With the merging of the banking and insurance concerns, regulators will have their hands full, warns Graham Wedlake. Graham Wedlake is head of banking at Barlow Lyde & Gilbert.
In recent years there has been an increasing overlap of the activities of banks and insurers. Bancassurance, as it has become known, has become the holy grail of banks looking for new sources of income and for insurers looking to access the large distribution network of the banks. It is only recently, however, that the regulatory authorities have started to get to grips with the challenges that this crossover of activities has thrown up.
The blurring of the boundaries is arguably having more impact on the insurance industry than on its banking counterpart. Banks have, for some time, needed to develop ever more innovative products for their customers in order to compete in the international financial marketplace. Insurers are now doing the same.
The structural changes have been striking. Financial conglomerates are being created with insurance companies playing a leading, if not the lead, role. In the past year, the mergers of Citicorp with Travellers Group (which had already absorbed Smith Barney and Salomon Brothers), and Credit Suisse with Winterthur have revealed the scale of what can happen.
The insurance industry has also embraced some of the innovative techniques of the capital markets. For instance, securitisation has been behind one of the more exotic of the recent derivative products – namely catastrophe bonds issued on the back of premium receivables.
The increasing sophistication of the insurance market is also offering opportunities for co-operation, as well as competition, with the banking sector. Use of insurance expertise in project and trade finance allows gaps in risk to be filled by those that best understand them.
Insurers are inevitably more comfortable with contingency risk than bankers. They are used to assessing political risks, or the risk that adverse weather will have an effect on project payment flows which may be calculated to within very fine margins for error.
The merging of traditional banking and insurance activities will also inevitably raise interesting legal issues. In cross-border transactions, the banking and insurance markets need to accommodate the requirements of multiple jurisdictions, each of which will have its own consumer environment, body of law, regulations and market practice. A financial product in one jurisdiction may be treated quite differently in another.
The specific characteristics of a banking or insurance investment product also need to be considered.
Underlying insurance or reinsurance policies are, in US and UK jurisdictions at least, contracts of the utmost good faith. These are voidable for non-disclosure or misrepresentation to the insurer or reinsurer of any material fact prior to entering into the insurance contract. As such they are distinguishable from banking products, which tend to create obligations or liabilities whose enforcement is far less conditional.
The insurance disclosure requirements also exist regardless of any local securities regulations which may govern the issue of the relevant securities to investors.
As might be expected, the wide range of financial services now being provided by bancassurance conglomerates, including banking, securities and insurance services, is also creating a challenge to supervisors and management.
On an international level, the Basle Committee on Banking Supervision held a joint forum on financial conglomerates in February this year. This culminated in the production of consultation documents which it was hoped would be adopted by national regulators worldwide.
One major concern identified with the move towards the merging of banking and insurance concerns was that of capital adequacy. It was recognised that there are different capital adequacy requirements in each sector. This is associated with the different risks to which each of these sectors are exposed, and the fact that risk management techniques in each sector are bound to be different.
The Basle Committee envisaged that this would be an area which would fall within the remit of the relevant supervising authority. Where financial conglomerates were concerned this supervisor would need to be able to monitor and understand the capital adequacy requirements not only of the individual corporate entities, but of those of the group as a whole.
The guidelines on the supervision of financial conglomerates provided by the Basle Committee have been broadly welcomed by regulators. In the UK, the Financial Services Authority (FSA) intends to take advantage of these consultative manoeuvres to incorporate some of the recommendations into its regime.
The FSA has, from the outset, been working closely with the Bank of England to provide stability in the financial system as a whole.
The integration of the prudential supervision section of the Bank of England in the FSA earlier this year was a first step towards an effective integrated regulation of banking and other sectors.
The Bank of England’s deputy governor is a member of the FSA board, and the FSA chairman sits on the court of the Bank of England. Information-sharing arrangements have also been put into place, to ensure that all information which is or may be relevant to the discharge of the relative responsibilities of the bank and the FSA are comprehensively shared.
At the end of July, the Government published for consultation a draft of the Financial Services and Markets Bill. This aims to reform the basis of financial regulation in the UK. The regulation of business carried out by recognised professional bodies such as the Securities and Futures Authority and the Insurance Directorate of the Treasury will be transferred to the FSA, following in the footsteps of the earlier transfer of banking supervision.
The Lloyd’s insurance market has also been brought within the new regime. It is currently regulated for solvency purposes by the Treasury. Other aspects of Lloyd’s business are regulated by its governing body – the council – under powers conferred on it by the various Lloyd’s Acts. This will change and the FSA will have significant powers to regulate the market.
It is envisaged that the Society of Lloyd’s, Lloyd’s managing agents and Lloyd’s members’ agents will all need authorisation by the FSA. In effect the FSA will have the same powers over Lloyd’s as it will have over regulated firms in general.
The remit of the FSA is deliberately broad based and ambitious. It has already taken on board some of the guidelines that emerged from the workings of the Basle Committee.
The FSA has set itself the task of exploring the scope for harmonising capital regimes, both within and across different sectors of the financial services industry. It sees risk-based supervision as the focus of its work in this area, but is keen to maintain flexibility in its approach. Where it can, it intends to allow firms with appropriate expertise and well developed controls to determine their own capital requirements within broadly defined parameters.
The FSA clearly also plans to play a significant part in international regulatory developments. It is perhaps uniquely positioned to do this with the scope of its remit and the fact it will formulate its approach in consultation with participants in the financial markets.
It sees itself playing a leadership role, particularly where regulatory issues cut across several different types of business. In doing so, it would be looking to ensure a proper balance is struck between protecting the interests of consumers and facilitating financial innovation.
In its willingness to exchange information in the conduct of its supervision and the use of its authorisation and enforcement powers, it is clearly hoping to influence the development of similar regimes elsewhere.
It is possible, therefore, that what we are seeing is not simply a blueprint for our own domestic financial services industry, but one which will significantly influence the regulatory development of overseas financial markets.