Global Policy Forum

by Lawrence J. White

How many financial regulatory agencies does a country need? One? Two? Perhaps three or four? How about two hundred? Such questions are gaining in urgency as more and more countries, and the European Union itself, debate whether or not to consolidate financial regulation under the umbrella of one all-powerful body.

Financial regulators' activities focus on maintaining the integrity of a country's financial system: its financial institutions and financial transactions. Their domain encompasses banks, other depository institutions, insurance companies, securities firms, pension funds, finance companies - indeed, just about any entity that conducts financial transactions. The current trend is for countries to consolidate their financial regulatory apparatus into a single agency, with Britain's Financial Services Agency (FSA) a leading example.

I believe that this trend is a serious mistake which, quite myopically, overlooks the potential for mistakes in regulation. Though I do not necessarily advocate 200 financial regulatory agencies (more about this below), I believe that a structure involving multiple financial regulators in a country is likely to create a healthier financial system than would a single all-encompassing regulator.

The argument for a single regulator is deceptively simple: after all, a single country has a single national government, so why not have a single regulator for all financial regulation? If the European Union is to have a single market, the argument continues, then it needs a single financial regulator. Agency rivalries will be avoided. No one will be confused as to who is responsible. There can be ``one stop shopping.'' Government will speak with ``one voice.''

Fine, as far as it goes. But consider another possibility: suppose that the financial regulator is mistaken in its approach to a particular issue. A promising financial instrument, capable of improving the efficiency of credit markets, is rejected; or the agency's investigative and review procedures become stultified. After all, government agencies are not omniscient; they do make mistakes; they can become ossified.

What happens then? With a single financial regulator, where can a rejected financial innovator turn? Where is the alternative forum? How can an agency's procedures be reformed? Where are the competitive pressures for innovative thinking in government?

Now consider the alternative structure of multiple financial regulatory agencies - say, one for banks, another for other deposit institutions, yet another regulator for insurance, another for securities, maybe another for pensions. Yes, this sounds messy, and may duplicate work or become overly compartmentalized. But it also creates safety valves, alternative forums, bases of comparison, sources of new ideas, and potential arenas for innovation. Regulatory competition is possible.

Won't this mean a regulatory ``race to the bottom?'' It need not. There are many aspects of financial regulation - e.g., information requirements, entry limitations, facilities limitations - where more choice and competition will often be beneficial. An exception may be prudential (safety-and-soundness) standards for banks, insurance companies, and some forms of pension plans, which should be tough, because national governments almost always will bear the losses in the event of failures of these types of financial institutions. Even here, multiple agencies can lead to beneficial innovations that can reduce the regulatory burden on institutions while maintaining effective levels of safety.

I write from the perspective of a former American financial regulator. In the US there are three national agencies that regulate commercial banks, one that regulates savings institutions, one that regulates credit unions, one that regulates securities markets, one that regulates commodity and financial options/futures markets, and two that regulate pension funds. In addition, the 50 American states each have separate bank regulators (with overlapping jurisdictions with the national regulators), most have savings bank regulators, all have credit union regulators, all have insurance regulators (which is solely a state responsibility), and all have securities regulators. Phew!

Of course, this system is a little messy; it does have the problem of duplicated efforts. (It's nearly impossible to explain the details to anyone who hasn't been an American financial regulator or a lawyer.) But the system works. In fact, it works pretty well, though mistakes do occur (as they do in any regulatory system). Most important, this multiple agency structure ensures regulatory competition - each agency generally wants to expand its domain of chartering and jurisdiction - that is generally beneficial for the financial system and for the health of the American economy.

I am not arguing for the world to replicate the American system of 200-plus regulatory agencies. Far fewer will suffice for most countries. But the next time that someone advocates a single financial regulator and its simplicity, remember that there is another side to that coin: where are the safety valves? Where are the alternatives? What about errors? How will innovation occur? In government (as well as in the private sector) a golden rule is that more competition and less monopoly is likely to be beneficial.

Lawrence J. White is Professor of economics, Stern School of Business, New York University.

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