What is it about?
This paper discusses the evolution of regulatory strategies from a consideration of the traditional command and control strategies to responsive and meta regulatory strategies. Moreover it highlights why risk based regulation has become very popular in response to the demands of a changing and dynamically evolving financial environment.
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Why is it important?
Risk based supervision is becoming increasingly important in view of the emergence of new forms of risks. Under the first pillar of the Basel capital framework reference is particularly made to the following risks, namely operational, credit risks - as well as operational risks. Under the second pillar, further reference is made to interest rate risks in the banking book. The complementary nature of Pillar Two to Pillar One is further illustrated: According to the BIS (2019:12), “the Basel Framework highlights the main areas of focus under Pillar 2: (i) risks considered under Pillar 1 that are not fully captured by the Pillar 1 process; (ii) factors not taken into account by the Pillar 1 process; and (iii) factors external to a bank (eg business cycle effects). For these reasons, some areas particularly suited to treatment under Pillar 2 are considered, namely: business model risk; Interest rate risk in the banking book IRRBB; concentration risk; and other emerging risk areas.”
Perspectives
Other forms of risks have emerged over the years, namely cyclical risks, cybersecurity risks, risks associated with OTC derivatives, emerging technological risks - in addition to the well known risks associated with the audit risk model (that is, inherent risks, control risks and detection risks). The Audit Risk model can be illustrated as follows: AR = IR * CR*DR (where AR represents audit risk, IR represents inherent risk, CR represents control risk and DR represents detection risk) The need for the operation of effective internal control systems and corporate governance measures which ensure that the business is prepared and well aligned to address the risks of operating using emerging technologies - as well as adapting to this environment needs to be facilitated. Further mechanisms of accountability within the business and internal controls environment, namely audit committees, the audit engagement team - as well as directors and authorisation systems need to be incorporated to facilitate independence, supervision, accountability, monitoring and verification procedures.
Prof Marianne Ojo
Northwestern University
Read the Original
This page is a summary of: Regulatory Strategies, SSRN Electronic Journal, January 2009, Elsevier,
DOI: 10.2139/ssrn.1407220.
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Resources
Addressing Risk Challenges in a Changing Financial Environment: The Need for Greater Accountability in Financial Regulation and Risk Management
The need for continuous monitoring and regulation is particularly attributed to, and justified by, the inevitable presence of risks and uncertainty – both in terms of certain externalities and indeterminacies which are capable of being reasonably quantified and those which are not. Amongst other goals, this paper aims to address complexities and challenges faced by regulators in identifying and assessing risk, problems arising from different perceptions of risk, and solutions aimed at countering problems of risk regulation. It will approach these issues through an assessment of explanations put forward to justify the growing importance of risks, well known risk theories such as cultural theory, risk society theory and governmentality theory. “Socio cultural” explanations which relate to how risk is increasingly becoming embedded in organisations and institutions will also be considered as part of those factors attributable to why the financial environment has become transformed to the state in which it currently exists. A consideration of regulatory developments which have contributed to a change in the way financial regulation is carried out, as well as developments which have contributed to the de formalisation of rules and a corresponding “loss of certainty”, will also constitute focal points of the paper. To what extent are risks capable of being quantified? Who is able to assist with such quantification – and why has it become necessary to introduce other regulatory actors and greater measures aimed at fostering corporate governance and accountability into the regulatory process? These questions constitute some of the issues which this paper aims to address.
Beyond the Financial Crisis: Addressing risk challenges in a changing financial environment
Theoretical models and hybrids of a responsive model of regulation such as Enforced self regulation and meta regulation, which have the potential to address the problems relating to risk will be addressed. By virtue of the pro cyclical nature of risk, the inability of Basel 2 to address risk cycles were revealed during the Northern Rock Crisis. Other flaws and deficiencies inherent in Basel 2, a form of meta regulation, will be highlighted. The relevance of internal control systems to an efficient system of regulation, the reasons for which meta regulation is not only considered to be the most responsive form of regulation, but also one which assigns central role to internal control systems will be discussed. The contested nature of risk and the difficulties attributed to its quantification, raise questions about its ability to function effectively as a regulatory tool. If risks could be eliminated in their entirety however, then regulation would serve no purpose. This paper aims generally therefore to direct attention to those areas which could be addressed, namely institutional risks, and measures whereby such risks, even though impossible to eliminate, could be minimized.
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