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Will the new “twin –peaks” structure of bank regulation ensure that banking crises will be a thing of the past?
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Introduction
The financial crisis of 2008 had many far reaching consequences for many countries, which led to different start contemplating about reforming and improving efficiency of their institutions. As a result, in UK, there is concerted effort to establish a regulatory twin-peaks structure that separates prudential and market conduct regulation[1]. A number of countries in other parts of the world have managed to successful establish twin-peaks regulatory structure. Examples of these countries are Netherlands and Australia, hence, the success to be achieved in UK with regard to implementation of the twin-peaks structure is likely to draw key lessons from these countries.
Twin-peaks regulatory structure in Netherlands and Australia is seen to have helped the countries to experienced lesser consequences of the global financial crisis than other countries that relied on centralised regulatory system[2]. As a result, UK aims to ensure that what was experienced during the financial crisis of 2008 is something that is not experienced again in future. Whether this goal is achieved or not remains ‘wait-and-see’ strategy. The planned move to implement the twin-peaks regulatory structure in UK is to commence on 1 April 2013. Two twin regulatory bodies are to be established: Financial Services Authority (FSA) and Prudential Regulation Authority (PRA). The two are to supervise the financial market structure in a transparent manner, unlike in the past when the responsibility was largely bestowed upon the bank. Therefore, with the anticipated reform initiatives, the basic question to ask is whether the instruments in place will cushion or protect the country against experiencing another financial crisis in future?
The road to twin-peaks regulatory structure
The financial crisis of 2008 provided awakening moment for the world, especially those in developed world to reflect on the soundness of financial institutions, especially those mandated with regulatory responsibilities, to protect or cushion future financial crises[3]. As a result, it became clear in the UK context that the failure of the financial system in the country could not be divorced from the activities of financial regulation agencies. The prime factor here is that no single institution possesses grand responsibility, authority or powers to conduct monitoring of the system as whole and also be in a proper position to respond to such trends with effective actions. In fact, after the financial crisis of 2008, diverse opinions both at global and national level agreed to one thing; the failures in regulation should be partly blamed for the financial crisis that occurred[4]. In the case of UK, an observation was made that the failure in regulatory agencies was caused by weaknesses in the tripartite system of regulation[5]. At this point of discovery, agreement was reached that the tripartite system of regulation required thorough reforms so as to equip the financial regulation regime adequately for future crises.
One of the outcomes for the reformation of the tripartite system of regulation is a proposal for a new regulatory structure that embeds the twin peak model of regulation. According to the Financial Services Act (2012) proposals have been made to split the role of regulating the financial market structure. According to the Financial Services Act (2012), there will be the establishment of an Independent Financial Policy Committee (FPC) that is based at the Bank of England[6]. At the same time, the move will see the Financial Services Authority (FSA) cease to operate in its current form where the body will be split into two and its responsibilities shared between the two new bodies. The first body the PRA will handle prudential matters and remain a component of the Bank of England[7]. The second body is the Financial Conduct Authority, which is a separate body and will be tasked with responsibility of supervising business and market conduct[8]. In addition, the process of reform largely bestows the role of supervising the financial market structure to the FSA instead of the bank.
Implementing twin-peaks regulatory structure
In 2012, Hector Sants, the chief executive officer of the FSA, who also doubles as the deputy governor at the Bank of England, hailed the move by the financial regime in the country to move towards twin-peaks regulatory structure[9]. According to Hector Sants, the move was well developed and would see those tasked with financial regulatory responsibilities change their behaviour of supervising, especially in regard to making assessment of the risks that individual firms in the country have. Twin-peaks model is perceived to be the opportunity that the country’s financial regime has to rise to the occasion and rectify past loopholes that in one way or the other are connected to dysfunctional of financial regulation structure[10]. For instance, under the new model, the financial supervisory and regulation roles are to be shared, unlike in the past when such roles have been the preserve of one institution.
Under the new arrangement, two independent groups have been proposed to carry out supervision roles for the banks, insurers and major investment groups in the country. The supervision of the two independent groups is to cover issues of prudence and conduct[11]. As a result, the new approach is seen to have the ability that will enable each of the independent groups to establish separate and independent regulatory judgments based on different set of objectives and benchmarks[12]. Also, the independent groups will be able to coordinate and maximise utilisation and exchange of information that improves the regulation process. Therefore, even as the two new groups aim to operate independently, they are supposed to coordinate their activities in order to enhance the regulation process. In an effort to move to the new direction of regulation, effort has been made identify the problems of the past regulatory system. The consensus is that the past regulatory regime lacked clear objectives of its supervisory roles, as well as transparency and efficiency of its activities[13]. In other words, the regime can be said to have lacked proactive capability, as well judgment-based supervision that in many ways would have seen soundness of financial regulation regime, thereby, cushioning the country against the financial crisis of 2008.
The Financial Services Act (2012) has proposed that FSA should be abolished. Furthermore, FSA should be substituted by the creation of Financial Policy Committee, the Financial Conduct Authority (FCA), and the Prudential Regulation Authority (PRA). These new institutions should have different responsibilities to fulfill in regard to the regulation of the financial regime in the country. When the new proposals come into function as from 1st April 2013, it is anticipated that the primary responsibility of Financial Policy Committee (FPC) will include identifying and monitoring systematic financial risks, thereby, developing protective mechanisms in an attempt to make and enhance the resilience of the financial system in the country[14]. Additionally, the committee will play an important role in the country’s economic policy process; a situation that is perceived will help the country’s financial system.
The second regulatory agency that has been created is the Prudential Regulation Authority. The Prudential Regulation Authority shall be part of the Bank of England and it has been envisioned that it will start to operate on 1 April 2013. The PRA has been mandated with responsibilities of supervising banks in the country, constructing insurers, credit unions, and societies together with big savings groups. It is estimated that the PRA will be in custody of regulating over 1,700 monetary institutions in the country. According to the Financial Service Act (2012), PRA has major objectives to accomplish and they include promoting and ensuring safety of financial firms and enhancing efficiency so as to guarantee policyholders maximum security of investments[15]. The other responsibilities that this regulatory agency has been accorded is the powers to ensure that all harms that firms may cause on the UK’S financial system are identified and addressed in advance. To perform this role properly, the PRA will operate in a coordinated manner with Financial Conduct Authority (FCA), hence creating a ‘twin-peaks’ regulatory regime in the country[16]. The primary responsibilities to be performed by FCA include ensuring healthy competition in the financial sector, ensuring financial markets are stable and their functions are not threatened and ensuring partnership between financial firms and clients is based on fairness and transparency[17].
Will the new reforms protect the country from future financial crises?
A survey of firms in recent past has indicated that overwhelming majority (79%) are confident that the new financial regulation regime will be able to deliver in ensuring that the UK’s financial system is strengthened and protected from future crisis[18]. The new regulatory regime offers opportunity for the country’s financial system regulation to move from the old reactive style of regulation. The structural changes are seen to provide relative adequate ‘checks’ and ‘balances’ that have been put in place in order to ensure that financial crisis in future are prevented in advance[19]. What can be expressed is that the establishment of more ‘checks’ instruments provide opportunity to increase transparency and efficiency in the whole process of regulation. Also, it provides opportunity for different institutions and players to participate in financial regulation, a process likely to ensure problems are identified in advance and remedies undertaken before such a problem can escalate to a large scale[20].
Furthermore, the primary worry among key stakeholders and analysts has been on the future effectiveness of the new institutions of regulation within an established and effective legal framework. The idea has been that there is need to establish an appropriate, effective and strong legal framework in order to enable the new institutions has ability to operate effectively and efficiently[21]. Nevertheless, efforts in the recent past have seen the legal framework to guide the new institutions strengthened as expressed in the Financial Services Act (2012). The aim of the strengthening the regulatory law is to empower the FCA and the PRA to have powers to act in ensuring all the laid down laws are observed.
Apart from the financial regulation law that is being strengthened, more attention is not just directed towards focusing on structural changes, but also paying attention to the need to change the behaviours of key stakeholders such as consumers of financial services[22]. Furthermore, financial operators have been requested to change the way they thing about regulation in order to increase the level of success of the reforms in future. What can be observed is that there is a call for the establishment of a wholistic approach towards ensuring new regulatory regime success and remains resilience to future financial crisis threats[23]. Hector Sants, deputy governor of Bank of England, has observed that in order for the new regulatory regimes to succeed and achieve the desired goals, there is need to accelerate the behavioural and cultural changes for both regulators and financial firms[24]. Furthermore, plans across the board are culminating into many firms aligning their goals with those of supervisors and society at large. Also, many firms have been found to be confident and trust the new regulatory regimes, hence they are willing to actively comply with the new supervisory laws and requirements[25]. Furthermore, there is the acceptance that the new ‘twin-peaks’ model may lead to increase in costs as new measures come into action, but consensus among many firms is that the model is worth implementing and sustaining given its long-term benefits to the financial system in the country.
Therefore, what remains important for the new regulatory regimes to succeed in their functions is to ensure that a good working relationship is established between consumers and the regulators, an aspect that has been lacking in the past[26]. This will ensure the two stakeholders work in a collaborative and cooperative manner, where exchange of information is not an issue and the level of transparency is increased. This will help to prevent some on the unethical financial practices that characterised the past regulatory regime. Similarly, more observation has been to the point that the UK new regulatory system should not insulate itself from other accredited regulatory systems being put in place within the European Union community[27]. This will ensure that in the long-run, the country’s regulatory regime is able to work in harmony with other relevant regulatory bodies so as to ensure that financial crises are prevent in advance or its symptoms mitigated in time. For instance, at the present, EU is involved in the creation of three new regulators known as European Supervisory Authorities[28]. The new regulators will be able to supervise activities of banking, securities and markets, insurance and pensions.
In summary, when the EU and UK regulation structures are viewed and analysed, it becomes clear that they manifest a number of differences, which have to be addressed in a proper manner. Therefore, an effective domestic coordination and cooperation regulatory regime is required in order to enable the country have more power when it comes to dealing with EU regulatory institutions. Therefore, evaluating the structural reforms that have been put in place, together with legal frameworks, it is clear that the new regulatory reforms are unlikely to become ineffective. The prevailing goodwill among stakeholders indicates that the success of the new reforms to some extent is guaranteed. As a result, the level of transparency, openness, supervision and delegation of responsibilities is likely to make the ‘twin-peaks’ model more effective and efficient. Its ability to handle and help the country’s future financial sector has been developed and all indications show that its performance and reliability can be guaranteed. Nevertheless, modification to the system will be need to be undertaken in future based on evaluation of the way the model function in order to make it more effective and resilience to future financial crises.
Conclusion
The financial crisis of 2008 affected UK and other countries in many ways. Different factors were identified which in one way or the other contributed to the financial crisis. In the case of UK, the role of an old reactive financial regulation regime came to forefront. It was found out that the regulation system prior to financial crisis was poor, a situation that gave rise to collapse of many financial institutions. Immediately after the financial crisis, efforts have been made to strengthen the regulation regime. Proposals have been made to adopt ‘twin-peaks’ model as a better way of strengthening the regulatory regime, hence preventing future financial crisis. The primary idea that is evident in the new financial regulation structure is that regulatory roles have been put in hands of two-empowered institutions: FCA and the PRA. This is to ensure transparence, efficiency and trustworthy of the new regulatory regime is achieved. There has been effort to improve the legal framework, as well as call for behavioural and cultural changes among the stakeholders so as to make the system successful. Therefore, analysis of the current framework of the regulatory systems indicate that with greater support and further structural legal changes to the system, it is likely that future financial crises may be dealt in advance before they cause enormous havoc like that witnessed in 2008.
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[1] Bank of England, Reforming the Regulatory Framework (2012) p.1
[2] Maarten Mittner, Banks Brace Themselves for Twin-Peaks Model (The Financial Mail, 2013 February 26) p. 1.
[3] FSA, Structural Reform of Financial Regulation : FSA Annual Report (2012) p.1.
[4] FSA, Delivering a ‘Twin- Peaks’ Regulatory Model within the FSA (2012) P.1.
[5] Clifford Chance, UK Regulatory Reform: Adapting to the New Approach to Regulating Insurers (2012) p. 2.
[6] Great Britain, Financial Services Act 2012 (2012).
[7] Gerard Caprio, Handbook of Safeguarding Global Financial Stability: Political, Social, Cultural, and Economic Theories and Models (London, UK: Academic Press, 2012) p. 476.
[8]Gerard Caprio, ibid.
[9] Central Banking, FSA Chief Hails New Twin Peaks Approach to Regulation (2012) p.1
[10] Adrian Brown and Sam Robinson, Impact of the new ‘Twin-Peaks’ Structure of Financial Regulation on Enforcement (Bloomberg Law, 2012) p.1
[11] Markets Media, UK moving to ‘Twin Peaks’ Structure (2012) p.1.
[12]Adrian Brown and Sam Robinson, ibid.
[13]Adrian Brown and Sam Robinson, ibid.
[14] Great Britain, ibid.
[15]Great Britain, ibid.
[16]Great Britain, ibid.
[17]Great Britain, ibid.
[18]BDO and DLA Piper, The New ‘Twin-Peaks’ Model: A Report on the Financial Services Industry’s Views on Upcoming Regulatory Issues (2012) p.8.
[19]BDO and DLA Piper, ibid
[20]BDO and DLA Piper, ibid
[21] George Osborne, Welcome to Twin Peaks (Central Banking, 2010) p.1
[22] KPMG, Twin Peaks Regulation: Key Changes and Challenges (2012) p.25.
[23]KPMG, ibid.
[24] FSA, Dear CEO: Updates on the Transition to the new Regulatory Structure (2012) p.6
[25]FSA, ibid.
[26] Charles Batchelor, High Hopes for the Twin Peaks (Financial Times, 2011) p.1.
[27]Maarten Mittner, Banks Brace Themselves for Twin-Peaks Model, p.1.
[28]Maarten Mittner, ibid.
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