Evaluating the Single Financial Services Regulator Question [PDF]

Financial Services. Regulator Question. George A. Hofheimer. Chief Research Officer. Filene Research Institute. Foreword

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Idea Transcript


ISBN 978-1-932795-66-0

Single Financial Services Regulator

ideas grow here PO Box 2998 Madison, WI 53701-2998 Phone (608) 231-8550

www.filene.org

PUBLICATION #187 (5/09) ISBN 978-1-932795-66-0

Evaluating the Single Financial Services Regulator Question George A. Hofheimer Chief Research Officer Filene Research Institute Foreword by

William E. Jackson III, PhD Professor of Finance Professor of Management The Smith Foundation Endowed Chair of Business Integrity Culverhouse College of Commerce University of Alabama

Evaluating the Single Financial Services Regulator Question George A. Hofheimer Chief Research Officer Filene Research Institute Foreword by

William E. Jackson III, PhD Professor of Finance Professor of Management The Smith Foundation Endowed Chair of Business Integrity Culverhouse College of Commerce University of Alabama

Copyright © 2009 by Filene Research Institute. All rights reserved. ISBN 978-1-932795-66-0 Printed in U.S.A.

Filene Research Institute

Deeply embedded in the credit union tradition is an ongoing search for better ways to understand and serve credit union members. Open inquiry, the free flow of ideas, and debate are essential parts of the true democratic process. The Filene Research Institute is a 501(c)(3) not-for-profit research organization dedicated to scientific and thoughtful analysis about issues affecting the future of consumer finance. Through independent research and innovation programs the Institute examines issues vital to the future of credit unions. Ideas grow through thoughtful and scientific analysis of toppriority consumer, public policy, and credit union competitive issues. Researchers are given considerable latitude in their exploration and studies of these high-priority issues.

Progress is the constant replacing of the best there is with something still better!

— Edward A. Filene

The Institute is governed by an Administrative Board made up of the credit union industry’s top leaders. Research topics and priorities are set by the Research Council, a select group of credit union CEOs, and the Filene Research Fellows, a blue ribbon panel of academic experts. Innovation programs are developed in part by Filene i3, an assembly of credit union executives screened for entrepreneurial competencies. The name of the Institute honors Edward A. Filene, the “father of the U.S. credit union movement.” Filene was an innovative leader who relied on insightful research and analysis when encouraging credit union development. Since its founding in 1989, the Institute has worked with over one hundred academic institutions and published hundreds of research studies. The entire research library is available online at www.filene.org.

iii

Acknowledgments

• Matt Bland, Association of British Credit Unions Limited, Manchester, England, UK • Martin Cihak, International Monetary Fund, Washington, DC • Diana Dykstra, San Francisco Fire Credit Union, San Francisco, CA • Rob Folsom, USA FCU, San Diego, CA • David Grace, World Council of Credit Unions, Madison, WI • William E. Jackson, III, University of Alabama, Tuscaloosa, AL • Louise Petschler, Mark Degotardi, and Luke Lawler, Association of Building Societies and Credit Unions, Sydney, Australia • David Snodgrass, Affinity FCU, Basking Ridge, NJ • James Wilcox, University of California–Berkeley, Berkeley, CA

v

Table of Contents



Foreword

ix



Executive Summary and Commentary

xi



About the Author

Chapter 1

Introduction

Chapter 2

Benefits and Drawbacks of a Single Financial Services Regulator

11

Chapter 3

Is There a “Best” Financial Regulatory System?

21

Chapter 4

An Agenda for Reform and Regulatory Consolidation

27

Implications for Credit Unions

35

Chapter 5

xiii 1

Appendix 1 A Brief History of U.S. Financial Services

Regulation

43

Appendix 2 Types of Credit Union Regulatory Structures

in G-20 Countries

45



Endnotes

47



References

49



Additional Reading

53

vii

Foreword

By William E. Jackson III, PhD, University of Alabama

“The world has changed. The world is changing. The world will continue to change.” This is an old saying that is especially relevant for our current dynamic financial system. Whether we like it or not, the U.S. financial system has changed. For example, who would have imagined that in the year 2009 there would not be even one major American investment bank—that they all would either go bankrupt or merge with a bank holding company or change their charter and become a bank holding company? Our financial system is changing, and it will continue to change. Because of these dramatic changes, it is imperative that the regulatory system and the structures that guide our financial system also change. And, changes to our financial regulatory system are coming. This fact is apparent given the announcements and activities of Congress and the Obama administration. For example, consider the recent remarks of President Obama on April 14, 2009, at Georgetown University’s Gaston Hall: The first step we will take to build this foundation is to reform the outdated rules and regulations that allowed this [financial] crisis to happen in the first place. It is time to lay down tough new rules of the road for Wall Street to ensure that we never find ourselves here again. Just as after the Great Depression new rules were designed for banks to avoid the kind of reckless speculation that helped to create the depression, so we’ve got to make adaptations to our current set of rules: create rules that punish shortcuts and abuse; rules that tie someone’s pay to their actual job performance—a novel concept; rules that protect typical American families when they buy a home, get a credit card or invest in a 401(k). So we’ve already begun to work with Congress to shape this comprehensive new regulatory framework—and I expect a bill to arrive on my desk for my signature before the year is out. The fact that major changes to our current financial regulatory system are coming raises at least three questions for credit unions: • What major changes are likely to occur? • How will these changes affect credit unions? • What should credit unions do to prepare for these changes or to become involved in the policymaking process that leads to these changes? These are very timely and very important questions. Fortunately, these are also the exact questions that Filene Chief Research Officer George Hofheimer addresses in this excellent report. With this report, Hofheimer has done a great service for the credit unions of America. This report provides value in every chapter—from an excellent summary of our current “fragmented” regulatory system to wellreasoned suggestions for what credit unions should do in the face of ix

potential major changes to the current regulatory framework. What about the question, What major changes are likely to occur? The answers are in this report. And the question, How will these changes affect credit unions? Hofheimer provides very intelligent scenarios to address this question. And finally the question, What should credit unions do to prepare for these changes or to become involved in the policymaking process that leads to these changes? The answers to this question provide perhaps the most valuable and thoughtful analysis in the report. The answers are so good that I cannot help but give a little preview here. In 2009, it is commonplace to hear policymakers and financial researchers speak about how our regulatory system has failed us. I agree; it has. But, we must also recognize that we have failed our regulatory system. We are currently in a major financial crisis. Who has the moral authority to lead the United States out of this critical situation? Certainly it is not the big banks, insurance companies, investment companies, or mortgage brokers. Credit unions may be the only major financial institutions that continue to have reputations for honesty, integrity, and fairness. As such, credit unions have a unique opportunity to help lead the political process that results in a new financial regulatory system for the United States. How should credit unions prepare for this role of leadership? Read George Hofheimer’s excellent report to find out.

x

Executive Summary and Commentary

This report explores the forthcoming reregulation of the financial services sector in the United States with a special focus on the impact a single financial services regulator may have on the credit union system. I examine this specific topic because a variety of political, economic, and social trends foreshadow its creation, and credit unions stand against the creation of such an entity. My analysis is based on an extensive and independent review of existing academic and policy research on this topic. I report the following: • Financial regulation is a constantly shifting standard due to new innovations and marketplace realities. • The U.S. financial regulatory system is viewed as “fractured” and “archaic” and full of regulatory gaps that don’t effectively police the complexities of the financial system. • The current economic crisis is viewed, in part, as a failure of financial services regulation, and therefore a major overhaul of the regulatory system is necessary. • The worldwide trend in financial services regulation has been toward a more consolidated structure. • The benefits and drawbacks of a single financial services regulator are well documented. • The academic literature is inconclusive and scant about the link between financial regulatory structure and financial sector safety, soundness, and/or performance. • New frameworks, structures, and processes have been introduced and considered by key policymakers as the potential road map for a single financial services regulator. Implications for credit unions: • Beware the tide: Public and political opinion seems to be pushing for a major overhaul in the financial regulatory structure. In normal times, such proposals would end up in the trash heap of previous modernization proposals, but these are not normal times. While I don’t expect credit unions to wither up and accept a new regulatory structure, it may be wise to prepare for a single regulator scenario. • Getting to yes: If the tide of change is indeed too strong, credit unions should be proactive in getting what they want. The experiences of UK and Australian credit unions may be beneficial models to study and understand.

xi

• Be helpful: Influential policymakers have extolled credit unions’ behaviors leading up to and during the current economic crisis. Credit unions have the unique opportunity to influence the new public policy structure to benefit “simple” banking organizations like themselves. Paradoxically, credit unions may have the opportunity to benefit in a new, more limited regulatory structure. The days, months, and years ahead portend a financial services regulatory structure that looks very different from the current model. While it is foolish to predict what the exact regulatory structure will look like, the probability of a more consolidated structure is quite high. My aim with this report is to present an independent view of this topic so that your credit union may traverse the future a bit more confidently.

xii

About the Author

George A. Hofheimer George A. Hofheimer is the chief research officer for the Filene Research Institute, where he oversees a large pipeline of economic, behavioral, and policy research related to the consumer finance industry. He is the current vice chairman of the board of directors at the Williamson Street Grocery Cooperative, a $17 million natural foods store. He earned a BBA and an MBA from the University of Wisconsin–Madison.

xiii

Chapter 1 Introduction

The current U.S. financial services regulatory environment was recently described as “outdated,” “ill-suited to meet the nation’s needs,” and “fragmented and complex” by an independent study. The desire for a change to the financial regulatory system is not new. Regulatory restructuring has been going on for more than a century. Academics and practitioners have offered dozens of serious reform proposals.

What Is the Purpose of Regulation? In sports, referees, or umpires, play a critical role over the course of a match. The best referees are barely noticed. They toil in the background by vigilantly applying a set of well-understood rules evenly to both teams. At the end of a well-played match, the team that puts forth the best effort, gets the luckiest bounce, or has the most talent usually prevails. Arguably, the ultimate test of a well-functioning regulatory framework is whether it contributes to Much like in sports, many the financial system’s intermediation capacity, while businesses are bound by a set of decreasing the likelihood and costs of systematic rules that define what is perfinancial crises. missible and what is forbidden —Martin Cihak and Alexander Tieman (2008, 4) on their playing field. In most cases these regulations emanate from legislative bodies and are “refereed” by administrative groups like the Environmental Protection Agency, the Food and Drug Administration, and the National Credit Union Administration. As each business operates under its specific set of rules, the most innovative, most customer-centric, or most flexible generally thrives and grows. It is the regrettable moment when the referee becomes the central focus of any endeavor—sporting, business, or otherwise. Sometimes, due to close calls (however accurate), when much is at stake, referees are unavoidably and even usefully visible. Other times, regulators become prominent if they have “bad rules” or incorrectly enforce “good rules.” One person’s estimation of a bad rule may be another person’s permissible rule. Organizations may have different opinions than regulators of what constitutes “risky behavior,” partly because of their differing assessments of risk and partly because of how wide their relevant purviews are. These tensions are a natural, and likely constant, element of regulated markets. This friction is captured in the following observations

2

from leading experts in financial regulation and helps get us closer to an understanding of the purpose of regulation: • “Government regulation helps to promote general financial stability and to protect investors and consumers against fraud. . . . [Regulation] must weigh the social costs and benefits of the contemplated intervention” (Bernanke 2007). • “Getting financial market regulation right is a difficult, painstaking job. . . . The ‘less’ vs. ‘more’ argument is not helpful. We don’t need more or less regulation; we need smarter regulation” (Rivlin 2008). • “On the one hand, we may want to encourage welfare-improving innovations by limiting the extent of regulation. On the other hand, because of possible systemic concerns, some policymakers may want to regulate innovative instruments and institutions even as they are developing” (Ferguson 2005). • “The regulation of credit unions (as with other depository institutions) should provide as much consumer choice as possible by promoting a competitive and innovative financial marketplace that recognizes the unique cooperative nature of credit unions, while insuring a safe and sound financial system” (W. Jackson 2003, 104). • “I believe we, as the regulator, have the responsibility to ensure credit unions can respond to today’s challenges and are not restrained by burdensome and unnecessary regulations” (Hood 2006). • “The National Credit Union Administration has the following stated goals: To ensure the safety and soundness of the credit union system; To foster cooperation between credit unions and NCUA (the regulator/insurer); To improve the efficiency and Figure 1: Innovation vs. Safety the effectiveness of NCUA’s supervision including reducing the regulatory burden; To ensure fair and equal access of financial services for all Americans” (National Credit Union Administration 2006, 8). I n n o v a t i o n

S a f e t y

Regulation, therefore, is best visualized as a seesaw, with “innovation” on one side and “safety” on the other side. In the middle is a precarious “regulatory” fulcrum about which these competing interests are balanced. Move too far toward safety via heavyhanded regulation, and innovation is squelched; shift too much toward innovation via laissez-faire oversight, and safety is endangered. Further complicating the issue of regulatory balance is that the external world is not constant. New technologies, changing consumer demands, macroeconomic events, and new 3

competitors can move the fulcrum as innovations and risks materially shift from year to year and even month to month. Such is the nature of our dynamic financial markets.

The Current U.S. Financial Services Regulatory Environment The U.S. financial services regulatory system was recently described as “outdated,” “ill-suited to meet the nation’s needs,” and “fragmented and complex” by an independent study undertaken by the Government Accountability Office (GAO; Dodaro 2009). It is fair to say that no one deliberately set out to design the system that has evolved. Recent Senate testimony on the adequacy of the current U.S. financial regulatory system by several experts went right to the jugular, describing the current system as “archaic” (Davidoff 2009) and “inefficient . . . redundant . . . wasteful” (H. Jackson 2008). With these ringing endorsements, it is perhaps instructive to understand the general organization of the current system so that we have a common frame of reference for the remainder of this report. • Federal Reserve System: The “Fed” is the central bank of the United States. In addition to its considerable role in regulating banking companies and activities, it has other responsibilities: ■■

■■

■■

Its board of governors guides monetary policy. Its Federal Open Market Committee works in conjunction with other internal parties to set the federal funds rate. Reserve banks are regional arms of the central bank that help coordinate monetary policy on a local basis. Additionally, reserve banks regulate the operations of all national banks and also oversee state-chartered banks that are part of the Federal Reserve System.

• Department of the Treasury: The Treasury’s main function is to manage the government’s revenues. Financial regulatory duties are conducted by two subagencies: ■■

■■

The Office of Thrift Supervision (OTS) charters, regulates, and supervises federal savings and loans (S&Ls) and federal savings banks. The Office of the Comptroller of the Currency (OCC) charters, regulates, and supervises all national banks (banks that have “National” in their name or the letters “N.A.” after their name) and the federal branches and agencies of foreign banks in the United States.

4

How Is the U.S. Financial System Different from the Financial Systems of Other Countries? • Size and importance of U.S. capital markets are unmatched. • Importance of investment banks in credit intermediation process. • Regionalized and localized nature of deposit-based banking institutions. • No national-level insurance regulation.

• Federal Deposit Insurance Corporation (FDIC): The FDIC insures consumer deposits at member banks up to $250,000. The FDIC examines and supervises some banks to ensure the health and stability of the Bank Insurance Fund (BIF).

• National Credit Union Administration (NCUA): The NCUA supervises ——Group of 30 (2009) and charters federal credit unions and insures savings in federally chartered and most state-chartered credit unions across the country through the National Credit Union Share Insurance Fund (NCUSIF).

• Government’s role in promoting home ownership and home financing.



• State banking regulators: In addition to federally chartered financial depositories, the U.S. banking system permits state-chartered institutions. State-chartered institutions can theoretically be regulated by multiple parties: states and either the Federal Reserve or the FDIC or NCUA.1 • Federal Financial Institutions Examination Council (FFIEC): The FFIEC is a formal interagency body of the U.S. government empowered to prescribe uniform principles, standards, and report forms for the federal examination of financial institutions by the Fed, FDIC, NCUA, OCC, and OTS, and to make recommendations to promote uniformity in the supervision of financial institutions.2 • Securities and Exchange Commission (SEC): The SEC regulates the U.S. securities markets, enforces securities law, and monitors the nation’s stocks and options exchanges along with other electronic securities markets. • Financial Industry Regulatory Authority (FINRA): FINRA is the largest independent regulator for all securities firms doing business in the United States. It oversees nearly 5,000 brokerage firms, 173,000 branch offices, and 659,000 registered securities representatives. Its chief role is to protect investors by maintaining the fairness of the U.S. capital markets. • Commodities Futures Trading Commission (CFTC): The CFTC protects market users and the public from fraud, manipulation, and abusive practices related to the sale of commodity and financial futures and options, and fosters open, competitive, and financially sound futures and options markets.

5

• Insurance regulators: The insurance industry is regulated on a state-by-state basis by an insurance commissioner. Each state insurance commissioner has different rules and regulations. • Consumer protection: Each regulatory body has some form of consumer protection capabilities; however, the main body to deal with this topic is the Federal Trade Commission (FTC). It is important to note that the FTC monitors all consumer protection topics—or in the words of its Web site, it “deals with issues that touch the economic life of every American.” This alphabet soup of financial services regulators is, to any objective eye, a complex web of interrelated but uncoordinated organizations. Adding to this complexity are the increasingly influential unregulated financial firms and products such as hedge funds, private equity, and credit default swaps. If you were to sketch out the current regulatory landscape, you would probably need more than two dimensions to get your point across, and you would probably end up with something akin to a Rube Goldberg contraption. Figure 2 attempts to capture the complexity of this regulatory landscape. For the current financial services players (banks, credit unions, insurance firms, investment managers, etc.), the regulatory environment is a complex and sometimes vexing structure to operate within. Time and again the industry has called for deregulation to make the players’ jobs less complex, and until recently, the referees have largely acquiesced. Since 2008, however, the issue has not been about more or less regulation, but about wholesale reregulation. Or more specifically, the reach or coverage of regulations is very likely to be broadened so that functions rather than charters are the defining sphere of regulations.

Why Reregulation? The demands for reform of the regulation of our financial system are ongoing and will become more insistent. Demands for regulatory restructuring have been going on for more than a century. Academics, practitioners, Congress, and regulators have advanced dozens of serious reform proposals since the 1930s. A 2005 paper published by the FDIC documents many of these proposals. The study concludes: The dynamic tension created by the presence not only of state regulators but also of multiple federal regulators has led many banking commentators to observe that nothing will change the regulatory structure of the financial services industry unless the politics of the current system are taken into consideration. Unlike citizens of other countries, who may not worry about concentrations of power, U.S. citizens have demonstrated a clear preference for decentralization. Further, it is commonly said that regulatory reform in the United 6

Figure 2: Simplified Framework of U.S. Financial Services Regulatory Structure

7

States will be very hard to achieve without a big event to propel it forward. Although some tinkering around the edges may be possible, wholesale change—which would require congressional action—is not likely in the absence of a crisis that would minimize battles over turf and unite the entrenched constituencies. (Kushmeider 2005, 18) Since then, a tsunami has rolled over our financial markets, damaging them and the global economy. While it is beyond the scope of this report, many experts agree this tailspin is primarily attributed to the activities of the U.S. financial sector. Some of the most welldocumented examples include extension of risky loans to unqualified borrowers, the securitization of these loans into collateralized debt obligations, the emergence of credit default swaps, and the meteoric growth of a highly leveraged (and unregulated) shadow banking sector. The regulatory system largely missed the boat on these activities. As a result, the demand for change is loud and growing louder. A proposal put forth by former Treasury Secretary Henry Paulson (2008), entitled Blueprint for a Modernized Financial Regulatory Structure, could have been relegated to the historical trash heap if not for the current economic environment. While it is unlikely the Blueprint proposal will be implemented as originally proposed, the paper enabled serious discussion and debate on the topic of regulatory restructuring. Recently President Obama (2009) stated in a speech to his economic advisory team, “The choice we face is not between some oppressive government-run economy or a chaotic and unforgiving capitalism. Rather, strong financial markets require clear rules of the road, not to hinder financial institutions, but to protect consumers and investors and ultimately to keep those financial institutions strong.” This sentiment is largely shared by legislators, who will be tasked with developing a new framework to overcome what Kushmeider calls “the entrenched constituencies.” These legislators—represented by the current chairs of the Senate Committee on Banking, Housing and Urban Affairs and the House Committee on Financial Services (Senator Dodd and Representative Frank, respectively)—are fairly clear in their exhortations for regulatory consolidation. Frank states, “While we will continue to work with the Obama Administration on stabilization, it is now essential that we continue work on our reform agenda and address the need for financial regulatory restructuring to diminish systemic risk and to enhance market integrity.”3 Dodd adds, “While we must ensure we do not unduly cramp innovation and creativity, for me the need for stronger protections for ordinary Americans is not negotiable. It is the key to restoring confidence in our financial system and, as such, must be the bedrock foundation upon which we build our new regulatory architecture.”4 8

Research Methodology The remainder of this report explores the pros and cons of a new regulatory structure in the United States. The focus is squarely on the notion of a single financial services regulator for a variety of reasons. First, the executive and legislative branches are calling for a consolidation of financial regulators as part of the restructuring process. Second, worldwide, the trend has been toward financial regulatory consolidation in such developed markets as South Korea, the United Kingdom, Germany, and Australia. Third, the Credit Union National Association (CUNA) lists financial services regulatory restructuring as its number one legislative issue in 2009.5 My analysis is based on a review of existing research on this topic.

9

Chapter 2 Benefits and Drawbacks of a Single Financial Ser vices Regulator

While there is no consensus regarding the ideal structure of financial regulation around the world, the trend toward a more consolidated regulatory structure is evident. Still, there is a great deal of debate in policy, academic, and practitioner circles about the effectiveness of each approach.

Before we examine the benefits and drawbacks of a single financial services regulator, it is important to define what a single financial services regulator actually means in today’s interconnected economy. A single “prudential” regulator6 regulates the safety, soundness, and activities of banks, nonbank financial institutions (e.g., credit unions), insurance firms, and securities markets. Whether a single regulator would have others under its aegis, such as finance companies, is an open issue. As stated earlier, the United States currently has multiple regulators for each major financial services sector. Figures 3 and 4 provide a simplistic overview of two major single

Figure 3: Simplified Structure of South Korea’s Single Financial Regulatory Structure Governor Deputy governor

Supervisory service division

Corporate disclosure services

Strategic planning Consumer protection

Banking services

Capital markets investigations

Nonbanking services

Accounting services

Insurance services Mutual savings Cooperative finance (credit unions) Full version available at www.fsc.go.kr/eng/ab/img/organization_img02.gif.

12

Financial investment division

Figure 4: Simplified Structure of the United Kingdom’s Single Financial Regulatory Structure Chairman Retail markets

Wholesale and institutional markets

Cross-sector industry leaders: Banking, insurance, retail and mortgage, asset management Cross-sector thematic leaders: Auditing/Accounting, capital markets, financial stability

Major retail groups

Wholesale firms

Retail firms

Markets

Small firms

Prudential risk

Retail policy and conduct

Insurance Investments

Insurance Mortgages and credit unions

Wholesale and prudential policy Financial crime and intelligence

Full version available at www.fsa.gov.uk/pages/About/Who/PDF/orgchart.pdf.

regulator countries and where credit unions fall in the supervisory structure. The common theme of all single regulatory structures is prudential supervision of all financial firms; the organizational charts and details of this supervision vary by locality. While there is no consensus regarding the ideal structure of financial regulation around the world, the trend toward a more consolidated regulatory structure is evident in Figure 5. Still, there is a great deal of debate (and a little research) in policy, academic, and practitioner circles about the qualities of each approach. The following is a summary of the benefits and drawbacks of such a single regulator structure.

13

Figure 5: Number of Fully Integrated Supervisory Agencies, 1985–2006 35 30

No. of agencies

25 20 15 10 5 0 1985

1990

1995

2000

2005

Source: Author’s calculations, based on data in Central Banking Publications (2005), information in the International Monetary Fund’s Article IV reports, and Web sites of the regulatory agencies; Cihak and Podpiera (2006, 4). Data are through October 2006.

What Is “Prudential” and “Non-Prudential” Regulation?

Regulation is prudential when it is aimed

operations and do not ultimately aim

specifically at protecting the financial

to protect the solvency of the financial

system as a whole as well as protecting

system. These rules tend to be easier to

the safety of deposits (and perhaps other

administer because government authori-

liabilities) in individual institutions. When a

ties do not have to take responsibility for

deposit-taking institution becomes insol-

the financial soundness of the organiza-

vent, it cannot repay its depositors. If it is

tion. These issues include, among others,

a large institution, its failure can undermine

consumer protection; fraud and financial

confidence enough so that the banking

crimes prevention; credit information

system suffers a run on deposits. There-

services; interest rate policies; limita-

fore, in prudential regulation, the govern-

tions on foreign ownership, management,

ment attempts to protect the financial

and sources of capital; tax and account-

soundness and solvency of the regulated

ing issues; and a variety of cross-cutting

institutions.

issues surrounding transformations from

Non-prudential rules encompass regulations about the institution’s business 14

one institutional type to another. Source: CGAP/World Bank.

What Are the Benefits of a Single Financial Services Regulator? The following high-level benefits have been widely acknowledged in various academic and independent studies and are based on the experiences of policymakers here and around the world. Consolidated View

The financial services marketplace has become more complex (see sidebar on pages 16–17). Deregulation and financial innovation have been rapid and extensive over the past few decades. For the handful of mega-sized financial institutions, the lines between banking, securities, and insurance are so blurred that it is often difficult to classify these organizations into a neat taxonomy. With the emergence of such conglomerates as AIG, Citigroup, UBS, HSBC, and Bank of America, the argument for a single financial services regulator “is advantageous because it mirrors the nature of modern financial markets” (Ferran 2003, 13). For example, in the United States, Citigroup’s various business units have been supervised (sufficiently or not) by multiple regulators according to each unit’s function. However, no one regulator had authority over the entire conglomerate’s activities and resolution. It is thought that a single regulator could effectively fill the regulatory gaps, take a consolidated view, and effectively assess and mitigate groupwide risks (Cihak and Podpiera 2006, 9). Filling the regulatory gaps is important because “experience has shown that, while firms generally claim to have financial firewalls between their various operations, they are often proven to be largely illusory when serious difficulties arise” (Abrams and Taylor 2000, 10). One only has to consider the experience of AIG to understand the importance of this observation. Economies of Scale

Much like individual credit unions, each U.S. financial services regulator conducts a variety of overlapping activities. For example, each regulatory body has costly operational functions like information technology, facilities, and personnel. The following list provides estimates of the number of employees at the major regulatory agencies: • FDIC: ~5,000 • OCC: ~3,000 • OTS: ~1,000 • NCUA: ~1,000 • Federal Reserve System: ~24,0007 • SEC: ~4,000 • FINRA: ~3,000 • CFTC: ~500 15

The Changing Face of Financial Services

Financial services are much more com-

doing business is a powerful example of

plex today mostly due to regulatory

this new complexity.

changes over the past several decades

Source: Correspondence with William

(see Appendix 1). The list of activities now

E. Jackson, III, professor of finance,

permissible and executed by “new” finan-

University of Alabama, March 2009.

cial firms contrasted with the “old” way of

Figure 6: The Old World Order of Financial Services Financial service

Commercial bank

Investment bank

Insurance company

S&L

Finance company

Start-up capital Checking account

XXX

Growth capital

XXX

Plant expansion

XXX

Asset-based loan

XXX

XXX XXX

Insurance on equipment

XXX

IPO stock

XXX XXX

Brokerage needs

XXX

Mortgages Real estate

XXX

IPO debt

XXX

Risk management Seasoned equity

XXX

XXX XXX

16

Other

XXX XXX

Credit cards

P. Equity V. Cap.

XXX

XXX

The Changing Face of Financial Services (continued)

Figure 6: The New World Order of Financial Services Financial service

Commercial bank

Investment bank

Insurance company

Start-up capital

XXX

XXX

XXX

Checking account

XXX

XXX

XXX

XXX

Growth capital

XXX

XXX

XXX

XXX

XXX

Plant expansion

XXX

XXX

XXX

XXX

XXX

Asset-based loan

XXX

XXX

XXX

XXX

XXX

Insurance on equipment

XXX

XXX

XXX

XXX

XXX

IPO stock

XXX

XXX

XXX

XXX

XXX

Credit cards

XXX

XXX

XXX

XXX

XXX

Brokerage needs

XXX

XXX

XXX

XXX

Mortgages Real estate

XXX

XXX

XXX

XXX

XXX

IPO debt

XXX

XXX

XXX

XXX

XXX

XXX

XXX

Risk management

XXX

XXX

XXX

XXX

XXX

XXX

XXX

Seasoned equity

XXX

XXX

XXX

XXX

XXX

S&L

Finance company

P. Equity V. Cap.

Other

XXX

XXX

XXX

XXX

XXX

XXX XXX XXX XXX

17

A single regulator should theoretically be able to rationalize a number of overlapping functions and activities to deliver a more efficient regulatory regime under a single management structure, saving firms and the government money. Economies of Scope

Similar to the economies of scale argument, a single regulator may be able to deliver a greater scope of services than regulators could individually. The scope of these services could include the following: • Standards setting (prudential and non-prudential) for the entire financial services industry. • More comprehensive supervision of individual firms. • Development of a high-powered staff. • Ability to address financial services-wide risk issues. Consistent Objectives

A single regulator would provide a consistent regulatory framework simply because it is the only game in town. This regulatory consistency would eliminate turf wars between competing regulatory bodies over the interpretation of rules or attraction of specific entities under their charter specifically because they have different regulations.8 Additionally, consistency would eliminate the regulatory, or jurisdictional, arbitrage many financial firms use to their advantage regarding a particular product or market niche. Finally, consistent objectives and practices would create a level playing field of rules and regulations each player would have to abide by. Accountability

Who is responsible for the current financial crisis? Various reports, congressional testimony, and media coverage put the onus on consumers, speculators, the SEC, the Community Reinvestment Act, Fannie Mae, Freddie Mac, George W. Bush, Bill Clinton, Phil Gramm, Democrats, Republicans, and greed. With a single regulator, one of the primary goals of granting it statutory authority is to allow it to protect the safety and soundness of the financial system. In other words, the buck stops here. In the current patchwork of regulatory bodies, the tendency for a “blame disbursement strategy” is present (Abrams and Taylor 2000, 15). Flexibility

Because of the “coherence and clarity of its mandate” (Ferran 2003, 21), a single regulator may be more flexible in dealing with the emergence of new innovations in the marketplace. As with any 18

Benefits of a Single Regulator • Consolidated view. • Economies of scale. • Economies of scope. • Consistent objectives. • Accountability. • Flexibility.

organization, the better defined its mandate, the more likely it is to deal with exigencies not specifically stated in its specific charter.

What Are the Drawbacks of a Financial Services Regulator? The following high-level drawbacks are sourced from a variety of academic papers, independent research, and experience of policymakers around the globe. Many of these drawbacks focus on the difficulties inherent in a major change process since most single regulator structures evolve from a legacy structure that embeds differing objectives, personnel, traditions, and skills. Unclear Objectives

Developing a single regulator structure involves drafting specialized legislation to define the purpose and charter of a new regulatory organization. The legislative process, often referred to as “sausage making,” may result in an ambiguous mission and an unclear set of objectives. If the objectives are unclear, the risk of a single regulator “can give rise to problems of holding the regulatory agency to account for its activities. Vague objectives may also provide little guidance for when (as inevitably will be the case) its different objectives come into conflict” (Abrams and Taylor 2000, 17). Drawbacks of a Single Regulator • Unclear objective. • Change process. • Unrealized synergies. • Too large to be effective. • Moral hazard.

Change Process

Even if the single regulator’s objectives are clearly stated, the enormous risk of change management remains. Imagine for a moment the difficulties of consolidating different agencies’ cultures, IT systems, and personnel. The addition of completely new regulatory duties (e.g., shadow banking sector activities) will need to be integrated with established regulatory bodies. This is not a trivial issue.

Unrealized Synergies

The main bet for any organizational merger is that the whole is greater than the sum of its parts. The risk is that the economies of scale and scope synergies imagined in the section above may fail to materialize. These unrealized synergies are likely to happen because of conflicting cultures and insufficient change management programs among the various insurance, banking, and securities regulators. Too Large to Be Effective

As stated above, consolidating regulatory agencies may create generous economies of scale, but the flip side is that a single regulator may also become too big to be effective. The regulatory monopoly 19

enjoyed by a single regulator necessarily creates a large bureaucracy that may lead to slowness and rigidity. An additional hazard can be what Abrams and Taylor (2000, 10) term the “Christmas-tree effect.” This situation results in the piling on of noncore, nonstatutory regulatory responsibilities, such as real estate broker regulation, to the sole financial services regulator. Moral Hazard

If a certain party perceives it is insulated from risk, it may behave differently than if it were fully exposed to the risk. The most common example of moral hazard is a person who buys fire insurance for his or her home and then is more negligent than before about risky activities such as smoking in bed or replacing batteries in the fire detector. In a single financial services regulator model, moral hazard refers to the assumption “that all creditors of all institutions supervised by an integrated supervisor will receive the same protection” (Cihak and Podpiera 2006, 11). For example, bank investors may assume they have the same protection as bank depositors. This so-called moral hazard may cause regulated firms to act in an overtly risky manner.

Conclusion This chapter outlined the major benefits and drawbacks of a single financial services regulator as sourced from various academic papers, independent researchers, and policymakers from around the world. In the next chapter I will examine whether the consolidation of financial services regulation into a unified body has benefited selected financial systems. Again I access the most relevant research available on the topic.

20

Chapter 3 Is There a “Best” Financial Regulatory System?

Thirty-three percent of countries have implemented a single regulator structure as of 2007. An additional 26% have so-called semi­integrated, or “twin peak,” regulation, where a single entity supervises two of the three major financial services sectors (banking, securities, and insurance). Finally, an additional 41% of countries, preferring a decentralized regulatory environment, employ a model similar to the U.S. model.

As stated in Figure 7, 33% of the countries have implemented a single regulator structure as of 2007. An additional 26% of countries have so-called semi-integrated, or “twin peak,” regulation, where a single entity supervises two of the three major financial services sectors (banking, securities, and insurance). Finally, an additional 41% of countries, preferring a decentralized regulatory environment, employ a model similar to the U.S. model.9 Given this diverse set of structures, which approach is most effective? True to the ageold economists’ maxim, “It depends.” Unfortunately there is scarce research about the impact of regulatory form vis-à-vis financial institution performance and/or overall financial sector safety and soundness. This chapter reviews the few studies that address this important topic. The benefits of financial regulation are multi-faceted and likely vary across jurisdictions. Even once specified, many of these benefits are difficult to measure. . . . Thus, the task of comparing marginal costs to marginal benefits in the field of financial regulation may be fundamentally intractable, and international comparisons of the sort . . . may be highly problematic. — Howell Jackson (2007, 255) In “Is One Watchdog Better than Three?” International Monetary Fund (IMF) economists Martin Cihak and Richard Podpiera (2006) review international experience with different forms of financial regulation and supervision. They conclude integrated financial regulators are characterized by more consistent and higher-quality supervision, although a significant amount of these advantages can be explained by the comparatively high level of economic development in single regulator countries. For example, the higher quality of regulation in Denmark is attributable to both the economic development10 of the country and the structure of financial regulation. They also discover that the presence of a single regulator does not necessarily create noticeable economies of scale, refuting one of the benefits listed in Chapter 2. 22

Figure 7: Jurisdictions with Single, Semi-Integrated, and Sectoral Prudential Supervisory Agencies, 2006 Single prudential supervisor for the financial system (year of establishment) Australia (1998)

Agency supervising two types of financial intermediaries

Multiple sectoral supervisors (at least one for banks, one for securities firms, and one for insurers)

Banks and securities firms

Banks and insurers

Securities firms and insurers

Kazakhstan* (1998)

Finland

Canada

Bolivia

Albania*

Italy*

Austria (2002)

Korea (1997)

Luxembourg

Colombia

Bulgaria*

Argentina*

Jordan*

Bahrain* (2002)

Latvia (1998)

Mexico

Ecuador

Chile

Bahamas*

Lithuania*

Belgium (2004)

Maldives* (1998)

Switzerland

El Salvador

Egypt*

Barbados*

New Zealand*

Bermuda* (2002)

Malta* (2002)

Uruguay

Guatemala

Jamaica*

Botswana*

Panama

Cayman Isl.* (1997)

Netherlands * (2004)

Malaysia*

Mauritius*

Brazil*

Philippines*

Czech Rep. (2007)*

Nicaragua * (1999)

Peru

Ukraine*

China (Mainland)

Portugal*

Denmark (1988)

Norway (1986)

Venezuela

Croatia*

Russia*

Estonia (1999)

Poland (2007)

Cyprus*

Slovenia*

Germany (2002)

Singapore* (1984)

Dominican Rep*

Sri Lanka*

Gibraltar (1989)

Slovak Rep.* (2007)

Egypt*

Spain*

Guernsey (1988)

South Africa * (1990)

France*

Thailand*

Hungary (2000)

Sweden (1991)

Greece*

Tunisia*

Iceland (1988)

UAE* (2000)

Hong Kong (China)*

Turkey

Ireland* (2003)

UK (1997)

India*

Uganda*

Indonesia*

USA*

Japan (2001)

Israel* As share of all countries in the sample (percentage) 33

6

11

9

41

Note: The table focuses on prudential supervision, not on business supervision (which can be carried out by the same agencies or by separate agencies, even in the integrated model). Also, we do not consider deposit insurers here, even though they play an important role in banking supervision in a number of countries and can do so under any regulatory model. * Banking supervision is conducted by the central bank. Source: Author’s calculations, based on data in Central Banking Publications (2004) and on Web sites of supervisory agencies.

In “Bank Safety and Soundness and the Structure of Bank Supervision” (Barth, Dopico, Nolle, and Wilcox 2002), a group of academics study whether supervision structure impacts bank safety and soundness. The research team concludes, “Countries with multiple authorities tend to have lower bank capital ratios and to have higher liquidity risk. Thus, the results indicated that having multiple banks supervisors (rather than one supervisor) is consistent with a ‘competition in laxity’. This finding that multiple supervisors tend to reduce equity capital ratios and increase liquidity risk comports with the hypothesis that having multiple bank supervisors weakens corporate governance of banks.11 We also find that, when a country’s central bank also supervises banks, its banks tend to have more 23

non‑performing loans. Our finding that non-performing loans are higher when the central bank supervises banks supports the hypothesis that a more focused bank supervisor might strengthen the monitoring and control of banks” (185). Their conclusions, therefore, hint that the regulatory structure currently present in the United States may be more lax and risky than a single regulator or a similarly structured regulatory regime in another part of the world. It is important to note that one of the drawbacks of a single regulatory structure mentioned earlier, moral hazard, appears to rear its head in the fragmented regulatory structure as well. In “Quality of Financial Sector Regulation and Supervision around the World,” IMF Economists Martin Cihak and Alexander Tieman (2008) attempt the Herculean task of measuring and comparing the quality of the world’s financial regulatory regimes. They state, “The main finding of this paper is a confirmation that there are significant differences in the quality of regulation and supervisory frameworks across countries, and that the level of economic development is an important explanatory factor. . . . On balance, therefore, our research cautions that despite the higher grades obtained by high-income countries, the supervisory knowledge about the financial strength of their institutions may not be higher than that for low- or middleincome countries. Indeed, the developments in the global financial system in late 2007 and early 2008 suggest that the higher quality of supervisory systems in high-income countries may not have been sufficient given the complexity of their financial systems” (20). In short, the authors offer little in the way of a definitive answer to the question of whether regulatory structure impacts supervisory quality. “A Cross-Country Analysis of the Bank Supervisory Framework and Bank Performance,” by James Barth, Daniel Nolle, Triphon Phumiwasana, and Glenn Yago (2002), attempts to provide a systematic and empirical analysis linking supervisory structure and bank performance. They conclude, “Our results indicate, at most, a weak influence for the structure of supervision on bank performance . . . given the dearth of empirical evidence on the issues, advocates of one form or another of supervisory structure have asserted that a particular change is likely to affect (favorably or adversely, as the advocate sees fit) the performance of banks. Our results provide little support at best to the belief that any particular bank supervisory structure will greatly affect bank performance” (1). So, this group of researchers can’t find a link either. “A Pragmatic Approach to the Phased Consolidation of Financial Regulation in the United States,” by Harvard law Professor Howell Jackson (2008), reports a much more definitive view, “Consolidated oversight as implemented in leading jurisdictions around the world offers a demonstrably superior model of supervision for the modern 24

financial services industry.” Jackson goes on to expound on the benefits of a single regulator model, including, “consistent regulatory requirements across different sectors . . . capacity to attract and retain higher quality staff . . . develop[ment] of broadly-based consumer financial education programs . . . accountability have been hardwired into many modern supervisory structures” (3–4). Jackson also raises questions about the current U.S. financial regulatory system: “The emergence of a near consensus among other jurisdictions regarding the desirability of a more consolidated financial regulatory oversight

Formation of the UK Financial Services Authority

The first stage of the reform of financial

infancy, although there are certainly many

services regulation in the United King-

possible signs, in particular the emphasis

dom was completed in June 1998, when

on an integrated approach to regulation

responsibility for banking supervision

across all parts of the financial services

was transferred to the Financial Services

industry” (28). Much has been written

Authority (FSA) from the Bank of England.

about the United Kingdom’s experience in

In May 2000 the FSA took over the role of

the development of the FSA, but there is

UK Listing Authority from the London Stock

a dearth of analysis on its effectiveness.

Exchange. The Financial Services and Mar-

A recent report, though, slams the FSA’s

kets Act, which received approval in June

supervisory role in the recent run on North-

2000 and was implemented in December

ern Rock, a large UK bank. This report is a

2001, transferred to the FSA the respon-

black eye to the idea of the world’s most

sibilities of several other organizations,

integrated regulator and one that has many

including the regulation of financial institu-

similarities to the U.S. financial system.

tions, securities, and insurance firms. The

Additionally, in 2008 the UK Financial Ser-

legislation also gives the FSA some new

vices Compensation Scheme (FSCS; similar

responsibilities—in particular, taking action

to FDIC) paid out £20 billion to consum-

to prevent market abuse and mortgage

ers who had money in financial services

regulation.

firms since September 2008. According

Cambridge University law Professor Ellis Ferran (2003) reflects on the lessons other countries can learn from the United Kingdom’s experience in adopting the single regulator structure. He states, “Political support for change [to a single regulator]

to David Hall, the chairman of this organization, “Between December 2001 and September 2008, the FSCS paid about £1bn in compensation” (5). (www.fscs.org. uk/industry/latest_industry_news/2009/feb/ FSCS_Plan_and_Budget_2009_10/)

will be greater where the existing system

Source: Adapted from www.fsa.gov.uk/

is, or is perceived to be, malfunctioning.

Pages/About/Who/History/index.shtml.

. . . It is impossible to draw firm conclusions because the new regime is still in its 25

should at least raise questions as to whether our [U.S.] national resistance to regulatory consolidation is well-founded” (15). This “under-researched” (Abrams and Taylor 2000) topic does not allow us to make sweeping conclusions about the “best” or “right” regulatory structure for the U.S. financial system. The papers referenced are inconclusive: Some report significant benefits of a single regulator structure, while others fail to correlate structure to financial industry safety and soundness. Also important to note is all the research studies quoted above were performed before the current financial crisis. If the authors were to replicate their studies today, they might get materially different findings. A recent paper by Cihak and Podpiera (2006, 24) provides a sufficiently balanced perspective on this topic by stating, “Integrated supervision may be associated with substantial benefits, particularly in terms of increased supervisory consistency and quality. This strengthens the case in favor of integrated supervision in the medium-to-long term. Country authorities considering whether to integrate their supervisory framework need to compare the likely medium- and long-term benefits with the short-term challenges and risk involved in the integration process and in the chosen model.” Given the political and economic climate in the United States, it is likely that policymakers will view short-term dislocations as a necessary means to the medium- and long-term ends of a more consistent and higher-quality regulatory system. Therefore, the final chapter explores a number of serious reform proposals for the creation of a single financial services regulator in the United States.

Figure 8: A Summary of Major Research on the Impact of Financial System Regulatory Structure Title

Conclusion

“Is One Watchdog Better than Three?” (2006)

Structure is important, but economic development of a country may be more important

“Bank Safety and Soundness and the Structure of Bank Supervision” (2002)

Countries with multiple regulators and central banks as regulator may be more lax and risky for banks

“Quality of Financial Sector Regulation and Supervision around the World” (2008)

Higher-income countries have better supervision and regulation than low-income countries, but complexity of higher-income countries’ financial systems may negate this advantage

“A Cross-Country Analysis of the Bank Supervisory Framework and Bank Performance” (2002)

Supervisory structure does not impact bank performance to any statistically significant manner

“A Pragmatic Approach to the Phased Consolidation of Financial Regulation in the United States” (2008)

Consolidated supervision is a superior model for a variety of reasons and should be implemented in the United States

26

Chapter 4 An Agenda for Reform and Regulatory Consolidation

What could credit unions expect from a single regulatory scenario? Three approaches are identified and are likely to be discussed as the regulatory debate heats up. Each approach has pros and cons and should be reviewed as an early warning system or road map to consider as the financial landscape evolves.

Assuming a single regulator model comes to pass, what can credit unions expect from this new model? I have analyzed the literature on this topic and have identified three approaches that have the prominence and likelihood of getting a significant hearing in the upcoming regulatory debate. First, we examine “A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System,” from the United States Government Accountability Office (GAO). Next, we review “A Pragmatic Approach to the Phased Consolidation of Financial Regulation in the United States,” by Harvard law professor Howell Jackson. Finally, we evaluate a report entitled “Financial Reform: A Framework for Financial Stability,” by the Group of 30 organization.12

GAO Report According to its Web site, the GAO “is known as ‘the investigative arm of Congress’ and ‘the congressional watchdog.’” It accomplishes this mission by researching and issuing reports at the behest of Congress. Congress utilizes these reports to help guide legislation, improve the performance of the federal government, and, as the name suggests, provide accountability to U.S. citizens. “A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System” (Dodaro 2009) was prepared for a Senate hearing in January 2009 to “help policymakers weigh various regulatory reform proposals and consider ways in which the current regulatory system could be made more effective and efficient” (2). This research did not occur in a vacuum, as input was obtained from 29 financial services organizations, including CUNA, the Center for Responsible Lending, NAFCU, and NCUA. Their major recommendations are summarized below: • Clearly defined regulatory goals. An updated regulatory system would need to have clear, articulated goals. While clear goals are a seemingly obvious recommendation, the GAO report (and others) identifies clear gaps in the current regulatory framework that

28

point to less than clear goals for financial services regulators and institutions. • Appropriately comprehensive. Some players are more important than others to the safety and soundness of the entire financial system. For example, a highly leveraged financial conglomerate provides more systemic risk than a small, highly capitalized credit union. Therefore, the GAO explicitly recognizes “that not all activities will require the same level of regulation” (11). • Systemwide focus. The GAO believes the current regulatory system is extremely siloed and any new regulatory regime would need to take a systemwide approach to risk management. This sentiment is also shared in Chairman Bernanke’s comments in the sidebar (see following page). • Flexible and adaptable. This topic is a fairly obvious wish for any regulatory structure; however, it emanates from the current regulatory structure’s inability to deal with new, innovative, and potentially dangerous products like credit derivatives and subprime mortgages. • Efficient and effective. The GAO recommends a regulatory regime that eliminates overlaps of the current agency’s missions and minimizes, when appropriate, the regulatory constraints on the financial sector. It also recommends “organizing agencies around regulatory goals as opposed to the existing sector-based regulation” (16). This recommendation intimates a more consolidated regulatory structure. • Consistent investor/consumer protection. The failures of the current regulatory system include serious lapses for the end user of financial products. Examples of these lapses include the misleading AAA-rated securities investors bought and the anti-consumer mortgages plied on unsuspecting homeowners. The GAO advises a more prominent role for this function in a new regulatory structure. • Regulators are independent, prominent, authoritative, and accountable. Most regulatory agencies are funded by the firms they supervise. This may be a less than ideal situation for fairly obvious reasons. Additionally, the fractured structure of the current regulatory system may not give individual regulators the prominence or authority they need to do their jobs effectively. Finally, with many referees on the field, it is sometimes difficult to know where the buck stops in terms of ultimate accountability. The GAO argues that a new, consolidated regulatory system should remedy all these issues. • Consistent financial oversight. Rep. Barney Frank, chairman of the House Financial Services Committee, recently said, “We need to regulate the activities, not the institution.”13 The GAO concurs, 29

“A [new] regulatory system should ensure that similar institutions, products, risks and services are subject to consistent regulation, oversight and transparency, which should help minimize negative competitive outcomes while harmonizing oversight” (21). • Minimal taxpayer exposure. A final element of the GAO’s recommendations speaks to the importance of safety and soundness. This topic “identify[ies] safeguards that are most appropriate to prevent systemic crises while minimizing moral hazard” (62). Indeed, this is the overarching goal of regulation, as discussed in Chapter 1.

Jackson Recommendations Howell Jackson is a professor of law and acting dean at Harvard Law School. He is frequently requested by Congress to testify on financial regulation issues and literally wrote the book on regulation of financial institutions.14 “A Pragmatic Approach to the Phased Consolidation of Financial Regulation in the United States” (H. Jackson 2008), which will be published in the 2009 edition of the Harvard Journal of Legislation, lays out a step-by-step course of events that may presage the creation of a single regulator in the United States. Obviously

Fed Chairman Ben Bernanke Addresses Financial System Reform

In a major speech before the Council on

potential change to regulatory policies that

Foreign Relations on March 10, 2009,

“induce excessive procyclicality—that is,

Chairman Ben Bernanke offered a view

do not overly magnify the ups and downs

of what reform to the financial regulatory

of the financial system and the economy,”

system may look like. In addition to speak-

and (d) create an authority to manage and

ing about the short-term importance of

oversee systematic risk (presumably this

restoring investor confidence and repairing

would be the Federal Reserve).

credit markets, Bernanke stated, “It is not too soon for policymakers to begin thinking about the reforms to the financial architecture . . . that could help prevent a similar crisis from developing in the future.” He then outlined four key elements of reform that may portend the future U.S. regulatory structure: (a) have a focused and intense

Bernanke did not touch on the structure of the new regulatory regime, as this question will initially be a legislative question. However, he did hint at the importance of reworking the current regulatory patchwork “to reduce balkanization and overlap and increase effectiveness.”

oversight on too-big-to-fail institutions,

Source: Council on Foreign Relations

(b) strengthen stress testing of the finan-

2009, 3.

cial system infrastructure, (c) review any 30

none of these steps will be easy to implement; however, Jackson’s approach provides a sneak peak of the anticipated road map toward a new financial regulatory regime: • The Federal Reserve Board shall oversee financial market stability. The need for a macro-prudential body is a strong and logical first step for a new regulatory regime. Jackson envisions that the Federal Reserve Board will “oversee financial market stability . . . to cover all sources of systemic risk in the financial services industry . . . coordinate effectively with other supervisory agencies . . . allow for consistent, appropriate forms of intervention in response to systemic risks” (9). Macro-prudential: The assessment and monitoring of the strengths and vulnerabilities of financial systems. It encompasses quantitative information from both financial services institutions and macroeconomic indicators that provide (1) a broader picture of economic and financial circumstances such as GDP growth and inflation, along with information on the structure of the financial system, and (2) qualitative information on the institutional and regulatory framework—particularly through assessments of compliance with international financial sector standards and codes— and the outcome of stress tests.15 • Four-phase consolidation to follow. Once the Fed is given systematic authority, Jackson envisions a four-step process to continue the consolidation of the financial services regulatory system. Jackson is quick to lean on the creation of the United Kingdom’s FSA (see sidebar on page 25) by stating, “Regulatory reorganization need not entail the immediate combination of our entire system of supervisory units” (27). The phased steps envisioned by Jackson are summarized below: ■■

■■

The first step would expand the charter of the President’s Working Group (PWG) on financial markets.16 These expanded responsibilities would enable the PWG to be the initial (and temporary) driver of a new regulatory system since major legislation to create a new structure could take “months (and perhaps even years)” (31). The second and most critical step enacts legislation to create a United States Financial Services Authority (USFSA), which would have the explicit statutory authority for “coordinating and rationalizing industry-wide oversight” (33). The USFSA would sit atop the current regulatory structure for a time as the “centralized rule-making body for the entire financial services industry” (34).

31

■■

■■

The third step would involve enactment of a second round of legislation authorizing the merger of all supervisory agencies into the USFSA. This step would likely involve a sequenced merging of agencies much like the UK’s FSA. The fourth and final step would involve the USFSA determining its organizational and operating structure. While this may seem like an action that should occur earlier in the process, Jackson claims, “The selection of an optimal organization structure is difficult to do before the reorganization process begins” (36).

Jackson’s framework models the sequence of the creation of a single financial regulator in the United States. While this is not the only approach to consider, this model represents a logical and comprehensive view of what the future may hold.

Group of 30 Report The Group of 30 (G30) is a private, nonprofit organization composed of 30 very senior representatives from the private and public sectors and academia, including former Fed Chair Paul Volcker and current Treasury Secretary Timothy Geithner. Recently the G30 released a paper entitled Financial Reform: A Framework for Financial Stability (2009),17 which offers suggestions for regulatory reform, focusing mainly on the United States’ system. This report complements the GAO study and Jackson’s research with specific recommendations on the duties and roles of a new regulatory system: • Redefining the boundaries of prudential regulation. The welldefined gaps and weaknesses of the current regulatory structure would need to be fixed. This would be accomplished by focusing significant resources on “systemically significant” financial services organizations. Specific tactics include: ■■

■■

■■

■■

■■

Creating a single prudential financial services regulator. Consolidating the supervision of nonbank financial institutions (e.g., broker-dealers and investment banks). Supervising money market mutual funds as special-purpose banks. Developing a regulatory scheme for private capital pools (e.g., hedge funds and other highly leveraged and systemically significant groups). Clarifying public/private role of government-sponsored entities (e.g., Freddie Mac and Fannie Mae).

32

• Structuring prudential regulation and supervision. Create a better resourced regulatory scheme, with special attention paid to the role of the central bank and international policy coordination. Specific tactics include: ■■

■■

■■

Structuring regulation and supervision such that gaps, regulatory arbitrage, and complexity are minimized or eliminated. The specific focus is on the creation of a single regulator that conducts both safety and soundness oversight and conducts business regulation for all financial sectors. Clearly distinguishing between the regulator and the central bank. Recommendations include having the central bank (e.g., the Fed) manage systemic risk issues and having the single regulator conduct business supervision. Recognizing that financial markets are a global phenomenon and that regulation and supervision must be coordinated in a more robust and formalized manner.

• Strengthening institutional regulation in certain key areas. In addition to changing the structure of supervision and regulation, the focus needs to center on key areas of vulnerability and risk to the financial sector. Specific tactics include: ■■

■■

■■

■■

Raising importance of risk management and governance oversight by ensuring independence of board, capability of board, and effectiveness of risk management procedures. Focusing on the development of international capital standards (e.g., BASEL II) and increasing minimum capital requirements to a more conservative level. Fortifying guidance for liquidity standards including a concrete understanding of capital structure and the impact of stress tests. Recognizing and updating fair-value accounting rules, especially in consideration of illiquid or distressed markets.

• Increasing transparency, improving incentives, and strengthening infrastructure. The crisis of confidence in the financial markets is one of the leading factors in the global economic downturn. A key element of any regulatory restructuring involves increasing the credibility of the financial system for both consumers and financial institutions. Specific tactics include: ■■

■■

Restoring confidence in securitized markets by increasing the transparency and regulation of credit underwriting standards and other disclosures. Completing the overhaul of securities rating agencies (e.g., S&P, Moody’s, Fitch) by fixing the regulation of these agencies and properly aligning the current incentive structure of ratings. 33

■■

■■

Beginning oversight of credit default swaps and other overthe-counter derivative markets. Increasing transparency in structured product markets (e.g., asset-backed securities) by creating greater transparency on market activity and valuation along with regulation of this product set.

Summary The GAO report, Jackson’s recommendations, and the G30 paper present realistic and logical views of how a single regulator may come to be in the United States. The influence of each publication will likely gain a significant hearing in the upcoming reregulation debate. While it is far from easy to predict what the reregulation of the U.S. financial services sector will look like, the credit union system is obviously concerned about the specter of a single regulator. Therefore, this section provides credit unions an early warning system or road map to consider as the debate heats up. In the final section of this report, I discuss potential credit union–specific implications of the creation of a single financial services regulator.

Figure 9: Summary of GAO Report, Jackson’s Recommendations, and G30 Approach

GAO report provides a conceptual framework for regulatory reform

Jackson’s recommendations introduce a process toward implementation of a new single regulator structure

G30 paper introduces mechanics of a new single regulator structure

34

Chapter 5 Implications for Credit Unions

Credit unions should consider the following: Beware the tide: A single regulator would be unlikely in normal times, but these are not normal times; Getting to yes: If we can’t avoid this reality, how can credit unions ensure their concerns are heard?; and Be helpful: Key lawmakers express admiration for credit unions’ performance in the current financial crisis.

The previous chapters tackled the following issues: 1. The current state of financial regulation in the United States is viewed as archaic, broken, and insufficient for the complexities of global finance. Many are calling for a more consolidated financial regulatory structure that balances safety and soundness with innovation. 2. Even for issues that ultimately involved little conceptual knowledge, the regulatory structure failed to sufficiently protect consumers from being offered unsavory and inappropriate credit instruments. 3. Valid arguments for and against the idea of a single regulator must be taken into account. Due to the paucity of and difficulty in collecting data on this topic, there is a great deal of ambiguity about the right approach for the U.S. regulatory system. International experience, however, indicates a trend toward more consolidated regulatory structures. 4. Narrow research on existing financial regulatory arrangements indicates there is no consensus on the “best” system. Experts claim the benefits of a single regulator accrue in the medium and long term, while short-term drawbacks are to be expected. Still, given the current political and economic tenor in the United States, the probability of a single financial regulator is higher than in “normal” times. 5. Serious thought has been given to the structure, approach, development, and design of a new single financial regulator in the United States. This work offers a realistic and helpful road map for what may come next in regulatory reform.

Potential Implications for Credit Unions CUNA (2009) recently stated, “Consolidation of the federal financial services regulators that includes the elimination of the independent credit union regulator would, in effect, end credit unions as we know them in America.” It is safe to say this declaration, which 36

represents the consensus view of the U.S. credit union system, puts credit unions squarely on the multiple regulator/status quo side of the ledger. So what might a single regulator structure look like for credit unions? It is impossible to say; however, the following may occur as a logical outgrowth of a single regulator structure: • NCUA becomes a subagency under the single financial services regulator. • Banks and credit unions operate under the same prudential structure. • Federal deposit insurance is consolidated into one fund. • NCUA board structure is changed or eliminated. The following lingering questions are also important to consider under a single regulator structure scenario: • What happens to the dual chartering structure (state and federal) for both banks and credit unions? • Are credit unions still tax-exempt? • Are credit unions still limited in terms of field of membership, business lending, and alternative capital sources? The purpose of this report is not to extrapolate what a single regulator looks like, or what rules they will apply, but rather to furnish credit unions with a nuanced view of the single regulator question and pose several major considerations to mull over. Beware the Tide

In normal times the potential for a dramatic shift in regulatory structure would be quite small. The complex legislative and political wrangling necessary to usurp the status quo would not be likely. In fact, just a year ago in a letter responding to the U.S. Treasury Department’s Blueprint for Modernized Financial Regulatory Structure, CUNA states, “Most of the recommendations [for regulatory restructuring], including the ones regarding credit unions and NCUA, would require Congressional action, which is not likely to occur any time soon.”18 It is an understatement to say the times have changed since last April. Now the new political realities are encouraging government to do something about financial regulation, and that something is looking more and more like a single financial regulator. In the United Kingdom, which appears to be the most useful (though imperfect) proxy to the United States, Ellis Ferran (2003, 14) states in his review of the formation of the UK’s FSA, “One key reason why there was no serious objection to the principle of the single regulator may have been that it had the great merit of 37

simplicity. . . . Moreover, in political terms it was clear that adoption of the principle of the single regulator was ‘non-negotiable’ and that the government’s large majority in Parliament would ensure the safe passage of the relevant legislation.” Credit unions aren’t expected to wither up and accept a new regulatory regime without voicing their opinion. However, it is prudent and advisable to prepare for a potential single regulator scenario. This report and its references provide an extensive and comprehensive set of resources for you to digest during the upcoming debate. Getting to Yes

If the tide of political and legislative opinion is indeed too strong, how can credit unions ensure their concerns are heard? Unfortunately, there is very little treatment given to the impact of a single

A Single Regulator: UK Perspective

In 2002, UK credit unions moved to a

change were positive overall. From 1997 to

single regulatory system called the Finan-

2007, credit unions increased membership

cial Services Authority (FSA). In so doing,

by 170%, savings by 318%, and assets by

the government did away with the previ-

351%. Additionally, mergers increased and

ous regulatory structure that had been

there was a 28% reduction in the number

criticized by many due to its lax approach

of credit unions. According to a recent

to regulation and its failure to properly

study, 61% of all credit unions, and 82%

manage credit union activity. Addition-

among work-based or SEG-based credit

ally, as regulated bodies of the FSA, credit

unions, said regulation had assisted growth

unions then came under the Financial

(Jones 2008).

Services Compensation Scheme (FSCS). This means that UK credit union members’ deposits are insured.

It is important to note that the UK credit union system is much smaller than the U.S. system, with only 501 British credit unions

It was thought that these policies would

serving 607,400 members. However, the

allow UK credit unions to better achieve

positive outcome of the UK regulation

economic viability so that they could better

change is important to review when evalu-

serve low-income members and work to

ating the efficacy of a U.S. single regulatory

alleviate poverty. But there was an initial

system.

fear that in their search for economic success, UK credit unions would lose their distinctiveness and commitment to social values. However, the results of this policy

38

Source: Correspondence with the Association of British Credit Unions Limited, March 2009.

regulator on smaller institutions like credit unions. Howell Jackson (2008) offers an incisive comment on this topic that may be helpful: Small firms and narrow sub sectors, such as credit unions, present a special challenge to consolidated supervision as representatives of these constituencies often voice concerns that a consolidated supervisor would favor larger firms and focus on the oversight of complex financial institutions. Concerns of this sort have also arisen in other jurisdictions. One of the difficulties of evaluating such complaints is that these constituencies may already suffer from competitive disadvantages, such as insufficient scale or geographic limitations, and may therefore depend on subsidies built into the current regulatory structure or even tax subsidies, such as the current exemption of credit unions from the federal income tax. Representatives of these groups may oppose consolidated supervision not because it threatens unequal supervision, but rather because it promises a level playing field on which smaller and more narrowly focused firms can no longer compete. The proper response to such concerns is not to abandon consolidated supervision, but rather to allow existing subsidies to persist within a consolidated regulatory structure and to leave the reconsideration of the propriety of these subsidies to a later date. In the meantime, the consolidated regulator can be tasked with monitoring the viability of these sub-sectors and the impact of future regulatory reforms on firms within the sub sectors, just as the SEC currently monitors the impact of its regulatory reforms on small business capital formation. (25) Additionally, Clive Briault (2002, 17), former director of prudential standards for the UK’s FSA, comments on the regulation of different-sized firms, “This [the FSA’s standards] is not a ‘one size fits all’ approach and appropriate differentiation has been achieved by taking into account the different degrees of protection required by different types of consumer and the different ways in which the FSA’s requirements can be met according to the nature and size of a firm’s business.” While compromise does not seem to be the goal of the credit union system on this topic, it may be wise to understand what compromise looks like for credit unions in a potential single regulatory structure. The UK and Australian credit union experiences provide realistic albeit imperfect examples of how credit unions operate under a single or quasi-single regulator structure. Be Helpful

Key lawmakers have recently stated their admiration for the strong performance of credit unions in the current financial crisis. It turns out the old-fashioned banking model, as opposed to the previously en vogue “originate to distribute” or “conglomerate” model, may be the favored depository institution approach of the future. Additional 39

A Single Regulator: Australian Experience

The Australian Prudential Regulation

regulatory capital requirements. However,

Authority (APRA) is the prudential regulator

APRA has listened to the credit union sec-

of the Australian financial services industry.

tor’s concerns and this particular risk has

It oversees banks, credit unions, building

diminished, particularly in the wake of the

societies, general insurance and reinsur-

global financial crisis.

ance companies, life insurance companies, friendly societies, and most members of the superannuation (pension) industry. APRA is funded largely by the industries that it supervises. APRA’s formation and the associated reorganization of prudential regulation in Australia was recommended by the March 1997 final report of the Australian Government’s Financial System Inquiry. The Inquiry found that the previous regulation was “cumbersome, duplicative and costly” and that while the regulation structure had “raised the prudential standing of institu-

APRA has further increased the prudential standing of credit unions by applying harmonized prudential standards to all ADIs and introducing new standards in areas such as governance and regulatory capital planning. This has improved the professionalism and strength of the Australian credit union sector, but the increased regulatory compliance burden, along with other factors, has contributed to a steady trend of mergers and a reduction in the number of credit unions.

tions supervised, it has failed to deliver

Larger credit unions have been able to

uniformity, cost efficiency or regulatory

offer a wider range of products and to

neutrality.”

cope with market developments such as

Under APRA since 2000, credit unions have been subject to a more consistent

increased competition in mortgage lending and changes in the consumer loan market.

prudential regulatory regime under the

Positive public perceptions about the pru-

Commonwealth Banking Act 1959. Pru-

dential standing of credit unions were con-

dential standards applying to all authorized

firmed as the sector maintained depositor

deposit-taking institutions (ADIs)—i.e.,

confidence during the financial sector

banks, building societies, and credit

instability in 2008 that prompted govern-

unions—have been harmonized, and there

ments around the globe to announce

is no special treatment for credit unions or

deposit guarantees.

banks.

Source: Correspondence with

In recent times, changes have posed a

Abacus - Australian Mutuals (the

risk that credit unions, as small ADIs, could

Association of Building Societies

be subject to less favorable regulatory

and Credit Unions), March 2009.

treatment than large ADIs in relation to

40

Although we recognize that there are many suggestions to address these issues, such as creating a centralized systemic risk regulator or perhaps by enhancing the Federal Reserve Board’s authority in the area of systemic risks, we urge Congress to exclude from the scope of such regulation smaller institutions that have shunned undue risk. Credit unions are among those in this category. By focusing on institutions whose operations and actions present the greatest risk, Congress will avoid the danger that credit unions— the very institutions that observed conservative lending and underwriting practices— could find themselves deprived not only of a voice, but even an audience, at a regulator dominated by larger, riskier institutions. —Dan Mica’s testimony before the Senate Banking Committee, March 24, 2009

credit union qualities that are highly admired today include pragmatic underwriting standards, conservative capital positions, and sanely compensated executives. Senator Christopher Dodd recently stated, “As we modernize the regulatory structure, there will be a seat at that table for America’s credit unions.”19 Credit unions should take advantage of this invitation by teaching their overleveraged financial conglomerate brethren how to run a well-functioning, simpler, and safer depository institution. This more “primitive finance” envisions the “radical idea of narrow banking and tightly limits what banks (and any other entities that raise short term deposits from the public) can do: nothing besides making loans—after old-fashioned due diligence—and simple hedging transactions. The standard would simply be whether the loan can be monitored by bankers and examiners who do not have PhDs in finance” (Bhide). Simply put, credit unions largely have the moral high ground to promote a regulatory structure that supports the way they do business today, and have done business since 1909.

Conclusion It is folly to predict how the financial services industry will be regulated in the future. We can only read the tea leaves of the current economic, political, and social trends. Since these trends are pointing in the direction of a more consolidated financial regulatory structure, it is constructive to learn from research, opinions, and experiences on the topic. I hope this report provides you with the requisite background, resources, and implications to navigate the complex question of reregulation of the financial services sector.

41

Appendix 1

A Brief History of U.S. Financial Services Regulation 1782

Pennsylvania chartered first bank in the U.S.

1791

Secretary of the Treasury, Alexander Hamilton, established first Bank of the United States.

1863

Office of the Comptroller of the Currency established in the U.S. Treasury Department. Authorized to charter banks and issue national currency.

1909

St. Mary’s Cooperative, first U.S. credit union, formed in New Hampshire. Massachusetts passed first state credit union law.

1913

Federal Reserve established to replace J.P. Morgan as lender of last resort.

1916

National Bank Act, limiting bank insurance sales except in small towns, passed.

1920

Financial options introduced.

1924

First mutual funds established in Boston.

1929

Stock market crash. Nearly 10,000 U.S. banks failed.

1932

Federal Home Loan Bank Act established Federal Home Loan Bank System to act as central credit system for savings and loans institutions.

1933

Glass-Steagall Act, separating banking and securities industries, passed by Congress. Federal Deposit Insurance Corporation, guaranteeing accounts up to $2,500, opened. Securities Act of 1933, to regulate registration and offering of new securities, including mutual funds, to the public, passed.

1934

Securities Exchange Act passed. Authorized Securities and Exchange Commission to provide for fair and equitable securities markets. Federal Savings and Loan Insurance Corporation established by Congress to insure savings and loans deposits. Replaced by Savings Association Insurance Fund in 1989. Federal Credit Union Act of 1934 authorized establishment of federally-chartered credit unions in all states.

1940

Investment Company Act set structure and regulatory framework for modern mutual fund industry.

1956

Bank Holding Company (BHC) Act, putting multiple bank holding companies under federal supervision, passed. Stipulates that nonbanking activities of BHCs must be “closely related to the business of banking.”

1960

Bank Merger Acts of 1960 and 1966 set standards for mergers and placed them under federal authority.

1961

Banking industry introduced fixed rate certificates of deposit.

1962

Keogh plans, providing savings opportunities for self-employed individuals, introduced under the Self Employed Individuals Tax Retirement Act.

1968

Mortgage insurance introduced.

1970

U.S. government introduced mortgage-related securities to increase liquidity. National Credit Union Administration created to charter and supervise federal credit unions. National Credit Union Share Insurance Fund created by Congress to insure members’ deposits in credit unions up to the $100,000 federal limit. Administered by the National Credit Union Administration.

1972

Money market mutual funds introduced.

1974

Automated teller machines (ATMs) widely introduced.

1975

SEC deregulated broker commissions by eliminating fixed commissions brokers charged for all securities transactions.

1977

Banking industry introduced variable rate certificates of deposit. Community Reinvestment Act passed to encourage banks to meet credit needs of their local communities.

1978

International Banking Act limited the extent to which foreign banks could engage in securities activities in the U.S.

1979

Congress created the Central Liquidity Facility, credit union lender of last resort.

Source: Insurance Information Institute (www.iii.org).

43

1980

Depository Institutions Deregulation and Monetary Control Act provided universal requirements for all financial institutions, marking first step toward removing restrictions on competition for deposits. The Office of the Comptroller of the Currency and the Federal Reserve authorized banks to establish securities subsidiaries to combine the sale of securities with investment advisory services.

1982

Garn-St.Germain Depository Institutions Act authorized money market accounts and expanded thrifts’ lending powers. Stock market futures contracts introduced.

1983

Federal government introduced collateralized mortgage obligations.

1987

Federal Reserve ruling interpreting Section 20 of Glass-Steagall as permitting separately capitalized affiliates of commercial bank holding companies to engage in a variety of securities activities on a limited basis.

1989

Financial Institutions Reform, Recovery and Enforcement Act, providing government funds to insolvent savings and loan institutions (S&Ls) from the Resolution Trust Corporation and incorporating sweeping changes in the examination and supervision of S&Ls, established. Savings Association Insurance Fund, deposit insurance fund operated by the FDIC, established.

1990

JPMorgan permitted to underwrite securities.

1994

Riegle-Neal Interstate Banking and Branching Efficiency Act allowed bank holding companies to acquire banks in any state and, as of June 1, 1997, to branch across state lines.

1996

Section 20 of Glass-Steagall amended to allow commercial bank affiliates to underwrite up to 25 percent of revenue in previously ineligible securities of corporate equity or debt.

1997

The Financial Services Agreement of the General Agreement on Trade in Services provided framework to reduce or eliminate barriers that prevent financial services from being freely provided across national borders, or that discriminate against foreign-owned firms.

1998

Citibank and Travelers merged to form Citigroup, a firm engaged in all major financial services sectors.

1999

Financial Services Modernization Act (Gramm-Leach-Bliley Act) allowed banks, insurance companies and securities firms to affiliate and sell each other’s products. Restructured the Federal Home Loan Bank System.

2001

U.S. House of Representatives Banking Committee renamed itself the Financial Services Committee.

2002

JPMorgan Chase introduced an annuity, becoming one of the first banking companies to underwrite an insurance product under the Gramm-Leach-Bliley Act Sarbanes-Oxley Act enacted to increase the accountability of the boards of publicly held companies to their shareholders. Strengthens the oversight of corporations and their accounting firms.

2003

State regulators and the Securities and Exchange Commission (SEC) launched investigations into late trading and market timing in the mutual funds and variable annuities industries.

2006

President Bush signed the Federal Deposit Insurance Reform Conforming Amendments Act of 2005, which merges the Bank Insurance Fund and the Savings Association Insurance Fund into the new Deposit Insurance Fund, and increases the deposit insurance limit for certain retirement accounts from $100,000 to $250,000, and indexes that limit to inflation. NASD and the New York Stock Exchange formed the Financial Industry Regulatory Authority (FINRA), a self-regulatory organization to serve as the single regulator for all securities firms doing business in the U.S.

2008

Federal regulators took control of IndyMac Bank of California, one of the nation’s largest savings and loans and the biggest U.S. lender to fail in more than two decades. The Treasury Department unveiled plans for a sweeping overhaul of the regulation of the U.S. financial services industry that would not consolidate bank regulation, provide stronger oversight of mortgage lending and introduce an optional federal charter for insurance companies. The federal government took over Fannie Mae and Freddie Mac and assumed a 80 percent ownership in American International Group, reflecting widespread turmoil in financial markets. Securities giant Lehman Brothers failed, marking the largest bankruptcy in U.S. history. Two other major securities firms, Goldman Sachs and Morgan Stanley, got federal approval to convert to bank holding companies. Congress considered a Treasury proposal for a $700 billion bailout of the U.S. financial services industry.

Source: Insurance Information Institute (www.iii.org).

44

Appendix 2

Types of Credit Union Regulatory Structures in G-20 Countries G-20 member

Legislated credit union supervisory body

Is the bank regulator regulating credit unions?

 1

Argentina

National Institute of Cooperative Action (agency of the Ministry of Social Welfare), Central Bank

No

 2

Australia

Australian Prudential Regulation Authority, Australian Securities and Investments Commission

Yes

 3

Brazil

Central Bank of the Republic of Brazil, which delegates supervisory functions such as data collection and examination to credit union federations

No

 4

Canada

Ministry of Finance, Superintendent of Financial Institutions sets the rules. Supervisory functions carried out at the provincial level by Credit Union Deposit Guarantee Corporations

No

 5

China

The People’s Bank of China

Yes

 6

France

National Confederation of Credit Mutuel, Banking Commission

No

 7

Germany

Federal Bank Regulatory Board; cooperative audit federations

No

 8

India

 9

Indonesia

N/A

N/A

Department of Cooperatives

No

10

Italy

N/A

N/A

11

Japan

Ministry of Finance

Yes

12

Mexico

National Banking Commission, which delegates supervisory functions to credit union federations

No

13

Russia

Ministry of Finance

No

14

Saudi Arabia

N/A

N/A

15

South Africa

Cooperative Development Agency

No

16

South Korea

Financial Supervisory Service, which delegates supervisory functions to the National CU Federation

No

17

Turkey

N/A

N/A

18

United Kingdom

FSA

Yes

19

United States

20

The European Union

NCUA; state supervisors of credit unions

No

N/A

N/A

Key: N/A—data not available. Source: Correspondence with WOCCU, March 2009.

45

Endnotes

1. Although this may seem like an onerous situation, many depository institutions prefer a state charter because of specific regulatory advantages at the state level. Wisconsin credit unions, for example, are overwhelmingly state chartered (260 state chartered vs. 2 federally chartered). Additionally, Wilcox (2005) highlights so-called home run advantages, which permit banks to apply state regulations to branches across the country. 2. While the FFIEC may resemble a single regulatory body, its actual authority and presence in regulatory affairs are minimal. However, this may change if regulatory consolidation occurs. 3. www.house.gov/apps/list/press/financialsvcs_dem/press030509. shtml. 4. banking.senate.gov/public/index.cfm?FuseAction=Newsroom. PressReleases&ContentRecord_id=fcd39d15-ca09-40ed-088a69107656e3b8&Region_id=&Issue_id=. 5. CUNA is strongly opposed to a single regulator structure and states that it would “lead to the demise of the credit union system” (“CUNA 2009 Legislative Briefing Paper” 2009). 6. IMF researchers define it as “an agency that is in charge of (micro) prudential supervision of at least three main segments of most financial sectors—banking, insurance and securities markets” (Cihak and Podpiera 2006, 5). 7. A considerable number of these employees are not involved in regulatory and/or supervisory issues, but rather work in operations such as check clearing and currency handling. 8. The most obvious example is the switch from a credit union to a mutual savings bank charter. 9. This number has been shrinking, according to IMF research studies referenced in this report. 10. By economic development this could mean higher gross domestic product (GDP), higher per capita income, or higher overall development of the country’s business sector. 11. Evidence of this weakness was measured by comparing performance indicators, including capital adequacy, asset quality, and earnings. 12. A full list of members can be found at www.group30.org/ members.htm. 13. The Harvard Business School Association of Boston sponsored a lunch on November 10, 2008, with Barney Frank presenting the speech “The Mortgage Meltdown: Lessons for Public Policy.” 47

14. Howell E. Jackson and Edward L. Symons, The Regulation of Financial Institutions: Cases and Materials (Eagan, MN: West Publications, 1999). 15. International Monetary Fund, appendix VII, glossary, in Compilation Guide on Financial Soundness Indicators (Washington, DC: IMF, 2004). 16. Current charter: “. . . enhancing the integrity, efficiency, orderliness, and competitiveness of [United States] financial markets and maintaining investor confidence” (www.archives.gov/ federal-register/codification/executive-order/12631.html). 17. The European Union recently released the “De Larosiere Report,” which comports with the recommendations provided in this chapter. A summary of this report can be found at ec.europa.eu/commission_barroso/president/pdf/ statement_20090225.pdf. 18. CUNA, “Summary of Treasury’s Plan to Restructure Financial Regulation,” updated April 1, 2008, www.cuna.org/reg_ advocacy/member/hot_topic/restructure_financial_regulation. html. 19. www.cuna.org/newsnow/archive/list.php?date=022509#39929.

48

References

Abrams, Richard, and Michael Taylor. 2000. “Issues in the Unification of Financial Sector Supervision.” International Monetary Fund Working Paper, Washington, DC. Barth, James, Luis Dopico, Daniel Nolle, and James A. Wilcox. 2002. “Bank Safety and Soundness and the Structure of Bank Supervision: A Cross-Country Analysis.” International Review of Finances 3(3/4): 163–88. Barth, James, Daniel Nolle, Triphon Phumiwasana, and Glenn Yago. 2002. “A Cross-Country Analysis of the Bank Supervisory Framework and Bank Performance.” Economic and Policy Analysis Working Paper 2002-2. Bernanke, Ben. 2007. “Financial Regulation and the Invisible Hand.” Speech, New York University Law School, New York. www. federalreserve.gov/newsevents/speech/bernanke20070411a.htm. Bhide, Amar. “In Praise of More Primitive Finance.” www.bhide.net/ financial_crisis_2008/bhide_praise_of_primitive_finance.pdf. Briault, Clive. 2002. “Revisiting the Rationale for a Single National Financial Services Regulator.” Financial Services Authority, United Kingdom, February. Cihak, Martin, and Richard Podpiera. 2006. “Is One Watchdog Better Than Three? International Experience with Integrated Financial Sector Supervision.” International Monetary Fund Working Paper, Washington, DC. Cihak, Martin, and Alexander Tieman. 2008. “Quality of Financial Sector Regulation and Supervision around the World.” International Monetary Fund Working Paper, Washington, DC. Council on Foreign Relations. 2009. “A Conversation with Ben S. Bernanke.” www.cfr.org/publication/18733. “CUNA 2009 Legislative Briefing Paper.” 2009. CUNA Legislative Affairs. www.cuna.org/gov_affairs/member/download/gac09_briefing.pdf. Davidoff, Steven. 2009. Filling Gaps and Dark Holes: Restructuring the Financial Regulatory Apparatus for the Next Crisis. Testimony, Committee on Homeland Security and Governmental Affairs, U.S. Senate, 111th Cong., January 21.

49

Dodaro, Gene. 2009. A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System. Statement, United States Government Accountability Office. Testimony, Committee on Homeland Security and Government Affairs, U.S. Senate, 111th Cong. Ferguson, Roger. 2005. Address to Joint Central Bank Research Conference on Risk Management and Systemic Risk. Frankfurt, Germany, November 8. Ferran, Eilis. 2003. “Examining the UK’s Experience in Adopting the Single Financial Regulator Model.” Brooklyn Journal of International Law (January). Available at the Social Science Research Network Web site: ssrn.com/abstract=346120. Group of 30. 2009. Financial Reform: A Framework for Financial Stability. Hood, Rodney. 2006. Speech at the CUNA GAC, Washington, DC, February 28. International Monetary Fund. 2004. Appendix VII, Glossary. Compilation Guide on Financial Soundness Indicators. Washington, DC: IMF. Jackson, Howell. 2007. “Variation in the Intensity of Financial Regulation: Preliminary Evidence and Potential Implications.” Yale Journal on Regulation 24(2). Available at the Social Science Research Network Web site: ssrn.com/abstract=839250. ———. 2008. “A Pragmatic Approach to the Phased Consolidation of Financial Regulation to the United States.” Harvard Law School. papers.ssrn.com/sol3/papers.cfm?abstract_id=1300431. ———. 2009. “Where Were the Watchdogs? The Financial Crisis and the Breakdown of Financial Governance.” Speech, Committee on Homeland Security and Governmental Affairs, U.S. Senate, 111th Cong., January 21. Jackson, William E. 2003. The Future of Credit Unions: Public Policy Issues. Madison, WI: Filene Research Institute. Jones, Paul. 2008. “Breaking through to the Future: The Strategic Development of Credit Unions in Britain, 1998–2008.” The Northern Financial Inclusion Conference, Manchester, England, December. Kushmeider, Rose Marie. 2005. “The US Federal Financial Regulatory System: Restructuring Federal Bank Regulation.” FDIC Banking Review 17(4): 1–31.

50

Mica, Daniel. 2009. CUNA on Modernizing Bank Supervision and Regulation. Part II of Testimony, Banking, Housing and Urban Affairs Committee, U.S. Senate, 111th Cong., March 24. National Credit Union Administration. 2006. Federal Credit Union Handbook. www.ncua.gov/guidesmanuals/fcu_handbook/fcu_ handbook.pdf. Obama, Barack. 2009. Remarks made to ranking members of the Senate Banking and the House Financial Services Committee, White House, February 25. Paulson, Henry. 2008. Blueprint for a Modernized Financial Regulatory Structure. www.treas.gov/press/releases/reports/Blueprint.pdf. Rivlin, Alice M. 2008. “Preliminary Thoughts on Reforming Financial Regulation.” Testimony, The Brookings Institution and Georgetown University Committee on Financial Services, U.S. House of Representatives, 110th Cong., October 21. Wilcox, James. 2005. “The Increasing Integration and Competition of Financial Institutions and of Financial Regulation.” Research in Finance 22: 215–38.

51

Additional Reading

APRA’s Policy Reform Program. 2000. “Policy Information Paper.” Working Paper, Sydney, Autstralia. Bank for International Settlement. “Y V Reddy: Issues in Choosing between Single and Multiple Regulators of Financial System.” www. bis.org/review/r010524c.pdf. Branch, Brian, and Dave Grace. 2008. Credit Union Regulation and Supervision. World Council of Credit Unions. Briault, Clive. 1999. The Rationale for a Single National Financial Services Regulator. Financial Services Authority, United Kingdom, May. Ferguson, Roger. 2006. “Financial Regulation: Seeking the Middle Way.” Speech, Institute of International Finance Spring 2006 Membership Meeting, Zurich, Switzerland, March 31. www.federalreserve. gov/newsevents/speech/ferguson20060331a.htm. Furlong, Frederick T., and Simon Kwan. 2006. “Safe and Sound Banking Twenty Years Later: What Was Proposed and What Has Been Adopted.” Federal Reserve Bank of San Francisco, Working Paper Series, San Francisco. “The Gap in the U.S. Treasury Recommendations.” 2008. Harvard Business School Working Knowledge, Cambridge, MA. Jackson, Howell. 2005. “An American Perspective on the UK Financial Services Authority: Politics, Goals and Regulatory Intensity.” John M. Olin Center for Law, Economics and Business at Harvard, Cambridge, MA. Laker, John. “The Evolution of Risk and Risk Management—A Prudential Regulator’s Perspective.” In The Structure and Resilience of the Financial System. www.rba.gov.au/PublicationsAndResearch/ Conferences/2007/Laker.pdf. Masciandara, Donato, Marc Quintyn, and Michael Taylor. 2008. “Financial Supervisory Independence and Accountability—Exploring the Determinants.” International Monetary Fund Working Paper, Washington, DC. McMahon, Robert. 2009. “Bernanke: Regulatory Overhaul Needed to Prevent Future Global Financial Shocks,” Council on Foreign Relations, www.cfr.org/publication/18734/avoiding_future_ meltdowns.html. Ramesha, K., and G. Nagaraju. 2007. “Prudential Standards and the Performance of Urban Cooperative Banks in India: An Empirical Investigation.” Journal of Financial Risk Management 4(2): 37–45. 53

Schaek, Klaus, Martin Cihak, and Simon Wolfe. 2006. “Are Competitive Banking Systems More Stable?” International Monetary Fund Presentation, Capri, Italy, May. Wilcox, James. 2007. “Policies and Prescriptions for Safe and Sound Banking: Shocks, Lessons and Prospects.” Federal Reserve Bank of Atlanta, Economic Review, First and Second Quarters 2007. World Council of Credit Unions. 1999. “Is It Alphabet Soup or Regulatory Consolidation?” Credit Union World 2: 18–19. Zingales, Luigi. 2009. “The Future of Securities Regulation.” Working Paper 08-27, Booth School of Business, University of Chicago.

54

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