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Principles of regulation


The principles of regulation are the principles that need to be applied when formulating regulatory policies, specific regulatory requirements and the structure of the regulatory institutions. They are derived from the objectives and may be categorized as follows:

• Efficiency-related principles.

• Stability-related principles.

• Conflict-conciliatory principles (to address conflicts between objectives).

• Regulatory-structure principles.

• General principles.

Efficiency-related principles

The principles that reside under this heading advance the achievement of a high level of efficiency in financial services, and there are two:

• Promotion of a high level of competition amongst financial system participants. Examples:

- the removal of restrictive practices that impair trading in financial assets,

- low barriers of entry to the financial markets,

- freedom of choice regarding financial services.

• Creating competitive neutrality between existing and potential supplies of financial services ("level playing field").

Stability-related principles

Stability-related principles are those that contribute to the promotion of stability in the financial system and the safety of financial intermediaries and institutions. They are:

• Incentives for the prudent assessment and management of risk. This requires the imposition of minimum prudential standards to be observed by participants, of which the capital requirement is the most important. Appropriate information systems are required. Cross-market risk management is also essential.

• Use of regulatory requirements that are based on market values. The viability of an institution can only be gauged with the use of market values of balance sheet items as opposed to historic values.

• A willingness of the regulators to take timely action to redress existing and future developments that threaten the stability of financial institutions and markets. By this is meant that the regulators should take appropriate action whenever actual or potential market deficiencies are detected.

Conflict-conciliatory principles

Conflict-conciliatory principles are designed to address potential conflicts between regulatory principles. These principles involve:

• Following an integrated approach, aiming at the simultaneous achievement of the objectives of regulation.

• Pursuing a target-instrument procedure, whereby the regulatory instruments are selected and applied in such a way that they facilitate the implementation of the integrated approach.

The target-instrument procedure means that the instruments of regulation used to achieve particular targets simultaneously neutralize the negative effects of other instruments.

Regulatory-structure principles

An unsolved debate in regulation circles is whether there should be a single regulator or a number of specialist regulators. This is a debate that is particularly relevant as the financial system becomes more and more complex. The principles are:

• Following a functional as well as an institutional approach to regulation.

• Co-ordination of regulation by different agencies in order to assure consistency in regulation.

• A preference for a small number of regulatory agencies.

General principles

General principles are those that have a bearing on the general conduct of the regulatory process, and they are:

• Each regulatory arrangement must be related to one or more of the objectives identified.

• Regulatory arrangements must be cost-effective. A judgment has to be made on how far the objectives are pursued and what cost is reasonable to bear.

• Cost of regulation must be distributed equitably. There are two models in this respect: the taxpayer via government that funds the regulator, or the user, i.e. the institution being regulated, funds the regulator.

• Regulatory arrangements must be flexible. This is because of the innovative nature of the environment regulated - the financial system.

• Regulatory arrangements should be practitioner-based, i.e. the regulated and the regulator must have a good relationship and the regulated must be involved in the process of regulation.

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