Late last year I finished up on a subject that generated some interesting responses for principle based regulation and since that time I haven't blogged which some readers have made comment to. So to pick up where I left off we are going to look at another not dissimilar approach to regulation in South East Asia but before we do, please accept my apology for not publishing and I can guarantee since last year I have looked at a little bit more than principle based regulation, well we hope so. Specifically Causal Capital is in the process of building a new operational risk tool for banks and that has been consuming a lot of my time but more on that in another space.
So back to principle based regulation or perhaps risk based regulation and last month the Monetary Authority of Singapore published its framework for Impact and Risk Assessment of Financial Institutions and its approach is relatively fresh and novel but before we delve into the semantics of this CRAFT one needs a little bit of insight into Singapore.
Singapore is an island city state nested between Malaysia and Indonesia and it runs like clockwork with the Economist ranking Singapore as the 11th most advanced in quality of life globally. Geographically its small being about 50km's or so long and 30km's or so across yet it packs in one of the most dense financial sectors in the world. Singapore is successful because it manages economic and political volatility swiftly so that systemic threats are treated. The outcome of this management machination results in a stable landscape and that attracts foreign investment, business and working capital; the driving force for the success of the country.
The Monetary Authority of Singapore's recent publication embellishes this very instrument to wellbeing and should be viewed in this light.
Like the FSA (Financial Services Authority) in the United Kingdom, the MAS approach is principles based yet it is structured in a way that makes best use of resources at hand to ensure that the principles are targeted where they are most needed and it does this with an industry wide impact assessment known as CRAFT or to escape the acronym; Common Risk Assessment and Techniques.
As MAS puts it 'the supervisory work addresses themes that affect the industry as a whole and issues that cut across different financial service sectors' and it works by articulating an impact risk model across the entire financial sector by first evaluating the rate and impact of a specific risk for one institution, then bench marking that threat in a back drop against the financial sector as a whole.
The concise risk steps involve the investigation of risks in the context of each institution and a direct connection to the outcome or impact. By reviewing the importance of what is at risk and the impact, risks are collected for each institution individually and the overall exposure assessed. MAS combines the relative systemic importance of the threat and the risk outcome profile to dimension a close proximity to the impact and then rates this into one of four 'supervisory buckets' and for each institution in turn. Level 1 buckets have the greatest potential of affecting the goals of MAS and level 4 risks are concerns that need monitoring.
From a regulatory perspective CRAFT has some distinct advantages, primarily it is risk focused so that each regulatory decision is based against a threat rather than some bureaucratic policy that just remains for the sake of its existence. In addition to this, an action is not practiced in discrete and rigid steps but operates to resolve the present problem in the best manner and this makes the approach in Singapore very Principles Based. The neat part to it all is that when a risk is managed, transferred or mitigated a policy is relaxed to free up resources to the next most pertinent threat. From a commercial perspective financial institutions are not 'interfered' with unnecessarily which translates to a lower cost of compliance. Alternatively countries that have heavy regulation dissimulated by several regulatory bodies have a tendency to over regulate resulting in duplication and higher costs. Now while I can see specific analysts assailing such an avouchment, I can also find more chief executive officers whining in the peanut gallery of the stadium of regulation with some semblance of agreement.
The most effective outcome of CRAFT however is that it is ever evolving so as threats appear a course of action is mapped. This technique lends itself quickly to the analytics of trends of potential vulnerabilities so that they can be written into policy for a quick resolution. Something else novel about the MAS approach is that this sorting of threats is actually applied to all disciplines of risk equally. It takes in market, credit, liquidity and operational risk so the tendency to correlate interdependencies to highlight a resident pathogen between risks ensures that the focus is on resolution rather than finger pointing. This holistic approach is also ideal for defining systemic failure and failure from the network of dependencies between risk elements and all of this seems relatively obvious but so many other regulators treat risks in silos.
The regulatory document can be downloaded from the MAS website and it is a concise read being only 22 or so pages.
