With technology in business comes regulatory headaches
By: David Wanyoike
The financial sector has undergone major transformation in the last decade presenting immense benefits as well as regulatory challenges due to operational complexities. The growing footprints in the region by the financial institutions coupled with the adoption of robust ICT tools has had major influence on financial services and shows every sign of becoming the thing of the day in the years to come.
The Finance Minister in his maiden budget reported that the government will shortly commence a process to establish a consolidated financial sector regulatory framework bringing together the Capital Markets Authority, Insurance Regulatory Authority and Retirement Benefits Authority. In addition, the Banking Supervision Department will be re-established as an entity under a reviewed CBK Act with a clear mechanism allowing for coordinated and effective financial sector supervision. This move was informed by the need to strengthen the supervisory capacity, safeguard stability and enhance efficiency of the financial sector regulators which appear to have faltered in the recent past.
In the Kenyan financial sector, there have been tendencies towards diversification of the available product spectre beyond the financial services and establishment of conglomerates. The driving force behind this trend is the convergence of different markets as a consequence of a common technological platform or infrastructure to offer products caused by technological development.
In spite of the noted developments, there has been no concerted effort towards addressing the regulatory complexities that have evolved over the time. The existing regulatory framework for the financial sector in Kenya consists of a number of independent regulators each charged with the supervision of their particular sub sectors. This regulatory structure has been characterized by regulatory gaps, regulatory overlaps, multiplicity of regulators, inconsistency of regulations and differences in operational standards.
Although the move taken by the Minister is praiseworthy, it is critical to appreciate that there is no one single optimal model for the organizational structure of financial regulation. The prevailing circumstances, historical factors and comparative advantages in any given country determine the structure of the integration. Thus, even if countries have much to learn from each other, different countries should adopt different integration approaches suitable to their unique circumstances.
There are obvious risks of having disjointed regulatory bodies. Where there are regulatory overlaps, as is the case in Kenya, then having multiple regulators can allow regulated entities to engage in regulatory arbitrage where entities opt to register products in those sub-sectors where regulations are weakest or most cost efficient. With a consolidated regulator, uniform standards can be applied to all subsectors hence eliminating the motivation for arbitrage.
The most compelling argument for consolidated regulation is to enhance the mirroring of the structure of regulation to the structure of the industry. If entities are conglomerates covering banking, insurance, securities and pension then it is difficult for a regulator for a particular sub-sector to draw a view of the overall risks facing the entity. A consolidated regulator on the other hand would be able to understand and monitor risks across the sub sectors and develop policies to address the risks facing the entire conglomerate. Under certain circumstances where the institutions are not in themselves conglomerates, the products they offer may defy conventional categorization. For instance, some banks are practicing bankassurance which poses more risks compared to convectional banking.
Another popular argument for consolidated regulation arises from the cost efficiency gains that can be obtained by consolidating multiple regulators into a single body. Certainly, a consolidated regulator will only have one set of service departments such as administration, finance and human resources hence reducing on staff and other overhead costs. Where there are overlaps in registration and licensing then consolidation will also bring cost reductions and efficiency gains by allowing regulated entities to have a one-stop licensing procedure as opposed to multiple registrations. These gains are maximized where regulation is consolidated by function as opposed to consolidation by institutions.
Consolidated regulation also curbs the blame game amongst the regulators. Regulatory gaps often lead to regulators absolving themselves from certain sub-sectors especially when things go wrong. Blame may be passed from one regulator to another when supervisory failure occurs. In Kenya, different regulators have been witnessed denying blame for an instrument that never came to market with no one ready to accept that they were the ones who had refused to approve the instrument. A consolidated financial regulator would be responsible for supervising all entities and products in the financial sector and would be duly held accountable.
The consolidated financial sector regulation has been employed in other countries and has been touted to be of value for the economic development. For instance UK and Australia did adopt this approach awhile back. Its adoption in Kenya would be expected to address unnecessary duplication and allow regulated entities to appeal on cross cutting issues.
In spite of the noted benefits, challenges abound in the implementation of a consolidated regulation. Consolidated regulation poses many risks including reduced effectiveness, loss of focus and moral hazard. In addition, the actual process of integration is likely to be disruptive and expensive watering down the expected benefits.
The case for consolidation appears weaker in Kenya as market developments have not seen the rise of truly universal conglomerates yet!
The writer is a tax expert with Ernst & Young. Email: firstname.lastname@example.org
Views expressed are not necessarily those of Ernst & Young.