Handle financial sector regulators’ reforms carefully

The recent Abdikadir Mohamed-led taskforce on parastatals reforms have proposed a new system of financial sector supervision that seeks to phase out multiple regulators.

The proposed model, if adopted, will entail the merger of four of the five current regulators — Capital Markets Authority (CMA), Retirement Benefits Authority (RBA), Insurance Regulatory Authority (IRA) and Sacco Societies Regulatory Authority (SASRA) — into one authority, the Financial Services Authority (FSA).

The Central Bank of Kenya (CBK), the regulator of banks is the other regulator.

Financial regulatory structure reform was needed even before the proposed parastatals shake up in order to prepare the country for developments in this sector.

The regulatory reform process must not be guided by the need to consolidate supervision for the sake of it but rather by the need to come up with an appropriate model following a carefully planned process and consultation.

Financial safety is fundamental to the economic development of any country. It is fundamental to the smooth operation of the economic system given that financial services are intermediate inputs to other areas of the economy.

Many services that the financial system provides to the economy at large are built on confidence that transactions will clear and that promises will be honoured. Without that confidence, overall economic efficiency can be seriously impaired.

The financial regulatory structure reform should thus be motivated and driven purely by the desire to have a competitive, efficient and effective structure that will support the kind of financial system we envisage to have in the future.

Merely lumping together four of the current regulators just for the sake of consolidation, is ‘‘lazy reorganisation’’ and could pose serious risk to the safety and soundness of the financial system.

The most appropriate basis for organising the institutional structure is in terms of the objectives of regulation.

Regulatory agencies are most effective and efficient when they have clearly defined, and precisely delineated, objectives and when their mandate is clear and precise.

Also, accountability is more effective and transparent when it is clear for what objectives particular agencies are responsible. We should use this opportunity to move on from our current ‘‘institutional based’’ supervision structure and not consolidate on the basis of the current structures but rather re-organise the financial regulatory bodies on the basis of a new and ‘‘objective based’’ supervision structure.

The general trend in most jurisdictions these days has been to keep the two functions of prudential and market conduct and consumer protection regulations separate.

The ‘‘twin peak’’ approach to regulating the financial services industry has been given the thumbs up by the international Financial Stability Board (FSB), a body that was established in 2009 to prevent a repeat of the global financial meltdown in 2008.

Best representation of ‘‘twin-peak’’ approach is Australia and the Netherland whose financial regulatory and supervisor oversight withstood the Global Financial Crisis of 2008/9 and which have been rated as the best in the world.

The UK has broken up its single integrated regulator, the Financial Services Authority (FSA), and has after the crisis adopted the ‘‘twin-peak’’ approach. South Africa, India, France and the US are also moving towards this approach. The “twin-peak” approach basically structures regulation around two agencies, one responsible for the safety and soundness of all financial firms and the other for regulating their sales practices.

The approach relies on two types of regulators: a prudential regulator and a conduct of business and consumer protection regulator.

The two complement each other but each needs to have its own independent focus to ensure both are able to give 100 per cent of their attention to their respective areas of regulation.

Financial stability

Although defined as separate entities, these two regulators generally employ a high level of co-ordination, as they are each responsible for overseeing the functioning of different aspects of the same institutions.

We would need to create a Financial Stability Committee (FSC) within the Central Bank of Kenya which should be given financial stability mandate across the financial system to deal with macro-prudential issues, a gap that currently exists.

The FSC will not directly regulate firms but its impact on the prudential regulation of firms will be very important.

The FSC should be in charge of macro-prudential policy and while not having direct oversight of individual financial institutions, it should have the powers and the necessary tools to give recommendations and directions to CBK, The National Treasury and the FSA. It will complement the existing Monetary Policy Committee (MPC) and will on a regular basis undertake financial stability reviews of the whole system to proactively address any issues.

This arrangement embeds prudential micro and macro-regulation of all the financial institutions within CBK but makes prudential supervision and monetary authority separate and independent arms.

The good thing with a ‘‘twin-peak’’ structure is that it is a simple reorganisation of the current structure into two main bodies, the CBK and the FSA.

Both regulators will supervise the entire financial sector but one will do so from the prudential regulation perspective and the other from the market conduct and consumer protection perspective.

It is simple, quick to achieve and less costly to implement and will cause the least amount of disruption to the financial industry.

How we regulate and supervise our financial sector will be key to our ambition to become a regional financial hub.

Wehliye is senior vice president, Financial Risk Management, Riyadh Bank and has previously worked as a regulator with the Australian Prudential Regulation Authority