IMF/Bank of IsraelFinancial Sector Conference

ISRAEL’S CAPITAL MARKET REFORMS:Supervisory Approaches and Managing Change:

Israel Capital Market Reforms

By William A. Ryback Special Advisor for Financial Supervisory Service

Seoul, Korea

The United States and Hong Kong Models

Supervision of Banks Domiciled within the Central Bank

Let us first turn to U.S. Model

• Historical Accident

• Not a model to be copied

• But, Federal Reserve has argued that it is necessary to have a meaningful role in the supervision of Financial Institutions, primarily banks

The Central Bank houses a trilogy of functions absolutely critical to the effective

efficient functioning of the real economy

1. First, and foremost, Monetary Policy

2. Broad oversight of the financial system – financial stability

3. Oversight and/or direct participation in the payment and settlement systems through which payment of goods and services are made quickly, efficiently, and safely – public confidence and trust

Monetary Policy and Supervisory Objectives – Do They Conflict?

• Some would argue that Central Bank with supervisory responsibility would distort monetary policy to avoid exacerbating instability in the banking sector

• But, if supervisory goals are interdependent then a single agency responsible for both monetary policy and financial stability might be in a superior position to take those interdependencies into account then multiple agencies (FSA/BoE issue)

• Greenspan has argued that “a single regulator with a narrow view of safety and soundness and with no responsibility for macroeconomic implications of its decisions would inevitably have a long-term bias against risk-taking and innovation”

Many Chairman and Governor’s have stressed that Federal Reserve’s

ability to deal with diverse and hard-to-predict threats to financial stability depends critically on the information, expertise, and powers that it holds by

virtue of being both a bank supervisor and a central bank

• Technical support • International Coordination and discussion• Development of standards (both

domestically and internationally)• Window onto financial institutions • Sophisticated techniques to manage risks• In-house expertise• Seat at the table• Timely and reliable information• Ease communication • Improve cooperation

Supervisory responsibility appears to have very significant collateral benefits to the primary task of a central bank – financial stability

• Information

• Expertise

• Powers

The central Bank can than act more aggressively, more quickly, more effectively, with more informed judgment

Changes under Gramm, Leach, and Bliley (GLB)

• Structural versus Functional Supervision• Umbrella Supervision versus Consolidated

Supervision• Not optimal from a supervisors view• Concerns about leakage of the safety net• Industry concerns about mega-supervisor • Did not alter landscape as hoped

Arguments for Regulatory Reform

• Duplication of process• Coordination • Managing shared responsibility• Delay in resolution• Burden• Conflicts• Competition in laxity• Unclear authority• Lack of accountability

Arguments Against Reform

• Present system works reasonably well• Single agency will not assure uniform performance in all

supervisory activities• Single regulator may become too bureaucratic and

unwieldy • FFIEC promotes consistency and uniformity• Maintenance of the dual banking system• System promotes innovative approaches • Maintains a system of checks and balances• Single regulator more likely to adopt sudden shifts in

policy, practice or procedures that could add to instability and produce uncertainty

Prospects for Reform

• Attempts at reform more numerous then spots on a leopard

• Fear of the large

• Who does it?

• Demise of the dual banking system

• Too many lawyers would lose their jobs

Turning to the Hong Kong ModelPrudential Supervision as we know it

relatively new• Introduced in 1970 after series of problems• Commissioner of Banking was part of British colonial

administration and largely dealt with “tidying” up problems

• Inconvenience of time zones led to creation of an organization to deal with monetary matters and the statistical bureau and the Commissioner of Banking office were combined to form the Hong Kong Monetary Authority in 1993

Turning to the Hong Kong Model

• Confidence in the banking system is very fragile and subject to runs caused by real and imagined concerns

• Lack of “trust” in the government leads to public confidence issues as much today as during British rule

• The public trusts where the money is located and Hong Kong Monetary Authority holds and manages the Exchange Fund (U.S. Dollar pool backing the currency) and the governments fiscal reserves and Land Fund Reserves (Deep Pockets)

Turning to the Hong Kong Model• In June 1999 the Hong Kong Monetary Authority

specifically spelled out that it was ready to act as Lender of Last Resort and specified terms and nature of that support by way of a policy statement

• In order to better address the nature of its activities as manager of the Special Administrative Region’s Reserves and its separate and distinct responsibilities for monetary affairs and bank supervision there was an exchange of letters between the Financial Secretary and the Monetary Authority in 2003. Among other things, the exchange of letters outlined the responsibilities of the Monetary Authority in regards to bank supervision: setting prudential policies, standards, and guidelines; international cooperation; setting in place a deposit insurance system; and generally, supporting the stability and integrity of the financial system

Turning to the Hong Kong Model• Supervision of securities activity conducted by banks

(authorized institutions) is shared with the Securities and Futures Commission (SFC). The HKMA retains examination authority but in order to maintain a level playing field for all securities intermediaries authorized institutions must comply with standards equivalent to those applied to licensed securities brokers in relation to regulated activities.

• In practice, the HKMA must consult with the SFC before taking any enforcement action on an authorized institution or licensed person. Such discussions often highlight the difference in approach between securities and banking supervisors and primarily center on market conduct issues.

Turning to the Hong Kong Model

Supervision over insurance activities in Hong Kong is the responsibility of the Office of the Commissioner of Insurance which is a creature of the industry. There have been discussions about bringing regulation of insurance under a government umbrella and sooner or later this must be addressed

Turning to the Hong Kong Model

• The situation in Hong Kong is one that continues to evolve. Maintaining its image as a global player is a paramount driver in Hong Kong and the Monetary Authority strives to adopt the most modern practices. The structure is unlikely to change until 2047 when the one country – two systems model ceases to be relevant.

• Hong Kong employs sophisticated financial supervision coupled with the old Bank of England approach of relying on the industry to self-regulate itself by keeping the regulator fully informed of what is going on in the neighborhood.

Turning to the Hong Kong Model• The Banker’s Association rotates Chairman through the three

note-issuing banks which makes banking issues in Hong Kong especially volatile because the industry primarily takes up the views of the large banks – could be more professional by hiring a full time Executive and staff

• The Financial Secretary hosts a quarterly meeting of all supervisors (bank, securities, insurance, and pension scheme) and the bureau to ensure that nothing is falling through the cracks. It also provides an opportunity to discuss local, regional, and global macro-economic concerns although these are ad hoc in nature rather then structured discussions.

• The Exchange fund Advisory Board and its various sub-committees and the Bank Advisory Board meet frequently which also serves as platforms to discuss macro issues and provides amble opportunity for information exchange on banking and financial issues

Turning to the Hong Kong Model

Given the size, nature, and diversity of financial activity in Hong Kong the Monetary Authority actually is an efficient and effective regulator. It encourages financial modernization yet embraces very traditional supervisory methods that some could argue are antiquated like a high LTV ratio against residential real-estate lending.