“A single agency responsible for systemic risk would be
accountable in a way that no regulator was in the run-up to the 2008 crisis.
With access to all necessary information to monitor the markets, this regulator
would have a better chance of identifying and limiting the impact of future
speculative bubbles.” Former US Secretary of the Treasury Henry Paulson


Financial supervision is
essential in order to be able to monitor financial institutions. Therefore,
regulation will help investors to gain trust in the financial system. Investors
trust in the financial system can be gained by showing evidence that financial
institutions that breach the law (example make use of market abuse) will face
negative sanctions against them which will result into any type of enforcement
in order to ensure that the financial market is fair, efficient and transparent
by monitoring all transactions and investigating suspicious transactions in the
financial market. Financial supervision can be divided into two, this includes
the Macro-prudential supervision which seeks to ensure financial stability and
the Micro-prudential supervision which seeks to focus on the stability of
individual financial institutions. The micro-prudential supervision may be
classified into three models which are the sectoral model, twin peaks model and
the single regulator model. Globally, different institutional models are used
in relation to financial supervision. Each type of institutional model has its
own advantages and disadvantages. There are 3 factors one should keep in mind
when considering which type of institutional model for financial supervision
one should choose. These factors include: the size of the state and sector, how
complex business is in that particular country (complexity of business) and
also the culture in that particular state.

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The Sectoral model (the
three pillar model) is an institutional model which consists of a regulator for
the 3 main sectors which includes, banking supervisor, securities and markets
supervisor and insurance supervisor. This means that each one of those areas
will have its own supervisor which consists of its own policies and practices.
Therefore using this system will include separate supervisors for each area of
the financial services and will also include separate policies held out in
order to measure accordingly each sector. This type of institutional model is
used in countries like Greece, Portugal, Cyprus, and Italy.

The main advantage of the
sectoral model is that since it is made out of 3 sectors it will consist 3
supervisors one in each and every sector. Therefore one should note that this
type of model is more focused than the other models because apart from the
supervisor focusing on that particular sector, there will also be supervision
based on the type of entity. On the other hand the main disadvantage that will
be experienced while using this type of model is the lack of communication,
which will result in lack of co-operation. Communication is very important
especially in the financial markets because if there is lack of communication
between supervisors they can easily miss information (example missing a
potential emerging risk) which is essential for them to identify in order to
take action.  Fragmented supervision can
impact the efficiency and thoroughness (complete system) of supervision.
Another disadvantage that can be encountered while using the sectoral model is
turf wars. Turf wars in this case is basically an argument which is raised
between supervisors since they are all competing in the same particular area
(state). The difficulties that emerged from this type of model, played a role
in order to develop the other two alternative institutional models for micro-prudential
supervision. These two alternative institutional modules are the twin peaks
model and the single financial supervisor model.


The second model is the Twin
Peaks model, where this model consists of the functions of regulation separated
between two supervisors, these two supervisors consists of the Conduct
supervisor and the Prudential supervisor where both of them focus on different
objectives rather than sectors (as the sectoral model does).The Conduct
supervisor is responsible for market integrity and investor protection while
the Prudential supervisor is responsible for financial soundness of
institutions and financial stability. This regulatory model has two core
functions, the first function is the ability to be able to maintain the financial
system stability while the second function is to assure market conduct and
consumer protection in the financial markets. This model is implemented in
Europe such as the United Kingdom, Netherlands, Belgium and also outside of
Europe in Australia.

The main benefit of
implementing the Twin Peaks model is that regulators will be much more
effective, accountable and also focused since there are two supervisors
focusing on a particular area. Furthermore, this model will allow each
regulator to generate their own culture that best fits with their objectives
and will also allow regulators to acquire specific expertise in order to meet
the objectives. On the other hand, the biggest disadvantage in this model would
be the lack of communication between supervisors which could also lead to
overlapping supervision .Therefore, if the two supervisors do not co-operate
between each other , risks in the financial system can occur . Those risks
which are identified by only one supervisor and not the other supervisor, are considered
as not sufficiently addressed risks. Overlapping supervision occurs when the
objective of the Conduct supervisor conflicts with the objectives of the
Prudential supervisor. This means that, one of the supervisors (either the
conduct or the prudential) will take priority and therefore the institution
will have to choose either the conduct approach or the prudential approach.


Finally, the third and last
institutional model is the single regulator model. This model includes one
financial supervision covering the entire market. Where the supervisor has the
responsibility to monitor compliance with both prudential and conduct of
business regulation of the entire industry. Therefore, this may be a suitable
option in order to avoid turf wars which alters the effectiveness of
supervision. This type of model is increasing its popularity and it is commonly
used in small states and medium size states, including Malta, Ireland and
Germany amongst many more. Like every other model, this type of model has both
advantages and disadvantages.

The main benefit of
implementing this regulatory model is because of the higher quality of
supervision, which occurs since there is only a single supervisor. Eventually,
the single supervisor has the ability to acquire the required information more
easily than the other models since with this model lack of communication will
be minimized by a lot. Furthermore, with a single regulator, one can be able to
prioritize issues example, when there is a crisis the regulator will focus all
the energy on that crisis. Therefore, having a single regulator will lead
priorities to what the supervisor thinks it’s best and most important for that
particular state. The single regulator model also allows economies of scale to
take place. Research pointed out that using this type of model will lead to
less corruption which will result in better institutional governance and a more
efficient judicial system. In contrast, the main disadvantage of using this
system is because of the lack of regulatory competition improvement in
supervisory systems could be restrained. Having just a single supervisor could
result in having an over might bully which can curb accountability and
independence of the regulation. Therefore, using this model will result in
having less specialization and also less expertise. Furthermore, although this
type of model is more effective it is not that efficient, since, unlike the
sectoral model there is less specialization in banking, securities and
insurance sectors since in the single regulatory model there will be one
supervisor regulating all sectors.


In this quote by Henry Paulson, “A
single agency responsible for systemic risk would be accountable in a way that
no regulator was in the run-up to the 2008 crisis. With access to all necessary
information to monitor the markets, this regulator would have a better chance
of identifying and limiting the impact of future speculative bubbles.” Henry
Paulson is pointing out that having multiple regulators has led to the
financial crisis which occurred in 2008. Therefore, I believe that the most
appropriate model would be the single regulator model because having just a
single supervisor will result in a unified system. Eventually, a unified system
will consist all the required information in order to be able to identify
potential risks in the financial markets. This shows that communication is very
crucial especially communication in the financial markets, because with
communication it will be easier to identify the potential risks. In contrary,
in the twin peaks model and the sectoral model lack of communication may occur
since there isn’t just a single supervisor which can also result in conflicts
or turf wars between supervisors which makes it even more difficult to identify
the risks.