to a subsidiary of the central bank.

The ‘mega-regulator’ approach

71. The exact definition of the ‘mega-regulator’ concept is somewhat arbitrary. On the broadest possible definition, such a regulator would have responsibility for prudential supervision of all financial institutions as well as being responsible for product regulation and competition policy in the financial sector. We are aware of no example of a national system that gives such wide responsibilities to a single regulator. Sweden is perhaps the closest approximation to this extreme, combining wide supervisory responsibilities and product regulation in the one agency. In virtually all countries, however, the three broad regulatory areas of prudential supervision, product regulation and competition policy are separated, with competition policy in the financial sector generally the responsibility of the economy-wide competition authority.
72. A more practical approach to the ‘mega-regulator’ concept is to focus on the allocation of responsibilities within the field of prudential supervision. A number of countries have agencies which are responsible for supervision of more than one of the main groups of financial institutions. The allocation of responsibilities in these countries is summarised in Table A10. The table defines a ‘mega-regulator’ in the prudential sphere as one that combines responsibility for the three main industry groupings of banks (or credit institutions generally), insurance, and funds management operations. On this definition there are four countries with mega-regulators outside the central bank: Denmark, Norway, Sweden and Japan. Of these, the Japanese regulator is located in the Ministry of Finance while the others are stand-alone regulators. In addition, Singapore has a ‘mega-regulator’ which is part of the central bank.
73. The Scandinavian ‘mega-regulators’ were established in the late 1980s and early 1990s through the merger mainly of insurance and bank supervisors. These mergers took place in 1986 in Norway, 1988 in Denmark and 1991 in Sweden. The Danish regulator's coverage was further expanded in 1990 to include mortgage credit institutions. A number of reasons were given for merging the supervisory authorities in these countries. These included the emergence of financial conglomerates and the growth of competition across traditional institutional boundaries. There was also a view that staff resources could be used more efficiently by gathering the supervisory expertise together into one organisation. In Norway, for example, there had reportedly been difficulties in keeping up with market developments and in attracting staff, particularly for the insurance regulator, and it was felt that a combined agency would generate improved performance in this regard. Notwithstanding these expectations, it appears that the organisation of supervisory resources within the Scandinavian ‘mega-regulators’ still reflects the fundamental differences between banks and insurance companies. The regulators have made some moves towards supervision of bank/insurance conglomerates but continue to require specialist staff groups focussing on the different component entities.
74. A number of other countries have financial supervisors with broadly based responsibilities but whose scope falls short of the ‘mega-regulator’ definition adopted in Table A10. Finland has a combined supervisor for credit institutions and securities markets (the Financial Supervision Authority) but a separate supervisor of insurance companies. As discussed below, the Financial Supervision Authority was brought under the administration of the central bank in 1993. Canada has a broadly-based supervisor, the Office of the Superintendent of Financial Institutions, responsible for federally-incorporated institutions. It emerged in the late 1980s out of a perception that the regulatory system needed to be rebuilt following some financial failures. Its creation also reflected a general view that financial developments were moving ahead of existing regulatory arrangements. The separate supervisory agencies covering banks (which was not the central bank), insurance companies and pension funds were merged, but the new authority does not have general responsibility for the funds-management industry.
75. In Germany, the Netherlands and Switzerland the bank supervisor has responsibilities for funds managers and collective investments but not for insurance, which has a separate supervisor in each country. The grouping of banks and funds managers reflects the universal nature of banks in those countries, so that bank supervisors' regulation of collective investments was a natural progression from their involvement in banks' securities activities.
76. A proposal to merge prudential supervisory authorities in a stand-alone regulator was recently considered, and rejected, in South Africa. The issue was investigated in 1992 by the Jacobs Committee and subsequently by the Melamet Committee, which recommended that a single prudential supervisor be established. After public comment and close examination of the proposal, however, the Government decided to continue with South Africa's existing regulatory structure where the central bank supervises banks, and the Financial Services Board supervises all other financial institutions (there is a separate Registrar of Companies). As discussed further below and in Appendix C, a move in the opposite direction was recommended but not implemented in Norway. In 1992, a parliamentary inquiry recommended bringing the existing ‘mega-regulator’ under the central bank, but the proposal was not adopted by the full parliament.

Involvement of central banks in supervision

77. The preceding section has outlined a limited number of cases where the main prudential regulator of banks is a ‘mega-regulator’ outside the central bank, but this is not the dominant pattern. In the majority of countries, it is the central bank that has primary responsibility for supervision of the banking system, sometimes in conjunction with responsibility for other types of financial institutions as well. The overall pattern is illustrated in Table A11: of the 27 countries listed, 17 place responsibility for bank supervision primarily with the central bank, and in another four countries the central bank shares the responsibility with other agencies. In only six cases does the central bank have little or no involvement in bank supervision.
78. There are four countries listed in Table A11 where the central bank shares close monitoring of the banking system with another agency (or agencies): sometimes, as in Germany and Japan, this occurs despite formal responsibility resting with another body. The Federal Reserve System in the US is the primary supervisor for bank holding companies and state-chartered member commercial banks. Other banks, including some owned by bank holding companies, are supervised primarily by the Office of the Comptroller of Currency, the Federal Deposit Insurance Corporation, and by state supervisors. Each of these supervisory agencies has a role in supervising the US operations of foreign banking organisations. Because of the often overlapping roles of the various supervisory agencies, there is a close degree of co-operation among them.
79. In Germany, the Bundesbank is closely involved in the supervision of banks. It carries out on-site inspections and reviews and follows up on reports by external auditors before they are passed on to the Federal Banking Supervisory Office (FBSO). Despite not being the primary supervisor, the Bundesbank employs more supervisory staff than the FBSO. Under German legislation, the FBSO and the Bundesbank ‘…shall communicate to each other any observation and findings which may be of significance for the performance of their functions’. The FBSO can be required to consult with the Bundesbank before changing policy directives (eg Principles Concerning Capital or Liquidity). Nonetheless, the FBSO has prime carriage of legal responsibilities connected with supervision; these include granting and withdrawing banking licences, ordering special audits or issuing special instructions to banks' management.
80. The Ministry of Finance in Japan supervises banks, insurance companies and securities companies and markets. Bank supervision is conducted in conjunction with the Bank of Japan (BOJ), whose supervisory role lies mainly in bank examinations, and is based on contractual agreements struck between the BOJ and financial institutions at the time they open current accounts with the BOJ. The BOJ uses off-site and on-site techniques in supervising banks. Information gleaned from on-site visits is passed onto the Credit Department. The BOJ is also involved in decisions regarding both privately-managed payments systems and those in which final settlement is made through the BOJ accounts.
81. In the Scandinavian countries where the central bank is described as having little or no involvement in bank supervision (Denmark, Norway and Sweden), the supervisory authority is a ‘mega-regulator’. The central bank in each country is nonetheless the lender of last resort, there is generally some degree of formal or informal co-operation with the supervisory authority, and the central bank maintains an interest in financial system stability. The Swedish Riksbank for example has recently noted that it ‘cannot disregard the stability of particular institutions because the failure of a sizeable institution may constitute a systemic risk’.^[31]
82. The Bank of Canada appears to have the least involvement in bank supervision of any central bank studied. However, the Bank of Canada has acted as lender of last resort to banks and has recently acquired statutory responsibility for payments system policy. Appendix C discusses problems that have resulted from the Bank of Canada effectively outsourcing credit assessment procedures for its lender-of-last-resort role. Partly as a consequence of those problems, the Financial Institution Supervisory Committee was formed and the Bank of Canada has taken a somewhat closer interest in financial system issues in recent years.

Recent moves to shift supervisory responsibility involving the central bank

83. The involvement of central banks in bank supervision has been extensively debated in a number of countries in recent years, both at the official level and among academics. These debates are reviewed in detail in Appendix C. There have been at least four countries in recent history where a shift in the institutional responsibility for bank supervision has occurred: Spain (1962), Luxembourg (1983), Finland (1993) and Hong Kong (1993). In each case the supervisory responsibility was moved from a separate authority into the central bank, or into a subsidiary body of the central bank.
84. In Finland the banking crisis of the early 1990s prompted a review of regulatory arrangements in 1992 (see Aranko (1994) and Tuya and Zamalloa (1994)). Prior to that review, bank supervision was the responsibility of a separate Banking Supervision Office. The old regulatory arrangements were criticised on several counts, including an excessive focus on judicial compliance rather than risk evaluation, underfunding of the banking supervisor, and inadequate provision of information to the central bank. The working party responsible for the review recommended that the Banking Supervision Office be incorporated into the administration of the central bank. This recommendation was accepted by the parliament. The working party felt that the two organisations had parallel objectives, that the central bank was better resourced, and that there were considerable gains in efficiency that could be realised by combining the two institutions. To prevent conflicts of interest, the decision making processes of the Bank of Finland and the supervision area are separate; each has its own board. The Board of the Financial Supervision Authority (which is chaired by the representative of the Bank of Finland) also has representatives from the Ministry of Finance and the Ministry of Social Affairs and Health (which supervises insurance companies and pension funds).
85. Another recent example of bank supervision being brought into the central bank comes from Hong Kong. In April 1993, the Hong Kong Monetary Authority was formed by merging the office of the Exchange Fund (monetary policy) with the office of the Commissioner of Banking (bank supervision). The merger aimed to ensure that the central banking functions of maintaining monetary and banking stability were properly co-ordinated and conducted, particularly in the lead up to 1997 and beyond. Primary influences on the changes were a series of banking crises in 1982–86 and the BCCI collapse in 1991, which illustrated the importance of the central bank having a close knowledge of the banking system if it was to respond quickly to requests for emergency liquidity support.
86. There are also two recent examples of a shift in supervisory responsibilities being recommended by an official inquiry but not implemented. In Norway, a parliamentary inquiry recommended moving supervisory responsibilities into the central bank in 1992. As in Finland, the proposal reflected serious dissatisfaction with the performance of the supervisory regime in the recent banking crisis; however, unlike in Finland, the proposal was not adopted by the parliament. In South Africa two recent government inquiries recommended moving bank supervisory responsibilities to a ‘mega-regulator’ outside the Reserve Bank, but again the proposal was not implemented. These debates, along with those in other countries where the central bank's supervisory responsibilities have been reviewed but not fundamentally changed, are discussed in Appendix C.

Footnotes

Information in this Appendix has been gathered from a variety of sources including direct from the supervisors. [29]

Regulatory structure charts for most of the countries discussed in this Appendix are available from the Reserve Bank. [30]

Sveriges Riksbank, Quarterly Review, No 1, 1996, p. 72. [31]