Pavel Racocha May, 2004 Dubrovnik, Croatia Gradual Integration of Financial Regulation and Supervision In the Czech Republic Pavel Racocha May, 2004 Dubrovnik, Croatia

General considerations Variety in institutional structure of financial regulation and supervision world-wide. Two basic models - traditional and functional. Trend toward integration of financial regulation and supervision, especially in the EU and more developed countries. However, traditional model with separate authorities still prevails world-wide.

General considerations - continued Structures of financial regulation and supervision are country specific. No optimal and generally recommended model. Principle of subsidiarity is applied in EU. Institutional structure is important, but there are other key pre-conditions for effective financial regulation and supervision.

Traditional model Structure of financial regulation and supervision reflects sectors of financial intermediation e.g. banking, capital market, investment services and insurance. Three alternatives: - three (or more) authorities - partial integration (twin peak arrangement etc.) - single authority

Functional model Institutional structure of financial regulation and supervision follows regulatory matrix, which reflects market failures. Areas of financial regulation and supervision correspond with types of market failures. Information asymmetry - prudential regulation and supervision focusing on the safety and soundness of financial institutions.

Functional model - continued Market misconduct - consumer protection and focus on fair trading in securities. Systemic instability - focus on stability of the financial system as a whole, oversight of payment systems, lender of last resort. Anti-competitive behaviour - regulation and supervision to ensure appropriate degree of competition in financial system

Functional model - basic alternative One authority for prudential regulation and supervision of financial institutions Other authority for regulation and supervision of market misconduct Central bank - financial stability, lender of last resort, oversight of payment systems Regulatory authority for protection of competition (for the whole economy)

Functional model - two other alternatives Partial integration, for example, twin peak model. Single authority, usually with exemption of protection of competition. - If concentrated within central bank, then central bank becomes a real mega-regulator. - Otherwise close co-operation between single authority (FSA) and central bank necessary.

Key pre-conditions for effective regulation and supervision Clearly determined goals Independence (operational, personal, financial) balanced by accountability and transparency Adequate financial and human resources Adequate legal framework supporting enforcement of regulations Implementation of international standards Regulation and supervision under one roof

Regulation and Supervision of the Czech Financial Sector

Pros for integration of financial regulation and supervision in the Czech Republic Four regulatory agencies are too many for relatively small Czech financial system. Integrated structure is more transparent for the general public. Diversification of businesses of financial institutions. Supporting supervision of financial groups on a consolidated basis. Synergies, e.g. economies of scope, to make better use of limited human resources.

Pros for integration of financial regulation and supervision in the Czech Republic - continued Economies of scale, e.g single set of supporting services and uniform procedures. Avoiding duplicities and/or shadow zone in financial regulation and supervision. Pre-condition for level playing field for competition by unified regulatory rules and supervisory procedures whenever it is possible and desirable Supporting international co-operation.

Risks and costs connected with integration of financial regulation and supervision in the Czech Republic Decreasing efficiency of supervision on an operational level High financial costs Challenges connected with integration of different cultures Challenges connected with integration of complex and different IT systems Reputational risk

Why gradual approach Integration is a complex task Need for improvement in legal definitions of the goals of regulation and supervision Consensus about the statute of unified authority has not yet been reached Differences between existing agencies Mitigation of risk of integration mismanagement

Project of integration of financial regulation and supervision Consensual proposal of Ministry of Finance, Czech National Bank and Czech Security Commission (April 2004) Two stages of integration: - First stage - establishment of twin peak system, principle of regulation and supervision under one roof is followed. - Second stage - integration of financial regulation and supervision into a single authority.

First stage - twin peak system Integration of regulation and supervision of credit institutions - the CNB takes-over regulation and supervision of credit unions as of 30/6 2005. Integration of supervision over remaining parts of financial system - SEC will become responsible for regulation and supervision of market conduct, securities sector and insurance and pension fund sector as of 31/12 2005.

First stage - twin peak system - continued Responsibilities of Ministry of Finance: - preparation of laws - supervision of use of regular state support for building savings scheme, pension funds and life insurance

Second stage Project of integration (December 2006). Implementation to be completed ca one year before joining EMU, e.g. roughly in 2009. Key questions remain open including: - the issue of independence of unified authority - the role of the CNB and the SEC - regulation and supervision under one roof

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