Institutional Structures of Financial Sector Supervision, Their Drivers

Institutional Structures of Financial Sector Supervision, Their Drivers and Emerging

Benchmark Models

Martin Melecky and Anca Maria Podpiera

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Outline of the Presentation

1. Introduction

2. International trends in supervisory integration

3. Estimation methodology

4. Empirical findings

5. Robustness analysis

6. Conclusion

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1. Introduction: Background

During the past two decades, the structure of financial sector supervision has changed, mostly towards supervisory unification.

The creation of U.K.’s Financial Services Authority (FSA) in June 1998 was the ignition point for changes in financial supervisory architecture.

Supervisory structures vary across countries concerning: the degree of integration of microprudential supervision; proximity of micro- and macro-prudential supervision; implementation of business conduct supervision.

1. Introduction: Related Literature Different models of prudential supervision, the arguments for and

against supervisory unification, and the role of central bank in the supervision and eventual unification (De Luna Martinez and Rose, 2003; Cihak and Podpiera, 2007; Masciandaro, Quintyn and Taylor, 2008; Di Giorgio and Di Noia, 2007; Herring and Carmassi, 2008).

Relevance of country characteristics for the type of supervision (Shen, 2006; Masciandaro, 2006, 2007 and 2009; Masciandaro and Quintyn, 2008).

The relationship between the degree of unification across financial sectors’ supervision and the performance of supervisors (Arnoneand Gambini, 2006; and Cihak and Podpiera, 2006; Masciandaro, Vega Pansini and Quintyn, 2011).

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1. Introduction: Objective Study developments of supervisory structures for financial services

concerning prudential and business conduct supervision over the past decade for 98 high and middle income countries. A new panel dataset that enables to study changes and

differences in supervisory structures across countries and over time.

Estimate possible drivers of supervisory integration using a panel ordered probit analysis. We consider four sets of indicators: (i) countries’ general and

economic development indicators; (ii) political and governance indicators; (iii) financial sector development indicators, and (iv) the number of past financial crises experienced by a country.

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2. International trends in prudential supervision The database of prudential supervision institutions during 1999-2010

across 98 high and middle income countries was compiled based on “How countries supervise their banking, insurers and securities markets” and online official information from country authorities.

The following supervisory models are distinguished: Sectoral (institutional) supervision with the banking supervision

assigned to an agency other than the central bank; Sectoral (institutional) supervision with the banking supervision

within the central bank; Partial integration, where two financial sub-sectors are supervised

by the same institution, either the central bank or an agency outside of central bank;

Integration of the main financial sub-sectors’ supervisions in a Financial Supervisory Authority (FSA);

Integration of the main financial sub-sectors’ supervisions into the central bank.

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Figure 1. Evolution of prudential supervision structures, 1999-2010

All Economies

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10

20

30

40

50

60

70

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

%

CB integration FSA integration

Sectoral Supervision Partial Integration

High financial depth

0

5

10

15

20

25

30

35

40

45

50

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

%



Low financial depth

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10

20

30

40

50

60

70

80

90%



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Main data trends in prudential supervision

The data show a trend towards greater integration of prudential supervision both across financial sub-sectors and, to some extent, across microprudential and macroprudetial supervision.

The share of countries that kept the traditional model of institutional regulation decreased from 62 percent in 1999 to 44 percent in 2010.

The share of countries that integrated microprudential supervision in a FSA increased from 11 percent in 1999 to 25 percent in 2010. A half of these countries had initially a partial integration outside the central bank.

Six countries integrated the prudential supervision in the central bank. Four of the changes took place in economies with lower financial depth. Typically, these countries had initially a sectoralsupervision with the central bank supervising banks.

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Main data trends in prudential supervision

Countries that originally had sectoral or partial supervision with banking supervision outside of the central bank, typically tend to either maintain their supervisory structure or integrate it in a FSA.

Countries in which the central bank supervises the banking sector show a higher probability to integrate under the central bank than under a FSA.

The prevalence of the central bank in prudential supervision diminished: Among high financial depth economies, in 2010 the central banks

supervised banking sector in 58 percent of countries - down from 66 percent in 1999;

Among lower financial depth economies, in 2010 the central banks supervised banking sector in 67 percent of countries - down from 70 percent in 1999.

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Figure 2. Sectoral Supervision and Partial Integration vis-à-vis central bank

All Economies

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10

20

30

40

50

60%

Partial Integration in the Central Bank

Partial Integration outside the Central Bank

Sectoral Supervision, Banking Supervision within the CentralBankSectoral Supervision, Banking Supervision outside theCentral Bank


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5

10

15

20

25

30

35

40

45%




Low financial depth

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10

20

30

40

50

60

70%




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International trends in business conduct supervision We consider regulation, enforcement and dispute resolution as the full

set of functions necessary for financial consumer protection (FCP) and FCP as a subset of business conduct supervision.

For BCS, the following supervisory models could be identified: No BCS – not all financial sectors have assigned business conduct

supervisor; Elements of BCS implemented – no agency with statutory

responsibility for BCS, but there exist institutions that oversee the protection of financial consumers, e.g., FCP Agency (Canada), specialized complaint boards (Denmark), Financial Ombudsman (Greece);

Sectoral supervisors – the prudential supervisor of each financial sub-sector also performs business conduct supervision;

Integrated dual-mandate supervisor – business conduct supervision is assigned either to the central bank or the FSA, which act as integrated supervisor;

Integrated single-mandate supervisor – exclusively supervises the business conduct for all financial services (the “twin peak” model).

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Figure 3. Evolution of Business Conduct Supervision, 1999-2010

All Economies

0

10

20

30

40

50

60

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

%

Integrated business conductBusiness conduct in placeTw in peaks


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20

30

40

50

60

70

1999

2000

2001

2002

2003

2004

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2006

2007

2008

2009

2010

%

Integrated business conductBusiness conduct in placeTwin peaks

Low financial depth

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10

15

20

25

30

35

40

45

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

%

Integrated business conductBusiness conduct in placeTwin peaks

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Main trends in business conduct supervision

There is an important increase in the proportion of countries that introduced business conduct supervision during 1999-2010.

Almost half of countries that did not have a holistic business conduct supervision for financial services in 1999, have adopted it during the past decade.

In half of these cases, the change was accomplished by integration of the function into an FSA or CB, or by adopting the “twin peak” model.

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3. Empirical analysis

Several important questions have emerged: Why microprudential supervisory structures differ across countries?

Why some countries have chosen to integrate microprudential and macroprudential supervisions?

Why business conduct supervision has been introduced only in some countries, and how does it institutionally interact with prudential supervision?

And from the development perspective: What models have the developing countries chosen to follow and why?

Is there a prevailing trend toward certain benchmark models that countries have followed according to their country typology?

Estimation Methodology We employ an ordered probit analysis to model the choices of

supervisory structures using as potential determinants: development indicators: population count, GDP per capita, and

degree of openness; governance indicators: the quality of governance, and the

autonomy of the central bank; financial sector indicators: depth and complexity of the

financial system, banking sector characteristics (private credit as a percent of GDP, stock market capitalization as a percent of GDP, the number of listed companies, the non-life insurance premium as a percent of GDP, banking concentration, efficiency, profitability, liquidity, and performance.

the number of past financial crises experienced by a country.

The explanatory variables, except for “central bank autonomy”, are lagged by one period to avoid possible endogeneity problems.

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Estimation Methodology (cont’d)

Supervisory structures, the dependent variable, are ordered with respect to the degree of integration.

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Prudential Supervision:1. Sectoral supervision, with the

banking sector supervised by an agency outside of the central bank;

2. Sectoral supervision, with the central bank overseeing the banking sector;

3. Unified supervision in a FSA; 4. Unified supervision in the

central bank.

Business Conduct Supervision:1. No business conduct; 2. Elements of BCS implemented, but

no agency with statutory responsibility for BCS;

3. Sectoral business conduct; 4. FSA or CB as integrated supervisors

are also assigned business conduct supervision;

5. “Twin peak” model, i.e., there is a unified authority with a single mandate for BCS.

4. Empirical findings

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Dependent variable

Explanatory variables Prudential Supervision Business Conduct Supervision

GDP per capita +*** +***

Population -*** ns

Trade to GDP ratio +*** -***Governance +* ns

Central Bank Autonomy Index

-*** ns

Cumulative number of crises +*** +*

Credit to GDP ratio ns +***

Stock market capitalization -*** ns

Concentration ns -*Net interest margin ns -***

Private credit to deposit ratio +*** nsNote:*** p<0.01, ** p<0.05, * p<0.1.

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4. Empirical findings: country characteristics

As countries advance to a higher stage of economic development, they tend to integrate more their financial sector supervisory structures.

Small open economies tend to opt for more integrated structuresfor prudential supervision; a progressively higher degree of openness could coincide with less integration of business conduct supervision.

Improvements in overall public governance are associated with more integrated supervisory arrangements.

Greater independence of the central bank, which is often involved in supervision of banks, could entail less integration of prudential supervision, but not necessarily business conduct.

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Empirical findings: financial sector characteristics The size of the banking sector influences positively the integration

of both prudential and business conduct structures.

In contrast, strong development of the non-bank financial sectorsincluding capital markets and the insurance industry is associated with a less integrated prudential supervision structure.

For business conduct supervision, higher concentration of the banking sector, often associated with higher lobbying power, appears to act as a significant negative force against business conduct supervision .

Countries with banking sectors that have been more exposed to aggregate liquidity risk and capital flow reversal tend to integrate more their prudential supervision.

The number of past financial crises strongly increases the probability that a county will opt for integration of both prudential and business conduct supervisory structures.

5. Robustness analysis Ordered probit pooled regression: overall, the results support the baseline results. Binary choice model in which supervisory structures are classified as unified or non-unified supervision:

From the prudential supervision regression, income, stock market capitalization, banking liquidity as well as variables related to the lobbying power appear crucial for the decision to integrate.

From the business conduct supervision regression, the baseline results regarding income, number of past crises, stock market capitalization, and concentration are supported.

Multinomial logit model: Prudential supervision: the results support of the baseline results. The

crisis variable influences positively only the tendency toward central bank integration.

BCS: the results are less uniform across probability ratios; however, they convey interesting information (e.g., openness negatively influences only the change from No-BCS to sectoral or partial BCS).

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The historical benchmark and current supervisory structures for prudential supervision

Countries as Luxemburg, Panama, Canada, and Chile, are expected to have implemented more integrated prudential supervisory structures given the experience of their peers.

There are several countries, including Armenia, Czech Republic, Uruguay, Netherlands, and Slovakia that integrated their prudential supervisory structures more than predicted.

ARG

ARMAUS

AUT

AZE

BEL

BOL

BWABRABGR

CANCHL

CHN

COL

CRI

HRV CYP

CZE

DNK

ECU

EGYSLV

EST

FINFRAGEODEU

GRC

GTM

HND

HKG

HUNISL

IND IDN IRN

IRL

ISRITA

JPN

JOR

KAZ

KOR

LVA

LBNLTU

LUX

MKD MYS

MLT

MUS

MEX

MDAAPR NAM

NLD

NZLNGA

NOR

PANPER

PHLPOL

PRTROM RUSSAU

SGP

SVK

SVNZAFESPLKA

SWE

CHE

THATTOTUN

TUR

UKR

ARE

GBR

USA

URY

VEN

VNM

0

0.5

1

1.5

2

2.5

3

3.5

0 0.5 1 1.5 2 2.5 3

Act

ual V

alue

s

Fitted Values

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The historical benchmark and current supervisory structures for business conduct supervision

In USA, Austria, Cyprus, and New Zealand, the implementation and integration of business conduct supervision, is less advanced than predicted by our model.

Countries, as Singapore, Czech Republic, Hungary, Poland, Uruguay, Kazakhstan, and Malta, shown greater tendency to address business conduct supervision than their country typology suggests.

ARG

ARM

AUS

AUTAZE

BEL

BOL

BWA

BRABGR

CAN

CHL

CHN

COL

CRIHRV CYP

CZE

DNK

EGYSLVEST

FIN

FRA

GEO

DEU

GRC

GTMHND HKG

HUN

ISL

IND

IDNIRN

IRL

ISR

ITA

JAM

JPN

JOR

KAZ

KOR

LVA LBNLTU

LUX

MKD

MYS

MLT

MUSMEX

MDAAPRNAM

NLD

NZLNGA NOR

PANPERPHL

POL PRT

ROM RUSSAU

SGP

SVKSVN

ZAF

ESPLKA

SWE

CHE

THATTOTUNTURUKR

ARE

GBR

USA

URY

VEN

VNM0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

0 0.5 1 1.5 2 2.5 3 3.5

Act

ual V

alue

s

Fitted Values

6. Conclusion

Financial supervisory structures vary significantly across countries.

This variation could be explained by differences in economic development, financial sector structure and crisis experience.

Future research should focus on the performance of different supervisory structures in financial sector risk management.

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Institutional Structures of Financial Sector Supervision, Their Drivers