Curbing excessive regulation in finance

Dr Alex T Magaisa

THE financial crisis in Zimbabwe over the past year has resulted in a number of interventions by the state, mainly through action by the RBZ as the chief regulator.



>In addition to “soft laws” contained in guidance notes normally incorporated in the RBZ governor Gideon Gono’s quarterly monetary policy statements, the state has also intervened through specific legislation aimed at curbing malpractices and criminal activities such as money laundering and corruption.


This combination of “hard” and “soft” laws has increased the layers of regulation already available within the financial sector.


This enhanced regulatory regime echoes the developments in the international markets reflecting calls towards greater regulation in the wake of corporate scandals that rocked US markets at the turn of the century.

Nonetheless, while calls for regulation are understandable against that disastrous background, there are emerging concerns that the regulatory authorities at times run the risk of over-reacting.


A recent report by The Financial Times, a premier financial daily newspaper in the UK, indicated that there is increasing concern by the business executives that the financial industry is facing the burden of excessive regulation.


An annual survey conducted by the Centre for the Study of Financial Innovation (CSFI) discovered that over-regulation is considered to be the biggest risk to the financial sector and individual institutions. In the wake of local developments in the regulatory structure in Zimbabwe, it is important to gauge not only whether the regulatory structure that has been established meets the requirements, but also whether it serves the market and financial institutions without distracting them from their core business interests.


There is always the danger that in enacting regulations overzealous behaviour might lead to a regulatory structure that will stifle rather than promote business growth.


There are several problems arising from excessive regulation that ought to be taken into account when formulating regulations for the financial industry.

Firstly, regulations usually impose obligations that entail increases in compliance and administrative costs for individual institutions and the industry as a whole.


Compliance costs generally refer to the costs incurred in pursuance of the obligations to satisfy regulatory demands. This includes setting up specialised compliance departments, hiring qualified staff, training personnel and also adopting procedures and special infrastructure to fulfill the regulatory needs. This naturally entails additional costs to the organisations that are obliged to comply with the regulatory structure.


Arguably, the radical changes to the capital adequacy requirements put pressure on a number of banks particularly at a time when their alternative sources of income such as the parallel market upon which they had been dependent had been curtailed.


It is arguable that a more gradual and calculated compliance requirement on this issue combined with a generous allowance for return to “normal business” would have been preferable and might well have given hope to some of the banks that have now collapsed.


The RBZ has also called for banks to set up special information technology systems for risk management while legislation such as the Bank Use Promotion and Suppression of Money Laundering Act requires banks to engage and train staff to meet the objectives of detecting and combating money laundering.


The requirements to keep records over a specified period of time requires banks to set up storage facilities which may also increase costs. Additional costs will be incurred in administration as banks expand their capacities to deal with the new demands.


Given the possibilities of increased compliance and administrative costs, it is important to tread carefully and avoid imposing further costs that might end up diverting resources from the core business of the organisations.


Secondly, the increased regulatory demands will consume extra time and energy within financial institutions. The fear is that boards and management will now spend the majority of their time grappling with the need to satisfy regulatory demands rather than focusing on the core business of the banks.


Arguably, over the last few months, most banks have been overwhelmed by the regulatory demands and their time has been spent largely on trying to comply and survive.


Consequently, it diverts time and resources away from the core business and this might end up affecting the profit levels which ironically, are essential for their survival in the long-run.


In the same vein, one might also question the efficacy of legislation such as the anti-money-laundering laws which effectively make banks a key part of the policing regime.


To what extent should they be held responsible for this role? What is the extent of the costs that they will incur in fulfilling this role? Does this not divert resources from the core banking business?


These are some of the questions that need to be answered because inevitably, fulfilling for example, the “suspicion-based reporting” requirements will expose financial institutions to possible legal action and extra costs.


They may also have to pursue costly legal action to determine or protect their rights and it may be unfair to impose such costs on them given that they are effectively performing the duties in the public interest.


In my view, rather than blindly following standards set for specific markets, Zimbabwe needs to adopt legislation that reflects its realities otherwise the costs will be too heavy on the fragile financial sector.


Policing authorities should be given a greater role and more resources to enhance their capacity and banks should be allowed to pursue their core interests without facing further regulatory demands and consequent costs.


According to the CSFI, the third problem is that excessive regulation may give a false sense of comfort and security to banks. In other words, banks will begin to believe that by simply fulfilling the onerous regulatory demands they will have done enough to prevent problems.


The mission becomes one of simply fulfilling regulatory demands without addressing the specific needs of the individual institution. Aligned to this is the problem that excessive regulation might also give a false sense of security to other key stakeholders such as consumers and investors who should otherwise be playing a vigilant role in the market.


For example, institutional investors have a key role to play in corporate governance because of their influence and resources but once they notice an over-regulated market, they might withdraw and play a very minimal role.

Consumers that do not have effective avenues to hold banks accountable also cease to play a critical role in this regard. The false sense of comfort created by over-regulation is not good for promoting market discipline.


Finally, the biggest risk of excessive regulation in general is that if the available regulations are not enforced regularly, consistently and effectively, it will lead to a dangerous culture of complacency and general disregard of the law.


If the state establishes a regulatory structure it must ensure that the rules are followed effectively. If not, those obliged to do so will simply descend into a culture of general disregard of laws knowing that nothing will be done against them. Thus, in addition to creating a false atmosphere of comfort, it might also fuel corrupt tendencies within the business sector.


The question that must be asked therefore, is whether the regulatory authorities in Zimbabwe have sufficient capacity to enforce the financial regulations that have been established so far?


It would be a disaster if in the long-run, the plethora of laws and regulations are not effectively enforced because of lack of capacity.


In a nutshell, the key is to ensure that the regulatory authorities have sufficient capacity to enforce the laws. In addition, it is necessary to streamline the regulatory authorities and create a system that is efficient, transparent and easy to deal with.


The financial sector needs one regulator with which to deal and it is also important to minimise onerous obligations that are not necessary within the economic context of a developing economy.


The roles of other key stakeholders such as institutional shareholders and consumers must be enhanced while other bodies such as the Zimbabwe Stock Exchange must be seen to be more active and effective in their own right rather than play a subservient role to the regulator.


A risk-based regulatory structure may also help to place the onus on the financial institutions without too much interference from the regulator.


Steps must be taken to reduce the costs that would divert resources, including time and energy from the core business of banking and responsibility for policing financial crime must as much as possible, rest with the traditional policing authorities.


There is no doubt that financial regulation is necessary, but care must be taken not to impose unnecessary and excessive obligations that will stifle the business of banking.


*Dr Alex T Magaisa is the Baker & McKenzie lecturer in corporate law at The University of Nottingham. Contact alex.magaisa@nottingham.ac.uk

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