Financial Sector Supervision for Dummies

A new working paper from the Fund; Building Supervisory Structures in Sub-Saharan Africa--An Analytical Framework;

"Summary: Current trends in financial sector development in sub-Saharan Africa are prompting policymakers to focus on the design of appropriate supervisory structures. Against the backdrop of worldwide efforts to remodel supervisory structures, this paper develops an analytical framework for designing a regulatory strategy that could assist in prioritizing the needs for regulation and supervision over time. Such a strategy should facilitate the design of a supervisory structure suitable for an individual country's current and future needs. The paper emphasizes that in the case of sub-Saharan Africa, any such strategy is constrained by the reality of capacity limitations and should take into account the need to keep the central bank involved in the process. Building on the framework, the paper identifies a number of supervisory structures that could meet sub-Saharan Africa's needs….


The Singapore model
The unification of all supervisory functions inside the central bank has several advantages. New supervisory activities could benefit from the existing ones (scope and scale economies), there would be no regulatory gaps and regulatory scope, and intensity could be built up smoothly—contentious inter-agency issues could be avoided. In addition, supervision could benefit from the central bank’s infrastructure, budget, and expertise, and also from its prestige and, potentially, independence. Crisis management would be facilitated as well.

On the downside, the country would be faced with an extremely powerful institution. Some scholars see this as a potential drawback, although solid accountability arrangements should be able to keep this institution “in check” (Hüpkes, Quintyn and Taylor, 2005). In addition, the commonly cited disadvantages of combining banking supervision and monetary policy (conflicts of interest, moral hazard) would apply in a particularly pronounced form. Moral hazard would be a particular concern if it led the customers of NBFIs to believe that they enjoyed the same level of protection as bank depositors. However, in the circumstances of SSA, the advantages of this model may be sufficient to outweigh these drawbacks, especially given the relative smallness of the NBFI sector.

The U.K.-FSA model
A unified regulator outside the central bank seems the least desirable for developing countries. As discussed earlier, the conglomerates-argument and the blurring-of-boundaries argument are not applicable in largely bank-dominated financial systems. Moreover, not involving the central bank in the supervisory process and instead starting a new institution from scratch will be very demanding in terms of institution and capacity building. In the absence of the need to supervise financial conglomerate groups, the only advantages with this model are that (i) economies of scale can be realized—although it may take some time for them to become apparent, given the extent of institution building that is required; (ii) there will be no regulatory gaps; and (iii) the central bank will not be too powerful and there will be no moral hazard problems in the central bank.”