Is One Financial Sector Watchdog Better than Three?

International Monetary Fund. External Relations Dept.
Published Date:
October 2006
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The banking, securities, and insurance industries were traditionally supervised by separate agencies. Over the past two decades, however, the number of integrated agencies keeping watch over the entire financial sector has grown considerably. Are these watchdogs providing higher-quality and more cost-effective supervision? A new IMF Working Paper examines the issues empirically.

The number of integrated supervisory agencies has grown rapidly over the past 20 years, partly in response to increased consolidation in the financial sector. By the end of 2004, there were 29 fully integrated supervisory agencies, defined in this study as agencies that are, at a minimum, in charge of micro-prudential supervision of banking, insurance, and securities markets.

Integrated supervisors tend to have a higher degree of compliance with supervisory standards in banking, insurance, and securities supervision.

Impetus to integrate

The most important arguments for integrated supervision are efficiency gains and a greater ability to deal with the issues stemming from the creation of financial conglomerates. Merging multiple supervisory agencies should increase efficiency, if only by eliminating duplicated support functions. There can, of course, be broader synergies as well. With the blurring of lines between traditional components of the financial sector and the creation of conglomerates in many industrial countries, there is an added incentive to integrate supervision to ensure uniform coverage that would minimize the opportunities for regulatory arbitrage.

The integrated supervisor model is not without its downsides, however. First, if the objectives are not clearly specified, an integrated supervisor may be less effective than sectoral supervisors. Second, the economies of scope may be difficult to achieve as long as the regulations across banking, insurance, and securities sectors remain unharmonized. Third, there may even be some diseconomies of scale if the integrated agency becomes too large to be managed effectively. And fourth, an integrated supervisor may extend moral hazard problems across the whole financial sector if financial market participants start to believe that all creditors of all institutions supervised by an integrated supervisor will receive the same protection.

Weighing the benefits

Does integration translate into higher-quality supervision? To measure quality, the paper evaluates the degree to which agencies comply with internationally accepted standards in banking, insurance, and securities regulation. These are the regulations developed, respectively, by the Basel Committee on Banking Supervision (Basel Core Principles for Effective Banking Supervision), the International Association of Insurance Supervisors (IAIS Insurance Core Principles), and the International Organization of Security Commissions (IOSCO Objectives and Principles of Securities Regulation).

A simple comparison of compliance in countries with integrated supervision and in those without it could be misleading. Integrated supervisors tend to be found in more developed economies that also have a better general regulatory environment, which is, in turn, positively correlated with the level of implementation of financial sector standards. However, integrated supervisors tend to have a higher degree of compliance with supervisory standards in banking supervision even after taking the general regulatory environment into account—the Working Paper shows this is the case for three out of every four supervisors.

The paper asks whether integrated supervisors generally have a higher degree of compliance with financial sector standards even after adjusting for the general regulatory environment. To address this issue formally, the paper turns to regression analysis. The regression models include a constant, a measure of development of the economy, the general level of regulatory environment, and an indicator of integration of a given regulator. The results suggest that the integrated supervisory agencies tend to have a higher quality of banking and insurance supervision, as well as of securities regulation. A statistical analysis of the variation of performance across the three sectors and across different components of supervision also suggests that integrated supervisory agencies tend to provide a more consistent quality of supervision across the sectors they supervise.

Based on available data, however, it is less clear that integration reduces costs. The Working Paper did not have access to the costs of supervision incurred by the supervised institutions. However, the paper examined the number of supervisory staff in integrated and other supervisory agencies. It found that the number of supervisors depends on the country’s population and level of development. However, whether the country has or does not have an integrated supervisory agency does not have a significant effect on the supervisory staff.

Martin Čihák and Richard Podpiera

IMF Monetary and Capital Markets Department

Based on IMF Working Paper No. 06/57, “Is One Watchdog Better Than Three? International Experience with Integrated Financial Sector Supervision,” by Martin (Čihák and Richard Podpiera. Copies are available for $15.00 each.

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