Transcript competition, regulation & financila market stability

Competition as The Regulator or Regulation
of Competition in Financial Markets?
Experience and Lessons
Presentation by
R. Shyam Khemani
MiCRA
(Microeconomic Consulting & Research Associates, Inc)
Washington, D.C. USA
Email address: [email protected]
COMPETITION, REGULATION & FINANCIAL
MARKET STABILITY-1
It’s recognized that a number of ‘market’, ‘regulatory’ and
‘institutional’ factors have contributed to the current financial
market crisis.
One question posed: To what extent competition positively or
negatively impacts on financial market stability?
Past episodes of financial market liberalization and
deregulation have been followed by financial crisis .
An argument advanced favoring less competition is: countries
with highly concentrated financial markets (Australia, Canada,
Germany, Sweden, …) have fared better in the recent crisis.
There are however differences in cross-country and countryspecific comparisons. In addition, high/low concentration can
not be equated with less/more competition.
There are other undesirable consequences of maintaining or
promoting high concentration in financial markets including:
“Too big to fail”
COMPETITION, REGULATION & FINANCIAL
MARKET STABILITY-2
Moreover, no unambiguous relationship or causal link can
be postulated in economic theory or found in empirical
data between competition, concentration and financial
market stability.
YET: Regulators in several jurisdictions trade-off between
Competition Concentration in “interests” of
promoting financial market (‘systemic’) stability.
Arguments can be advanced that regulatory and
supervisory failures rather than competition have
contributed more financial market fragility.
Regulatory and supervisory policies have lagged changes is
financial market structure, products and services.
Rather than fine tuning competition, focusing regulatory
and supervisory policies on promoting competition
driven incentives would serve the economy and society
better.
RATIONALE FOR REGULATING FINANCIAL
MARKETS
Driven by the role and importance of financial markets in the
economy, and inherent nature of money and its functions
(medium of exchange, store of value, fungibility…)
It is critical to ensure financial markets provide efficient,
effective, predictable intermediation between savers and
investors to foster economic growth and development
through appropriately designed and supervised institutions.
Risks of ‘Market Failure’:
Asymmetric information between lender-borrower
Adverse selection (borrowers at any interest rate even when
likely to default)
Moral hazard (borrowers/lenders partly insulated from risk)
OBEJECTIVES OF REGULATING FINANCIAL
MARKETS
Ensure Macroeconomic Stability:
Controls over financial exchanges, clearing houses and
securities settlement systems…
Ensure Microeconomic Stability:
Controls over financial intermediaries capital ratios,
portfolio limits, off-balance sheet activities, capital,
borrowing, lending limits and integrity requirements…
Transparency in markets, in intermediaries, equity and
non-discrimination in activities, investor protection…
Foster efficiency and competition
Controls over market structure-behavior, entry-exit,
cartels, abuse of market dominance, fees……
INSTITUTIONAL DESIGN AND APPROACHES TO
REGULATING FINANCIAL MARKETS
Different supervisory/regulatory models across countries:
1. Institutional Supervision
2. Supervision by Objective
3. Functional Supervision
4. Supervision by Single-Regulator
Different countries, different models
Pros/Cons to different models
Major challenge to institutional design and supervision:
blurring between different markets (domesticinternational, products and services, ‘financial innovations’,
conglomeration and co-mingling of banking, investment,
insurance and real sector activity…..
FACTORS CONTRIBUTING TO FINANCIAL CRISIS
Multiple factors: Difficult to weight one against other.
Factors include:
-Easy money, low interest environment fostering excessive
borrowing: funds flow into speculative assets: equities,
housing, commodities
-Distorted incentives, ‘false’ notions of wealth effects led to
excessive borrowing, misleading and fraudulent lending
practices (especialy sub-prime mortgages), moral hazard
-Inadequate controls and regulatory oversight over financial
innovations(securitization, derivatives, risk shifting), agency
problems, credit ratings, non-banks trading on own
accounts….
-Globalization and conglomeration including increased
consolidation (M&A activity) in financial markets.
FINDINGS ON FINANCIAL MARKET
CONSOLIDATION AND CONGLOMERATION-1
• Number of banks have declined in almost all countries.
• While US financial market displays low concentration—
markets regionally segmented, some products and services
dominated by few firms.
• Over the counter (OTC) derivatives quadrupled in 1990s
alone.
• Globally, banks account for 60%+ of all financial sector
M&As.
• Consolidation driven by various factors: technology,
diversification, specialization, outsourcing…risk reduction
not assured, nor evidence of cost reduction, efficiency
FINDINGS ON FINANCIAL MARKET
CONSOLIDATION AND CONGLOMERATION-2
• Post consolidation firms have shown shift towards
riskier asset portfolios. Other risks include operating
and managerial complexities.
• Larger financial institutions tend to be more highly
leveraged.
Systemic financial risk more likely to be transmitted to the
real economy thru’ wholesale activities of financial
institutions in markets—including payment and
settlement systems
Markets in terms of structure, products and services have
evolved faster than regulatory supervision institutions.
ROLE OF/FOR COMPETITION POLICY?
Can protecting and promoting competition provide safeguards?
Regulation of financial markets unavoidable. Financial markets
ARE different from other markets for goods and services.
Competition can play complementary not substitute role.
Competition law and policy (CLP) in most jurisdictions extends
to financial markets.
But exemptions/exceptions exist in respect to structural
changes (especially financial institution failures)
Competition ‘trumped’ by ‘systemic stability’, ‘public interest’
concerns in many countries (most recently, US, UK…)
Untested what consequences of letting financial institutions
fail.
Why share-and bond holders of financial institutions be treated
differently from firms in other sectors not evident.
Need re-balancing role of competition and regulatory policies
and institutions.
DID PAST DE-REGULATION GO TOO FAR?
NEED FOR RE-REGULATION?
• Some view repeal of Glass-Steagall Act in US (1999) a
mistake.
• In many countries blurring of boundaries between ‘4pillars’ (banking, insurance, trust and investment
activities) has occurred with few problems (Canada).
• Depends on content and quality of regulatory
oversight.
• Some need for ‘un-bundling’…especially between
traditional banking and investment banking (Volcker
Proposals).
• More intensive ‘antitrust’ scrutiny required.
THANK YOU