5.2. Arguments against Unified Regulation

A number of important countries continue to persist with multiple regulators, though regulatory co-ordination has been increasing everywhere. The US, for example, has adopted a model, which blends functional regulation with umbrella supervision. For over 60 years, regulation of financial institutions in the US was divided among several different agencies. The Gramm-Leach-Bliley Act, enacted in November 1999, adheres to the principle of functional regulation whereby the primary regulators of insurance companies, investment companies and banks continue to be specialist regulators as earlier. However, the Federal Reserve Board is now entrusted with the role of the umbrella supervisor to regulate the financial holding companies subject to some limitations, which are collectively referred to as Fed-Lite provisions.

The persistence of separate regulators in most economies reflects the fact that there are equally compelling arguments against unified supervision. This includes:

♤ Given the diversity of objectives – ranging from guarding against systemic risk to protecting the individual consumer from fraud – it is possible that a single regulator might not have a clear focus on the objectives and rationale of regulation and might not be able to adequately differentiate between different types of institutions.

♤ A single unified regulator may also suffer from some diseconomies of scale. One source of inefficiency could arise because a unified agency is effectively a regulatory monopoly, which may give rise to the type of inefficiencies usually associated with monopolies. A particular concern about a monopoly regulator is that its functions could be more rigid and bureaucratic than these separate specialized agencies. It is argued that another source of diseconomies of scale is the tendency for unified agencies to be assigned an ever-increasing range of functions; sometimes called ‘Christmas-tree effect’.

♤ Some critics argue that the synergy gains from unification will not be very large, i.e. economies of scope are likely to be much less significant than economies of scale. The cultures, focus, and skills of the various supervisors vary markedly. For example, it has been argued that the sources of risks at banks are on the asset side, while most of the risks at insurance companies are on the liability side.

♤ The public could tend to assume that all creditors of institutions supervised by a given supervisor will receive equal protection, generating ‘moral hazard’. Hence depositors and perhaps other creditors of all other financial institutions supervised by the same regulatory authority may expect to be treated in an equivalent manner.

♤ Another serious disadvantage of a decision to create a unified supervisory agency can be the unpredictability of the change process itself. The first risk is that opening the issue for discussion will set in place a chain of events that will lead to the creation of a unified agency, whether or not it is appropriate to create. The second risk is legislation in that the creation of a unified agency will generally require new legislation, but this creates the possibility that the process will be exploited by special interests. The third risk is a possible reduction in regulating capacity through the loss of key personnel. Another risk is that the management process itself will go off track.