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Financial Sector Legal and Regulatory Toolkit : Part Three: Financial Regulation and Supervision : I. Financial Stability, Development and Institutional Design
B. Roles and Responsibilities of Financial Authorities
Dealing with financial distress requires that (i) the regulatory and supervisory authorities have an adequate degree of operational autonomy, (ii) different government agencies understand their respective roles in crisis management, and (iii) there exist arrangements for these agencies to coordinate and cooperate effectively with the availability of the necessary tools and resources. The following is an indicative set of main features that any financial authority should meet to constitute an effective structure:
The institutional design of a system of financial authorities requires careful consideration. All functions could be placed in a single institution. One example of this is the Monetary Authority of Singapore (MAS). More usually, however, various functions are divided among several authorities, which is the case in the People's Republic of China and India.
When a single organization performs all of the safety net functions, the smooth resolution of potential tensions is dependent on the clarity of mandates and an adequate accountability regime among the relevant departments. However, when the functions are assigned to different organizations, issues related to information-sharing, allocation of powers and responsibilities, and coordination of actions are more complex and need to be addressed clearly and explicitly. With respect to the actual roles of the various financial authorities, as a general principle, it is better to keep the roles pure and separate. The supervisory authorities should not go too far in involving themselves in rescue negotiations with an ailing financial institutions. They need their scarce supervisory resources and expertise to exercise strong supervision over the financial institutions, and over all other financial institutions-and this is particularly needed in a systemic crisis situation. Central banks should focus on their functions of providing liquidity, including Lender of Last Resort (LoLR), and of ensuring that large value payment systems function without problems. Practical considerations may also lead to the establishment of a separate financial institutions support authority, because it may be deemed efficient to have this function outside the ministry of finance, the central bank, and the supervisory authority. In such cases, the financial institutions support authority should be an independent financial regulatory agency, structured under similar principles to those applying to central banks and financial regulators in general.
The ministry of finance is generally responsible for overall financial sector policy development and coordination of the various financial sector agencies. In addition, in the context of financial stability, the ministry of finance will have a specific role in cases where public funds such as taxpayer funds are potentially at stake. In this context, financial intermediary solvency support (as opposed to liquidity support to solvent intermediaries) should only be provided by the ministry of finance and in circumstances designed to (i) maximize financial stability while (ii) minimizing moral hazard concerns and use of public funds. The central bank typically focuses on the following objectives: In the context of the financial safety net, the central bank generally should be responsible for Once the various conditions for effective regulation are in place, the institutional structure of financial sector supervision should then be considered. To be effective, the regulatory system structure needs to reflect the structure of the regulated markets. Independent regulatory agencies offer the most adequate solution to the need for good regulatory governance. The circumstances of each country dictate whether the regulator is located within the central bank or elsewhere. Regardless of location, however, the regulator should be both financially and operationally autonomous, accountable, transparent, and efficient (qualified efficacy) with respect to both regulation and supervision. However, information can and should be shared with the central bank and other regulatory bodies. The powers of a financial regulator should be sufficiently flexible to enable it to resolve any problems efficiently. These powers should include, as a minimum Ideally, the regulatory authority should have the ability to revoke licenses to conduct financial services business. However, in countries where this may not be possible, then the authority should have the ability to make recommendations on the revocation of licenses, with the decision-maker required to give reasons in the event that the authority's recommendation is not acted on. Enforcement powers are likely to remain more effective if the regulator has the ability to amend them quickly. For this reason, it is generally preferable to set out only the broad framework of the regulatory agency's powers in legislation, leaving the details to be filled in by directives and guidelines that can be issued and amended by the regulatory agency itself. (Abrams & Taylor, 2000) Decisions respecting intervention should be independent yet accountable and reviewable (in most cases ex post, with damages as the appropriate remedy). Decisions regarding restructuring (individual cases) versus resolution (based on viability) and decisions regarding specific form of resolution (based on the principle of least cost resolution in the context of minimizing systemic implications) should both be taken at the agency responsible for financial institution resolution with the participation of the ministry of finance, the central bank, and the relevant financial regulators. The financial regulator can be involved in resolutions that require a takeover by or merger with a healthier institution. When all other measures fail, the supervisor should have the ability to close or assist in the closing of an unhealthy financial institutions in order to protect the overall stability of the financial system. The regulator should be responsible for, or assist in, the orderly exit of problem financial institutions (in coordination with any applicable deposit insurance agency or other authority responsible for depositor protection). An efficient financial system should provide for the prompt and orderly exit of institutions that are no longer able to meet regulatory requirements. The financial institutions restructuring authority is often combined with an explicit deposit insurance agency (DIA). The leading example is the Federal Deposit Insurance Corporation (FDIC) in the United States. In some cases, the role of liquidator may also be aggregated. Structure in individual systems will depend upon the overall design. Typically, however, the restructuring authority/DIA/liquidator should be separate from both the central bank and the supervisory agency or agencies and should have control over resolution strategy, albeit coordinated with other agencies at management level. If a country has a competition authority, clear arrangements with respect to financial institution mergers and acquisitions are required. These will be necessary in the context of many approaches to dealing with insolvent financial institutions and should be addressed prior to the occurrence of problems. When addressing financial sector difficulties, the supervisor will probably need to coordinate actions with other authorities, e.g., the government, the central bank, operators of payment and settlement systems, deposit insurers and other domestic supervisory agencies and their foreign counterparts. On the domestic level, there should be a legal basis for the information exchange with other agencies. Similarly, on the international level, financial regulators should be able to receive and exchange information with foreign counterparts. Ideally, the terms of such understandings should be laid down in a reciprocal arrangement between the regulators, e.g., in the form of a memorandum of understanding (MoU) or an exchange of letters. Under the principles of consolidated supervision, information tends to flow from the host supervisor to the home supervisor and not in the opposite direction. Host supervisors however also have a right to be kept informed on matters affecting particular financial institutions with an office in the host territory and will also wish to be notified by home supervisor of significant matters affecting a parent bank or head office. If a home supervisor is intending to take action to protect the interests of depositors, such action should be coordinated with the host supervisors of the financial institution foreign establishments to the extent possible.
Financial reporting is one of the greatest single problem facing financial regulators. One of the primary roles of a financial regulator is to constantly obtain accurate and current information from the entities subject to its supervision. Once problems regarding a financial intermediary come to the attention of the supervisor, the first issue that should be determined is the financial position of the intermediary. To this end, the supervisor must have the necessary information to be able to make informed decisions on what strategy is appropriate for the problem at hand. Auditing requirements, along with a variety of reporting obligations of both financial intermediaries and their auditors, should ensure that the regulator is well-informed at all times. In addition, the supervisor must have the right to access all information and have the power to conduct unscheduled on-site examinations or investigations or to have third parties, e.g., auditing firms, conduct on-site examinations. Regulators should have unfettered access to reports and all other documents issued by the internal control and audit functions. As recommended by the Basel Committee on Banking Supervision (BCBS), supervisors should have the legal power to require financial intermediaries to report all relevant data, with sanctions available to punish deficient, incorrect, or late submissions of returns. In addition to financial information, the supervisor must have rapid access to a wide range of relevant non-financial information about financial intermediaries, including organization and legal structure and information regarding participation in the payments system. Office of the General Counsel
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