On July 15, I was privileged to attend the Bank of Uganda Golden Jubilee panel debate under the theme, “The Role of a Central Bank in a Market Oriented Economy”. This very topic will also inform the subject of discussion at the Golden Jubilee Joseph Mubiru memorial lecture on Tuesday, August 2 under the topic, “African Central Banks: Rethinking their role, or staying the course? Learning from global experience”. The shifting balance between the Central Bank’s monetary policy (price stability) and financial stability mandates is worth re-examination. In the history of Central Banking, every financial crisis provokes public rage and debate on the mandate and tools available to central banks to deal with such economic catastrophes.
Researchers of central bank history and policy are familiar with such debates in 1907, 1929, 1982, 2007/08. Modern central banks function in three areas: monetary policy, supervision and regulation of individual financial institutions and the systemic regulation of the financial sector as a whole. A clear lesson from the crisis is that central banks in the 21st Century will have to manage all these three functions simultaneously.
In the aftermath of the Global Financial Crisis, many countries have embarked on major central bank institutional reforms as a response to the challenges arising from regulating today’s increasingly integrated financial markets in which the traditional distinctions between banking, securities, pensions and insurance products have become blurred. Furthermore, the rise of diversified financial conglomerates/Systemically Important Financial Institutions (SIFIs) or “too big to fail, has also necessitated group-wide consolidated supervision in order to ensure effective regulation. The increasing internationalisation of financial markets and institutions creates risk for the domestic economy and financial sector, thereby requiring specific national regulatory arrangements.
Uganda’s current financial regulatory system is underpinned by a series of piecemeal interventions. It is disjointed, fragmented and encourages silo regulatory approaches. The banking industry is regulated by Bank of Uganda (the Central Bank), the insurance industry is regulated by the Insurance Regulatory Authority, the securities market is regulated by the Capital Markets Authority, and the Uganda Retirement Benefits Regulatory Authority is in charge of pensions sector.
However, the rapid economic changes and realities of the finance market suggest that due to increased market innovations such as creation of new products and financial instruments such as derivatives and credit securitisations, the traditional boundaries of the banking, securities, insurance and pensions sectors are shrinking, and, therefore, such kind of regulatory structure causes duplicity, overlaps and regulatory arbitrage.
Under the Twin Peaks model of financial regulation, instead of the various regulatory bodies listed above, the institutional structure of regulation should be based on two equal and independent regulatory agencies (peaks) – one in charge of the financial stability mandate (the financial stability department residing within the Bank of Uganda), and the other in charge of consumer protection and market conduct supervision of all the financial firms. The former should be responsible for ensuring the stability of the financial system as a whole, mainly through the implementation of prudential regulations, while the latter should be tasked with ensuring that financial firms treat their customers in a fair and transparent manner.
The bank supervision department can remain exercising its mandate of bank supervision and co-ordinate the lender of last resort function. The lender of last resort role is of greatest relevance in dealing with institutions whose instability would pose a direct threat to the financial system as a whole.
This is a better response to market developments. For example, the recent 2016 amendment to the Financial Institutions Act introducing “bancassurance” business- that is, business done by financial conglomerate groups engaging in both banking and insurance would permit better supervision of financial conglomerates under the twin peaks system, which encourages regulatory consolidation due to enhanced interlinkages in the financial services industry. The institutional/sectoral approach becomes increasingly difficult to operate as the complexity of financial products and financial institutions increases.
Furthermore, integrated supervision also creates significant economies of scale. Centralising regulatory functions enables the development of joint administrative systems, information technology and other support functions such as improved co-ordination and information sharing. This would improve the efficiency of financial regulation objectives such as financial stability, crisis management, prudential regulation of both systemically important financial institutions (SIFIs) and the non-systemically important and market conduct regulation. The history of financial regulation reform in Uganda has normalised discussion of the structure and effectiveness of our regulatory system against the backdrop of specific events such as bank failures of the 1990s and early 2000s, or perceived regulatory failures, thus contributing further to more fragmented, reactive and piecemeal interventions.
However, the suggested twin peaks approach is more forward-looking, proactive, and seeks a regulatory re-design of the system through reflecting on the purpose, aims and objectives of financial services regulation with a view of improving the robustness and resilience of the economy.
By and large, the twin peaks model is considered to have a number of advantages. First, the two peak regulators are more likely to have dedicated objectives and clear mandates which they exercise. Secondly, there is minimal danger that one aspect of regulation – such as prudential regulation – will come to dominate the regulatory landscape at the expense of consumer protection, and thirdly, the model may be better adapted towards keeping pace with the growing complexity of financial markets and the continuing rise of financial conglomerate groups in Uganda.
Mr Kayondo is a legal researcher on regulatory policy and compliance. Twitter: @Silver Kayondo
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