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Need for regulating the financial regulators

Assessment board the missing link in accountability and performance in the financial services sector.

An assessment board that provides continuous oversight of Australia’s financial regulators would help prevent regulatory failures exposed by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Banking Royal Commission) and potentially ward off financial crises, new research into the failings of the system argues.

In research published in the journal Law and Financial Markets Review, Dr Andy Schmulow, a senior lecturer with the University of Wollongong’s (UOW) School of Law, argues that the creation of an Assessment Board to provide continuous oversight of the financial regulators is an effective solution to the regulatory failures. 

Called the “Twin Peaks” model, Australia’s financial system has two statutory authorities with investigation and enforcement powers: the Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA).

Dr Schmulow and co-authors Karen Fairweather (University of Auckland) and John Tarrant (University of Western Australia) argue the Banking Royal Commission has provided ample evidence of the phenomenon of regulatory capture that has led to a “financial regulatory crisis”.

Regulatory capture occurs when agencies responsible for regulation have their efforts diverted away from public interest and act more favourably toward the interests of the industry groups who were subject to regulation.

The corrosive effect is a weakening or lessening of the regulation and possibly regulatory failure.

In their analysis, Dr Schmulow and co-authors show how the structure of financial regulation is fertile ground for capture, particularly as the close nature of supervision and monitoring required can lead to a “cosiness” between the regulator and the regulated.

The notion that banks are “too big to fail” leads to deferential treatment, particularly when the regulators can exercise discretion in enforcement actions, Dr Schmulow said.

The Royal Commission brought to light examples of regulatory capture, including where ASIC allowed major banks to water down announcements about industry misconduct.

Dr Schmulow writes in the paper that Commissioner Hayne’s astonished reaction to an email exchange between ASIC and a bank about handling of an enforcement notice lends support to the capture thesis, and is worth repeating: “The regulator asking the regulated whether the proposal was sufficient in the eyes of the party alleged to have broken the law, is that right?”.

To test the idea of a board of oversight, the researchers conducted an internationally comparative, cross-jurisdictional analysis of the method’s effectiveness to deter and prevent regulatory capture.

Examples abound, such as the UK’s Financial Policy Committee and the United States Government Accountability Office. The assessment board would be governed by a secretariat provided by The Treasury, but with the board at arm’s length from the bulk of Treasury.

Its membership would be diverse, highly experienced people serving fixed terms to prevent one person or industry group dominating.

It would submit reports to government on how the regulators had used their powers, providing ongoing measurement of how well regulators fulfil their mandates.

“Utilising nothing more than disapproving looks, the Commissioner Hayne has achieved more in some instances in 10 months than ASIC and APRA have, together, in 10 years,” Dr Schmulow said.

“Chairs and CEOs have tumbled, as have directors. Senior executives have resigned, so too senior regulators. Predatory operators have self-selected out of the market.

“The inferences we can get from the Royal Commission’s Interim Report is that capture of Australia’s regulators is both widespread and deep.

"Yet, when exposed, their response is to double-down on their existing, flawed methodologies.

“The benefits to Australia of the establishment of an Assessment Board are clear, and include enhanced accountability, improvements in the regulator’s culture, prevention of regulatory capture, and enhanced capacity to prevent financial crises.”

The idea of an assessment board was first recommended by the Financial System Inquiry (FSI) in 2014, chaired by David Murray AO.

Dr Schmulow gives short shrift to criticisms of the idea, which are typically based around the cost of the exercise, better use of governance structures already in place and providing the regulators with more power.

“Estimates of the costs of remediating failures in the banking sector are in the billions of dollars,” he said.

“To better use governance structures requires independent review, that’s the entire point. And additional powers are no good when they won’t enforce even existing laws.

“The introduction of an Assessment Board in Australia would serve as a timely and highly effective adjunct to the current Australian Twin Peaks financial regulatory architecture comprising APRA and ASIC.”


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