Case Against the Fully Unified Model
There is clear merit in the arguments stated in the case for a unified model, and there is a certain prima facie appeal to the concept of a unified prudential regulator. However, several reservations may be voiced about such an agency:
• One of the arguments in favor of a single prudential agency—that as financial firms have increasingly diversified, the traditional functional distinctions between institutions have been eroded—is not applicable in many countries. Although this lack of applicability is generally the case in industrial countries, it may not be true of all countries or even of all institutions in industrial countries. In very many countries, there remain—and will remain for the foreseeable future—major differences among banks, securities firms, and insurance companies.
• Firms in all sub-sectors of the financial system have diversified, but their core business almost invariably remains dominant. The nature of the risks may be sufficiently different to warrant a differentiated approach to prudential regulation. Insurance companies have long-term liabilities with ill-defined value, whereas assets are generally marketable with readily ascertainable values. Banks, by contrast, tend to have relatively short-term liabilities with assets that are difficult to liquidate and to value. Consequently, the applicable prudential supervisory regimes are different, and there would be few (if any) efficiencies in bringing their supervision together.
• Accountability of the single agency might be more difficult, because of the problems of defining clear objectives for the agency. Accountability always has been difficult to implement for a supervisory agency—whether it be in a single agency or with multiple agencies—given the multiple objectives and the need to ensure a sufficient degree of confidentiality of supervisory actions on individual institutions. Nevertheless, accountability for objectives can be better implemented if cross-sectoral integration of supervisory functions is organized based on objectives of supervision, as in Australia and the Netherlands.
• There is a danger within a single agency that the necessary distinctions between different products and institutions will not be made. A single agency might not have a clear focus on the objectives and rationale of regulation and supervision and might not make the necessary differentiations between different types of institutions and businesses. Even if the different regulatory requirements of different types of firms are managed within specialist divisions of an integrated regulator, there is no guarantee that supervisors who are within the same organization (but who are responsible for different types of business) will necessarily communicate and coordinate more efficiently and closely than if they were within different, specialist regulatory agencies. Regardless of the institutional structure that is chosen in a particular country, the ultimate skill lies in balancing conflicting pressures.
• A potential moral hazard is that the public will believe that the spectrum of risks among financial institutions has disappeared or become blurred. In particular,
the distinction could become obscured between deposits that are redeemable on demand at face value and certain investments where the value of an institution’s liability is a function of the performance of the institution in managing its assets. There may be a tendency for the public to assume that all creditors of institutions supervised by a given supervisor will receive equal protection.
• A large unified regulator might become excessively bureaucratic in its procedures and might be slow to react to problems as they emerge.
• The creation of a single regulator might involve a loss of potentially valuable information because a single approach is adopted. In effect, there might be merit in having a degree of competition and diversity in regulation so that lessons can be learned from the experience of different approaches. In some respects, the case for not having a monopoly regulator is the same as with any monopolist.
• Further, there may not be any economies of scale to be derived from an integrated regulator. The economics literature demonstrates quite clearly that diseconomies of scale can arise in some circumstances. Put another way, what economists refer to as X-inefficiencies (that is, inefficiencies caused by suboptimal resource allocation and not by a lack of economies of scale) may arise in a monopolist regulator. It is not self-evident that a single, unified regulator would, in practice, be more efficient than a series of specialist regulators that are based on clearly defined objectives and are focused specifically on regulation to meet those clearly defined objectives. In addition, as in Ireland and Finland, economies of scale in infrastructure, information technology, and services can be achieved by locating separate agencies within the same building and by sharing common resources while, nevertheless, maintaining strict separation of regulatory and supervisory policy and execution.
• A single, all-embracing agency also may be subject to the hazards of the “Christmas tree” effect, in which a wide range of miscellaneous functions are loaded onto it, overburdening it with activities divorced from its primary function and objectives.
• Regardless of the nature of the change made to institutional structure, there are always potentially serious transaction costs to consider. There is a degree of unpredictability in the process of change itself. A bargaining process may be opened between different interest groups, the legislative process might be captured by vested interests, key personnel may be lost, and management may be diverted from the core activity of regulation and supervision.
The arguments for and against unified prudential agencies are finely balanced, and the optimal structure is likely to vary between countries, depending on the structure of their financial system (and, in particular, whether the system is populated by specialist or conglomerate institutions), the past traditions, the political environment, and the size of the country. If a single agency is created, the type of unified supervision and the issue of internal structure need further consideration.