TheJakartaPost
Please Update your browser
Your browser is out of date, and may not be compatible with our website. A list of the most popular web browsers can be found below.
Just click on the icons to get to the download page.
What we can learn from abolition of UK FSA
On a side note, the UK’s regulatory style, for the last four decades, can be described as a series of experiments in search of a better approach.
Change Size
I
n 2013, the United Kingdom dissolved its Financial Services Authority (FSA). Many in Indonesia might have assumed that the move automatically restored the pre-FSA arrangement by putting the banking supervision authority under the Bank of England (BOE). The real story, however, was more complex than the common misreading.
To begin with, the dissolution was not about closing or merging of institutions for policy-expediency reasons. Nor was it offered as a panacea for interagency-coordination problems. Truth be told, it was about a bigger theme: paradigm shift in financial regulation.
The shift, as a consequence, has transformed the regulatory style in the UK by replacing integrated supervision with the objective-based approach or the twin peaks model. So clearly, the dissolution did not bring back a supposedly more effective older framework.
In the newest framework, jurisdictions are assigned to each “peak” based on objectives. One is responsible for prudential affairs while the other is tasked with regulating conduct. Hence, reducing the number of regulators was not the goal. In fact, the FSA’s supervisory/regulatory power is now distributed among three authorities: the Financial Policy Committee (FPC)—a policy court within the BOE, the Prudential Regulatory Authority (PRA)—the quasi subsidiary of the BOE, and the Financial Conduct Authority (FCA)—the renamed and restructured FSA.
On a side note, the UK’s regulatory style, for the last four decades, can be described as a series of experiments in search of a better approach. From 1986 to 1998, the country had adopted the self-regulation approach. Then from 1999 to 2013, it had briefly moved to integrated regulation. And since 2013, it has been experimenting with the twin peaks model.
Financial advancements require these experimentations to tune the balance of the three-arm scale of financial regulation: efficiency, stability, and protection of consumer/investor. Thus, each experiment has a varying degree of emphasis on any of these arms. Before 2013, the emphasis was more on the efficiency side while the latest experiment has more stability and protection concerns.
The earlier regulatory style was deemed ill-suited to handle macrofinancial stability concerns. And in the aftermath of the global financial crisis, there was a growing consensus that the arrangement failed to mitigate system-wide risk buildups or to reach swift decisions on crisis resolution.
Northern Rock’s episode in 2007 was the prime example of that ineffectiveness. The BOE and the FSA spent many weeks devising liquidity assistance for the failing bank only to realize that they were too late to extend supports to avoid the infamous bank run.
On a related note, jurisdictions with twin peaks structure showed strong performance during crises, even if their central banks have no supervisory authority. One example is Australia. The country navigated both the Asian and global financial crises relatively unscathed because the two peaks system provides a regulatory environment where authorities can act more resolutely.
Back in the UK, the new FCA is responsible mainly for market conduct, including investor or consumer protection, while the FPC regulates macroprudential aspects and the PRA performs microprudential oversights.
Although the PRA is now technically “part of the legal entity” of the BOE, the exercise of its microprudential duties must be, statutorily, independent of other functions of the bank. Moreover, it is— not to shock many Indonesian observers— still fully funded by fees from regulated entities.
Policies of the PRA, however, have since been set by the Prudential Regulation Committee (PRC), composed of the BOE’s board of governors, the chief executives of the PRA and the FCA, and other six external members. Also, as the FPC does not perform direct oversights, the PRA and the FCA administer the implementation of directions issued by the macroprudential authority. This symbiosis ensures that the BOE, whose board of governors sits in the FPC and the PRC, will act swiftly as the resolution authority should exigencies require interventions.
Still, the two peaks model is not without shortcoming. Since regulators are not assigned based on institutional types, a firm can be regulated by at least two authorities. For instance, credit unions were formerly regulated only by the FSA. But now they are dual regulated by the PRA and the FCA. Similarly, banks must conform to rules set by the three authorities.
These multiple regulatory requirements certainly incur more cost to comply. Financial entities might also face a more complex supervisory environment, especially if the two peaks perform conflicting supervisions, hence adding yet another indirect compliance cost. Yet this is acceptable in the UK’s context since efficiency is no longer the overriding concern.
Another problem that might arise from the structure is possible emergence of “shadow function.” In the previous era, challenges arose when innovations blurred the traditional boundaries defining institutional units. For instance, shadow banking rendered any institution-based approach useless because, again, the framework was designed with respect to legal forms of business. Likewise, there are concerns that financial advancements could one day make the conduct-prudential distinctions obsolete.
So, if the PRA and the FCA enforce an aggressive style, each can be the “shadow regulator” of the other’s function. The PRA would become “the shadow conduct regulator” or the FCA would be “the shadow prudential regulator.” But should they adopt a lenient approach, another “shadow function” would again fall outside regulatory purview.
Back in Indonesia, buzzes about revamping regulatory structure have been proliferating for months. And in many discussions, the abolition of the UK’s FSA is often cited, alas not accurately. Casual observers, as a result, might incorrectly conclude that the UK’s regulatory structure is now similar to the pre-FSA settings or somehow simpler than our current structure.
To really learn from others’ experience, however, we need to immerse ourselves with the complex details and avoid oversimplified depictions. Most importantly, policy-wise discussions should move beyond merely about pros and cons of dissolving or merging institutions. As the UK’s experience showed us: the agenda must be guided by a clear regulatory paradigm the Indonesian financial system shall need in years to come.
***
The writer works at Bank Indonesia. The views are personal.
