Cross-Sector Supervision: Which Model?

THE ORGANIZATIONAL STRUCTURE of financial supervision is, or has been, under revision in many countries—including the United Kingdom, Germany, the Netherlands, the United States, and Australia—in response to market developments. Several papers have been written about the different models adopted, either promoting a single model in isolation or comparing different models and concluding that there is no uniform best model, but that each should be seen within the context of its own financial system. ¹

The purpose of this paper is to take the analysis one step further by focusing on the key question as regards the organizational structure: what are the pros and cons of combining different supervisory activities within one organization? In this context, we start by briefly describing the old and new Dutch supervisory models. The question is: how did we arrive at the new model? To answer this question, we take a closer look at financial market developments. We then compare cross-sector organizational models for financial supervision. We introduce a new framework for comparing these models and apply it to the functional model of the Netherlands and the integrated model of the United Kingdom. While confirming the familiar conclusion that there is no uniform best model, this paper also systematically investigates the trade-offs involved in different organizational structures.

A New Dutch Model

Figure 1 provides a broad overview of the old and new Dutch organizational models of supervision. The old model was sectoral, with a separate supervisor for banks, insurance companies, and securities firms. In 1999, a cross-sectoral element was added: the Board of Financial Supervisors (RFT), in which the existing supervisors share responsibility for cross-sectoral issues. The Board of Financial Supervisors developed cross-sector issues such as the supervision of financial conglomerates, the harmonization of consumer information for financial products, and the harmonization of fit and proper management principles for financial institutions. During this process it became clear that cross-sector issues dominate the policy debate, and a consensus emerged that a more fundamental reform of the organizational structure of supervision would be necessary.

The new Dutch model—the "twin peaks" model—is based on the objectives of supervision. De Nederlandsche Bank (DNB) is responsible for financial stability, while the Authority for Financial Markets (AFM) specializes in conduct-of-business supervision. ² Financial stability is about promoting the safety and soundness of financial institutions and enhancing the stability of the financial sector as a whole. Conduct-of-business relates to promoting a fair and transparent market process and protecting the interests of investors and consumers. The underlying principle is that market developments should be accommodated as much as possible, while at the same time maintaining the effectiveness and efficiency of the objectives of financial supervision. The new Dutch model is where we are now, but how did we get here?

Market Developments

Financial systems evolve as a result of continuous pressure for efficiency. Over the past several decades, there have been striking developments in intermediation processes and institutional design. ³ Disintermediation and the disappearance of traditional sectoral boundaries between banking, securities, and insurance can be seen as particular forms of organizational evolution, just as is the unbundling of different kinds of financial activity within a group. From the perspective of regulation and supervision, it is important to create a supervisory system that accommodates market developments, and not to steer market developments in one particular direction or another. The task of the regulator and supervisor is not to predict market developments, but rather to create an infrastructure that is robust to different kinds of development, such as the bundling or unbundling of financial activities. Regulators need to monitor and analyze market developments, and their response should be driven by the quest for efficiency and effectiveness in terms of the objectives of financial supervision. Financial institutions...