By Darshana Rajendaran, IFMR Finance Foundation
Continuing our series of posts on Consumer Protection, this post looks at the approaches to financial regulation and supervision and studies the financial regulatory structure of South Africa.
It is commonly understood that regulation should be designed to achieve certain key policy goals, including: safety and soundness of financial institutions, mitigation of systemic risk, fairness and efficiency of markets and the protection of customers and investors. In practice there are essentially four approaches to financial regulation and supervision that achieve these policy goals in different ways. G30 report, 2008i defines these approaches as follows:
1. Institutional Approach:
The Institutional or Silos Approach is a legal-entity-driven approach. The firm’s legal status determines which regulator is tasked with overseeing its activity both from a prudential and business conduct perspective. In other words, this approach follows the boundaries of the financial system in different sectors and each sector is supervised by a different agency. Examples: China, Mexico and Hong Kong
2. The Integrated Approach
Under the Integrated or Unified Approach, there is a single universal regulator that conducts both safety and soundness oversight and conduct-of-business regulation for all the sectors of the financial services business. Example: Germany
3. The Twin Peaks Approach
The Twin Peaks Approach is a form of regulation based on objective and refers to a separation of regulatory functions between two regulators: one that performs the safety and soundness supervision function and the other that focuses on conduct-of-business regulation. Examples: Australia and Netherlands
4. Functional Approach
The Functional Approach is one in which supervisory oversight is determined by the business that is being transacted by the entity, without regard to its legal status. Each type of business may have its own functional regulator. Examples: France, Italy and Spain
The South Africa Financial Regulatory System
The regulatory regime in South Africa in the 1980s regarded the financial sector components – banks, insurance and capital markets as separate species. An institutional approach was in place, characterised by lack of coordination among regulators of these specific components. In 1987, the De Kock Commission pushed the process of deregulation and a shift towards a functional approach of regulating specific activities. The process of deregulation, with more reliance on market forces started to gain momentum in the 1990s. After South Africa’s political isolation ended in the mid-1990s, the country quickly adjusted to international standards and consumer protection issues moved more to centre stage. Following the 1993 Melamet Commission, South Africa planned to move towards a single regulator approach to be in line with developments in European countries whose financial systems are similar. However, the regulatory system has remained functional and partially integrated to the present day.
Presently, the two main regulatory authorities are the South African Reserve Bank (SARB) and the Financial Services Board (FSB). The deposit-taking banking sector is regulated by the Banking Supervision Department of the SARB while non-banking financial institutions are regulated by the FSB. In addition, there is also a National Credit Regulator whose objective is to promote fairness in accessing consumer credit, consumer protection and competitiveness in the credit industry. It presently does not have an overarching coordinating authority.
In 2008 the International Monetary Fund (IMF) and the World Bank performed a Financial Sector Assessment Program (FSAP) whereby they conducted a joint assessment of the South African financial system. The main outcome from the IMF team was that although South Africa had a modern and effective financial regulatory framework, it nevertheless needed reform that prioritize and strengthen both prudential and market conduct supervision and regulatory powers.ii
In order to address the shortcomings identified by the IMF, the Government issued the National Treasury Policy Documentiii in February 2011 that set out proposals for strengthening the financial regulatory system. The main policy thrust was the adoption of the twin-peak model of financial regulation in South Africa. It was in part recognition of the fact that there was a global shift from the single regulator model to the twin peak model after the crisis. The twin peaks approach was regarded as the optimal means of ensuring that transparency, market integrity, and consumer protection receive sufficient priority. It was believed that moving to a twin peaks system would cause the least amount of disruption to both market participants and to the regulators themselves
South Africa’s twin-peak model will be underpinned by three pillars – coordination, prudential regulation and market conduct of business. The Council of Financial Regulators comprising heads of key financial regulators, non-financial regulators and other stakeholders will ensure overall coordination of financial regulation. It will also serve as a formal channel for resolving conflicts that inevitably arise from separating prudential and market conduct regulation. The Financial Stability Oversight Committee comprising the South African Reserve Bank (SARB), the Financial Services Board (FSB) and National Treasury will coordinate financial stability issues and endeavour to mitigate risks. The South African Reserve Bank (SARB) will be responsible for prudential regulation while the Financial Service Board (FSB) will regulate the conduct of business. South Africa intends to phase in the system over a three year period.
i) ‘The structure of financial supervision: Approaches and challenges in a Global Marketplace’, G30 Report, 2008.
ii) IMF Country Report 2008
iii) ‘A safer financial sector to serve South Africa Better’, Department of National Treasury, South Africa, February 2011
‘Financial Regulation And Supervision: Theory And Practice In South Africa’, International Business & Economics Research Journal, November 2011
‘Financial Regulation in South Africa’, SA financial sector forum, 2001