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The Future of Financial Regulation: Structural Reform or Status Quo?

THE ROOTS OF FINANCIAL REGULATION: NEEDLESS DUPLICATION OR
HEALTHY COMPETITION
ANSWER: HEALTHY COMPETITION

SUBMITTED BY: Camden R. Fine

"Banking supervision and regulation can only benefit from the variety of viewpoints and checks and balances of a system of more than one regulatory authority. A system in which banks have choices, and in which regulations result from the give and take involving more than one agency, stands a better chance of avoiding the extremes of supervision. A single regulator… is likely to have a tendency to suppress risk taking. A system of multiple supervisors and regulators creates checks on this propensity."

Alan Greenspan, Chairman
Federal Reserve Board

"Regulatory choices and diversity help mitigate potential regulatory abuses."

John D. Hawke, Jr.
Comptroller of the Currency

"It is not best that we should all think alike; it is differences of opinion that make horse races."

Mark Twain
Great Missourian

BACKGROUND
Our current system of banking supervision mirrors our nation's strong cultural bias for fragmentation of governmental power and authority. Consolidation of regulatory authority is counter to our nation's basic cultural and political heritage. Our founders had a deep distrust of concentration of governmental power (rightly so in my opinion), and deliberately created a dynamic tension among the various elements of our government in order to limit the exercise of power by any one element over the other, or over its citizens. This framework has served the nation well as has our current system of banking supervision.

Proposals to consolidate financial regulation are nothing new. Since World War II, this issue has been raised by various administrations. The last determined attempt to consolidate bank regulatory agencies was made in the 1991 Financial Modernization bill. The motivation for these proposals is generally wrapped around the mantra of "efficiency" and elimination of needless duplication. While these proposals are intriguing, they are almost always generated from the government sector rather than the private sector. I think it is safe to say that the private sector sees value in the current regulatory scheme and would generally oppose the creation of a "super regulator" or the separation of rule making from supervision.

COMPETITION IS GOOD
A by-product of the 1991 Financial Modernization bill was a Treasury Department study of the current regulatory structure. The study concluded in part:

"…the existence of fewer agencies would concentrate regulatory power in the remaining ones, raising the danger of arbitrary or inflexible behavior. Agency pluralism, on the other hand, may be useful since it can bring to bear on general bank supervision the different perspectives and experiences of each regulator, and it subjects each one to the checks and balances of the others' opinion."

Government agencies can become compromised, whether dealing with multiple agencies or one large consolidated agency. Consolidation of agency functions does not guarantee parity, or competence, or independence. Given the enormous power of bank regulators over those they regulate, and the crucial roles that financial institutions play in the health and vitality of the national economy, it is imperative that the regulatory system preserves real choice and maintains regulatory checks and balances. Multiple agencies strengthen our regulatory system by creating a healthy tension among agencies, which encourages "best practices" and innovation.

Multiple agencies help prevent the "politicization" of bank supervision and rule making. It deflects politically motivated direction of policies. For any private sector group to be subject to one ultimate governmental authority is very dangerous.

REGULATORY ARBITRAGE
The financial services industry today is extremely complex. Regulators, whether rule makers or supervisors, cannot be expected to meet the challenge of understanding the issues facing the industry without direct and frequent contact with regulated institutions.

The current regulatory system does create some opportunity for "regulatory arbitrage". Within the context of our current regulatory scheme, however, regulatory arbitrage can be good particularly during cycles of over-zealous regulation when regulators focus on actual or perceived negative outcomes. Regulatory arbitrage can put some practical limits on the power of any one regulator.

Separating the rule making and supervisory functions would create the very high risk of an "ivory tower" of rule making, detached from the realities of the financial services industry. The creation of a kind of banking "FASB" sends chills down the spines of bankers everywhere. Most bankers would agree that a supervisory agency is best positioned to write regulations for the financial institutions that it supervises, and can gauge the impact that any regulation will have on those entities.

Regulatory arbitrage will occur whether you have one supervisory or rule making authority or multiple authorities. With only a single rule making or supervisory agency, regulatory arbitrage can go unchecked and have disastrous consequences--witness the FSLIC debacle in the 1980's. That is the dictionary definition of regulatory arbitrage.

REGULATORY ARBITRAGE
The financial services industry today is extremely complex. Regulators, whether rule makers or supervisors, cannot be expected to meet the challenge of understanding the issues facing the industry without direct and frequent contact with regulated institutions.

The current regulatory system does create some opportunity for "regulatory arbitrage". Within the context of our current regulatory scheme, however, regulatory arbitrage can be good particularly during cycles of over-zealous regulation when regulators focus on actual or perceived negative outcomes. Regulatory arbitrage can put some practical limits on the power of any one regulator.

Separating the rule making and supervisory functions would create the very high risk of an "ivory tower" of rule making, detached from the realities of the financial services industry. The creation of a kind of banking "FASB" sends chills down the spines of bankers everywhere. Most bankers would agree that a supervisory agency is best positioned to write regulations for the financial institutions that it supervises, and can gauge the impact that any regulation will have on those entities.

Regulatory arbitrage will occur whether you have one supervisory or rule making authority or multiple authorities. With only a single rule making or supervisory agency, regulatory arbitrage can go unchecked and have disastrous consequences--witness the FSLIC debacle in the 1980's. That is the dictionary definition of regulatory arbitrage.

HARMONIZATION OF RULE MAKING
There are many ways by which regulatory harmonization can and does occur - e.g., proposed regulations are published for comment (including comments by other regulators and the Treasury Department); regulators work closely together on important matters (e.g. shared national credits, and the inter-agency agreement on loan loss reserves); the FFIEC; the President's Working Group on Financial Markets; and congressionally mandated joint studies. These are all better forms of harmonization than a Federal "super-regulator". The greatest single opportunity for regulatory harmonization lies in the area of Federal preemption of proliferating state and local requirements with respect to important matters such as privacy, predatory lending, and insurance.

CONCLUSION
The role and responsibility of regulators is to serve the public interest. This can only be realized when the financial system operates in a safe, sound, competitive and profitable manner. The existence of competition in the public sector and the ability for banks to freely chose their primary regulator provides incentives for supervisory authorities to excel. It helps insure high quality and responsive supervision. It helps safeguard the banking system against unduly burdensome or over-zealous regulation. It acts to blunt regulatory abuses and excesses that dominance by a single agency can engender. Adoption of concurrent rules by several agencies may take more time and effort, but can yield a superior product with greater acceptability and legitimacy. Camden R. Fine, President/CEO
Midwest Bankers Bancorporation
Jefferson City, Missouri

Last Updated 03/20/2003 communications@fdic.gov

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