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# **4. The Organization of the Supervisory Authority and Framework**

_Independence as the Most Important Prerequisite_ The safety net is importantly determined by the regulatory framework which includes the supervisory authority. International experience, as embodied in the 25 Core principles, suggests that limiting the safety net requires a proper functioning of the supervisory authority, which in turn needs to be insulated against political pressures. Independence of the supervisory authority has in many developing countries been at the core of banking system and other financial crises. Thus, the supervisor need to reside in an agency with a high degree of independence from political interference. In most countries, supervision of credit institutions is part of the central bank, which is normally also the most independent agency. This arrangement is, however, not used everywhere. In about one-third of 70 countries reviewed, supervisory functions of credit institutions are conducted in agencies separate from the central bank (See Annex Table 3). Securities markets are generally supervised through specialized institutions. Regardless of institutional arrangement, the independence of the supervisor and its regulatory functions is key to ensure a proper functioning of the supervisory authority. And adequate information sharing between the monetary authority which has access to bank data and the supervisory authority is necessary.

# _The Institutional Structure of Supervision ofDifferent Financial Services_

The preferred institutional structure for regulation and supervision of different types of financial services involves an evaluation of many issues. These include the accountability of regulatory agencies, the direct costs of agencies, the merit of a degree of competition in regulation, costs imposed on regulated firms by multiple versus one regulator, possible impairment of innovation, regulatory capture, etc.

Countries have responded differently to the associated tradeoffs, and are using a variety of institutional structures. In terms of division of responsibility, for example, out of 70 countries surveyed by the Institute of International Bankers in 1998, 44 use specialist agencies for banking, securities markets and insurance, 19 combine two areas and 7 combine all three areas. Two criteria seem particularly important in determining institutional supervisory structures: (i) the objectives of regulation; and (ii) type of regulatory approach adopted (single or multiple regulatory agency).

Regulation has several dimensions and possible objectives: (i) minimize systemic risk, (ii) prudential, i. e., motivate bank owners and managers to behave soundly and prudently, (iii) consumer protection, (iv) preservation of integrity of financial markets, and (iv) ensure adequate franchise value (competition). These objectives differ by type of financial services and type of financial institutions. Securities markets regulators are often mostly concerned with the conduct of business to preserve the integrity of financial markets-for wholesale transactions-and to assure consumer protection-for retail transactions. Competitiveness issues need not be part of the financial regulator, but could be covered by a competition authority. Furthermore, many regulatory aspects are typically the domain of self-regulatory issues.