Unification of financial regulatory structures: the case of the Russian Federation

Abstract

In this paper we develop the case for the creation of a single financial supervisory and regulatory authority for the Russian Federation. This case is based on three criteria:
(a) it enables economies of scope to be exploited
(b) it ensures regulatory parity
(c) it satisfies prudential logic

The risk management function in banks, investment firms and insurance companies has become extremely complex utilising sophisticated statistical methodologies to analyse market data and credit ratings. Given the need for each of the three sectors to manage their risks using similar data and similar methodologies, there are economies of scope for regulators to adopt a comprehensive approach. This will also ensure regulatory parity. Over the past twenty years elimination of competitive barriers globally has led to increased cross-border and cross-sector competition. Hence in order to avoid disintermediation between sectors and between countries a unified approach will be required. Financial institutions in the three sectors are increasingly interrelated either as counter parties to a transaction or as a division within a conglomerate. Prudential logic suggests that the regulatory function should map onto the actual activities of the financial institutions themselves. This approach is being developed by the Joint Forum, a group comprising the Bank for International Settlements, the International Organisation of Security Commissioners and the International Association of Insurance Supervisors.

A unified financial regulator would not only concern itself with the prevention of institution failure in the face of market, credit and operational risks. We argue that it should provide protection to customers of a financial institution should that institution fail. In order to prevent moral hazard and adverse selection problems arising the prevention and protection functions must be integrated. To ensure that these functions are carried out the unified authority needs to establish principles for the governance of financial firms and through systematic audit ensure their implementation. There needs to be co-ordination if not integration of monetary policy formulation and regulation of the financial sector. On the one hand, a restrictive monetary policy can lead to increased failures in both the productive and financial sectors. On the other hand, stringent regulatory practice could lead to reduced lending and hence impact upon productive sector activity.

Finally, it is noted that an efficient financial system supported by effective supervision and regulation requires highly trained managers, auditors and supervisors. This is a necessary pre-condition and is independent of the type of regulatory structure adopted. However, a unified authority by reducing the extent of overlapping regulatory functions is able to economise on these scarce resources.

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ORCID for George McKenzie: orcid.org/0000-0001-9815-9535

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