Blueprint for Regulatory Reform

The current financial regulatory system came about after the Great Depression as a response and reaction to the market stresses of the time. 

The events of the past few months have prompted the Fed to analyze our current regulatory system and propose changes, which would best fit the present situation of our financial system.

Currently the industry is regulated by separate federal agencies (SEC, CFTC, Federal Reserve, and Insurance) in addition to a state based supervision.  We currently bifurcate securities and futures and the insurance industry, (SEC and CFTC) and one of the largest financial services provider is regulated, almost entirely, at the state level (Insurance Commission). 

According to the Fed, the optimal scenario, a long term scenario (8 to 10 year plan) would be a three regulator system:  a regulatory focused on market stability across all the sectors (Market Stability Regulatory), a regulator focused on the safety and soundness of the institutions (Prudential Financial Regulator) and a regulator focused on the protection of the investor and/or consumer (Conduct of Business Regulator). 

The Fed’s regulatory reform proposals do not come without criticisms from the various regulators and the financial industry itself. 

Market Stability Regulator

The Market Stability Regulator should be responsible for the overall issues of the financial market stability through the implementation of monetary policy and the provisions of liquidity of the financial system.  Because the Federal Reserve’s primary role in the current regulatory framework is one of promoting macroeconomic stability, the Fed should be charged with this duty. 

The Fed in it’s new role as the Market Stability Regulator would be provided with broader powers to allow it to focus on the overall financial system. To accomplish this the Fed would be given the authority to “move” along the entire financial system to collect information from commercial banks, investment banks, insurance companies, hedge funds, commodity pool operators so that it could determine if the health of a particular industry and/or firm are a detriment to the overall financial stability.

As I pointed out above, there are various criticisms of this enhanced power of the Fed.  It appears that “In 1998, the Fed was taken by surprise at the exposure of some banks it supervised to Long Term Capital Management, the giant hedge fund.” Some of the critics state that if the Fed was not able to supervise an entity that was under its supervision, how is it going to be able to supervise additional entities? Also there is the issue of a diluted “checks and balances.”  If too much power is given to the fed to supervise and regulate the various industries and to take corrective action on its own, “the safety net of checks and balances could be lost.” Revamp Proposed for Financial Regulators: Financial News – Yahoo! Finance, March 31, 2008 by Jeannine Aversa, AP Economics Writer.

Lyle Gramley, a former Fed official also stated that his concern is more of one of the Fed being given enough of the corrective power in order to be able to accomplish the job.  Mr. Gramley stated that the plan is not clear as to what types of corrective powers the Fed would be given under this scenario.  “If you create a police force and don’t give them any weapons, it is going to be useless.”

Prudential Financial Regulator

The Prudential Financial Regulator would assume the role of the Office of the Comptroller of Currency (OCC)  which charters, regulates, and supervises all national banks. It also supervises the federal branches and agencies of foreign banks and The Office of Thrift Supervision (OTS) which acts as the primary regulator of all federal and many state-chartered thrift institutions, which include savings banks and savings and loan associations.  This long term plan would establish a new FIDI charter which would consolidate the national bank, the federal savings association and the federal credit union charters. 

Creation of a new FIDI Charter

This new Federal Insured Depository Institution charter would consolidate those of the national bank, federal savings association and the federal credit union.  In order for an institution to obtain deposit insurance it would have to obtain a FIDI charter.

Establish a new FII Charter

This new charter would be similar to the FIDI charter and it should apply to insurers offering retail products where some type of government guarantee is present.  The Prudential Financial Regulator would be responsible for the financial regulation of FIIs under the same structure as FIDI.

 Conduct of Business Regulator

This regulator would be charged with the business of protecting the customer or consumer.  It includes the supervision of disclosures, business practices and chartering and licensing of certain types of financial firms.  The type of platform is different than that of the Prudential Regulator in that it will provide the appropriate standards for firms to be able to enter the financial services industry and sell their products and services.

Chartering and licensing

This charter should be flexible enough to incorporate a wide range of financial firms:  broker-dealers, hedge funds, private equity funds, venture capital funds and mutual funds.

The Conduct of Business Regulator should have oversight in three broad categories:  disclosure, sales and marketing practices (including laws and regulations addressing unfair and deceptive practices) and anti-discrimination laws.

In the Fed’s proposal the Conduct of Business Regulator would take the place of the SEC and the CFTC (merging both regulators into one).

This last type of model seems to be the one that is going to have the most criticism.  It appears that the one group that does not oppose this merger (SEC and CFTC) is the hedge funds.  The reason being that they, the hedge funds, have been on the radar of the SEC for regulations and oversight purposes.  This merger, it appears, would take the “heat” off of them for a while.

The CFTC is a principal based model, which means that it sets the parameters under which the regulated bodies are to act.  In contrast, the SEC is a rules based model in which it sets the regulation and institutions must follow.

The Fed’s thinking in this proposal is that if the SEC streamlines its process for approving financial products it would make our financial industry more competitive in today’s global marketplace.


The views on this post are mine.  They do not reflect the views of my employer.

2 thoughts on “Blueprint for Regulatory Reform

  1. I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog.

    Tim Ramsey

  2. Ana,

    You are quite an accomplished writer with great insight into the market. I look forward to reading more from you in the future.

    Paul Maingault

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