Tarisa Watanagase: Aspects of optimal supervisory arrangements
Remarks by Dr Tarisa Watanagase, Governor of the Bank of Thailand, at the SEACEN
Governors' Conference, Kuala Lumpur, 6 February 2009.
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Bank Negara Malaysia's background paper provides a good summary of issues related to
the choice of optimal supervisory arrangements. It is generally accepted that integrated
model of supervision may have inherent synergies, economy of scale and scope, very little or
no regulatory arbitrage and the ability to identify problems sooner. However, its possible
weaknesses are the blurring of focuses and a tendency to compromise multiple objectives.
On the other hand, separate supervisors have been credited with being more focused on
their mandates, but of course the biggest concern is about supervisory coordination, the lack
of which can lead to regulatory arbitrage, making supervision ineffective.
It is also generally accepted that no one model is better or more optimal than the other. It all
depends on the context of each country, including its supervisory capacity and resources,
and details in operational arrangements.
Thailand can certainly agree to such a conclusion. In our case, the Bank of Thailand (BOT)
supervises the banking sector, which is the core of the financial sector. The Securities and
Exchange Commission (SEC) supervises market conduct, the Insurance Commission
supervises the insurance companies. This model has worked well so far. By law, the BOT
chairs the Financial Institutions Policy Committee, whose members include the Secretary
General of the SEC and the Insurance Commissioner, that meets on a monthly basis. The
forum provides the opportunities for policy dialogues, exchange of views and concerns, and
information updates, among other things. This is the major operational arrangement that we
have put in place to make the separate authorities model work for us. No doubt other
operational arrangements can be put in place to make the integrated model work as well.
Having said that, let me add another dimension to the issue of supervisory arrangement -
one that is related to central bank's other key function, namely, monetary policy. I believe
that supervisory policy and monetary policy can be arranged in such a way that they are
complementary and supportive to each other. I also believe that the often-cited conflicts of
interest between the two roles, if performed by the same institution, may have been
overstated somewhat. If there are policy conflicts, these conflicts will have to be resolved
regardless of who is in charge of supervision. Then, would it not be more efficient if the
conflicts could be internalized and resolved within an institution? In fact, many possible
mechanisms exist to help ensure full accountability for each role, thereby minimizing
potential conflicts while getting synergies from having the two roles under one roof. The
arrangement we use In Thailand, as I alluded to earlier, is the establishment of two separate
policy boards that include outside experts. The linking pin is membership in both policy
boards by central bank's senior management, which makes it possible for information and
knowledge in one area to be usefully employed in performing the other, without
compromising the mandate of each policy board.
For example, detailed supervisory information about banks' changing risk appetite and
exposure to different economic sectors and markets - as well as how these risks are being
managed - can provide useful early warnings about the health of the economy and potential
systemic problems down the road. This can be a very important input for monetary policy
board. On the other hand, central bank's oversight of monetary policy and economic stability
can strengthen and provide context to its supervisory responsibilities, for example, in
identifying potential macro factors that may affect the health of financial institutions.
Decisions about the stance and timing of prudential and supervisory policies in general can
also be more appropriately made with the full knowledge of macroeconomic conditions and
monetary policy.
As can be seen, the two policies are essential to each other and hence it is useful or even
desirable, in my opinion, for central banks to supervise at least the core financial sector,
whether under a separate or integrated supervision model. This is most evident in times of
systemic crisis where central banks' last-resort lending is likely to be called upon and prompt
decision is vital. Central banks that also supervise core financial institutions would have the
clear benefits of immediate access to vital information and expert assessment from
supervisory staff about the health of individual institutions and their systemic implications.
This could greatly help reduce the likelihood of any unnecessary delay or even misinformed
decision that might hamper efforts to stem a financial crisis.
For emerging market economies, the case for central banks to supervise the core financial
institutions may be even stronger. This is because, financial markets in these countries are
typically not well developed enough to serve as an efficient channel for the transmission of
monetary policy. Market interest rates and even commercial banks' prime rates react only
sluggishly to changes in central bank's policy rate, and often with a long time lag. In these
circumstances, the traditional tool of monetary policy alone is unlikely to be enough to
maintain economic and financial stability. Since in most emerging market economies,
commercial banks are by far the most dominant players in the financial system, central banks
with supervisory responsibilities could and should make use of targeted prudential policy to
tackle financial imbalances and excessive asset price movements, both of which lie at the
heart of all financial crises.
This was what we did in 2003 to successfully contain incipient speculative bubbles in the
property sector by imposing a ceiling on banks' loan-to-value ratio of high-end housing loans.
In the same vein, in order to contain household debt at prudent levels to prevent financial
imbalances, a maximum credit-to-income ratio was imposed on credit card and personal
loans.
Let me now turn to the current financial crisis and discuss some lessons that are relevant to
the issue of supervisory arrangement. If we look at the wide range of counties afflicted by the
current turmoil, we immediately notice that financial sector problems happened in countries
with either supervisory model. Notably, the US is well-known for its multiple agencies,
whereas the UK has an integrated one. Yet both countries are currently faced with similar
financial sector problems. One cannot help but think that there must be certain common
supervisory weaknesses that led to the crisis, regardless of the supervisory arrangements.
So perhaps the key question is not about the institutional form but rather about how to
strength the regulatory framework to ensure financial stability.
Of course, this is not an easy task, given the scale and the complexity of the problems that
we are in right now. Several committees and working groups of various organizations,
including the BIS, are working on a number of issues that have been identified as
contributing to the crisis, such as the procyclical nature of supervisory and accounting rules
and the inadequate focus on liquidity risk. I do not know whether there are efforts to try to
identify common weaknesses of different institutional setup of supervision. But no doubt this
is an area that more work will be needed.
To me, both types of institutional setup may have one important common weakness, that is,
there does not seem to be the notion of a lead supervisor in either model. Allow me to
elaborate on this point.
In the case of separate authorities, it would be normal for each authority to assume that
every authority is doing its job according to its mandate. Therefore, one would tend to focus
only on its own mandate. This can be a problem if some authorities fail to do a proper job,
others may not be able to take note. Worse still, if there are supervisory gaps, the chance of
any one authority identifying potential adverse impact from areas outside of one's own
mandate is even smaller. Take the US as an example, the authorities and investors did not
realize that credit rating agencies were not doing an adequate job in their rating of complex
structured products. If there were a lead supervisor, would the whistle have been blown
earlier? I believe that there would have been a better chance if there were a lead supervisor
with a clear mandate to take the lead responsibility and who is risk focused. There would
have been more dialogues through which weaknesses may have been identified and
corrected.
The idea of a lead supervisor has gained widespread support in the area of cross-border
supervision, as it contributes to better coordination, which in turn could help to prevent or
identify problems at an early stage. By the same token, such benefits could be gained in the
domestic setting from having a lead supervisor under the separate authorities model. Of
course, in the case of the integrated model, the notion becomes a lead department in the
same agency, rather than an outside lead supervisor.
The next question is: who should be the lead supervisor? The obvious answer is it should be
the one that supervises the core financial institutions of the country. And following my
previous argument that a central bank should supervise the core financial sector, the central
bank should be the lead supervisor. The financial landscape, role, and systemic importance
of financial institutions evolve overtime, so must the scope of oversight and focus of lead
supervisor. The lead supervisor must closely monitor this evolution and ensure no regulatory
gap emerges. It can do so by expanding its scope of supervision either directly or indirectly
through the relevant agencies and build coordination to ensure it can perform its lead role
properly.