Financial regulation experienced some remarkable failures in the last two decades. These failures include the mis-selling of investment products by various financial institutions, venturing into providing financial services in foreign markets without an adequate understanding of the risks involved and governance failures caused by politics and human nature.
These were all the result not so much of lack of regulation as the lack of effective regulation.
The appointment of Jesmond Gatt as the new chair of the Malta Financial Services Authority is an excellent opportunity to define the way forward for financial regulation.
In his meeting with the Public Appointments Committee last Wednesday, Gatt, the former chair of the Financial Intelligence Analysis Unit, tried to distance himself from decisions taken by his predecessor in regard to highly publicised incidents relating to the conduct of former CEO Joseph Cuschieri and the financial arrangements made with Joseph Gavin, another former CEO, for the handing-over process to his successor.
Gatt promised to consider publishing the findings of an internal investigation into the alleged breach of ethics by Cuschieri. However, he has “to see what implications it could have on confidence in the sector”. He also said he disagreed with the arrangements made with Gavin.
The way forward for the MFSA to regain the respectability it once had must include the hard work of hammering out the details of how a new regulatory system can succeed without imposing costs triggered by unintended consequences. Gatt must resist the reflex to build incrementally on conventional wisdom and exploit the opportunity to reshape the local financial regulatory landscape.
The first place to start is to set micro-prudential goals to ensure that the governance of financial institutions is unassailable. Too many individuals involved in past failures in financial services have recycled themselves and are today still active in other roles in the sector.
No box-ticking due-diligence exercise can guarantee that those entrusted to manage people’s money will do so professionally. More intrusive and ongoing scrutiny is needed to ensure that only people who are experienced and of integrity occupy decision-making roles in the sector.
Another problematic issue that the regulators must address includes identifying and managing risk in areas that do not fall under the current remit of the MFSA. This will require a dispassionate assessment of the effects of regulatory fragmentation in the capital market.
Following the 2008 financial crisis, the regulation of banks became stricter thanks to the involvement of the European Central Bank in the supervision of systemically important banks in the eurozone. The supervision of non-bank financial institutions has been less rigorous. In recent years, the local capital market has shifted credit risk from banks to private investors.
More regulatory directives on information transparency and rigorous oversight should raise the level of protection given to such investors. Gatt must work with the ministry of finance to ensure that there are no loopholes in the regulation of non-bank institutions that today do not fall under the remit of the MFSA.
Regardless of regulation, the financial system is likely to retain the vulnerabilities that could trigger a systemic risk which, in turn, could shock the economy. The primary goal of regulation should be to protect the financial system’s capacity to function as a network.
The MFSA must address the past regulatory failures that have seriously damaged the country’s reputation. It must also mitigate the risk of systemic shocks that will inevitably occur in the future.