The recent crisis at local savings banks has sparked debate over the financial supervisory system. Some insist the current monopolistic power should be maintained because of redundancy and excessive auditing costs. But a series of supervision failures suggest there has been no effective mechanism to provide oversight of regulators. The solution is to introduce competition to financial supervision and conduct random and constant verification of audit outcomes.

With the savings bank crisis still sending shockwaves throughout the country, the issue of financial supervisory reform has reemerged. Although a task force team abruptly created by President Lee Myung-bak`s direct order will come up with a reform plan soon, its success is uncertain. Many people are already split over the direction of reform and differ over how to achieve it. Related parties have conflicting views on how to change the supervisory system. Striking an agreement among authorities will be a key to the success of reforms. 

Financial supervisory system reform

The Financial Services Commission (FSC) and the Financial Supervisory Service (FSS) believe that FSS should maintain its monopoly over the financial supervisory system. Although the recent crisis involving savings banks is a typical case of oversight failure, they insist that they should have more power to strengthen their control under the current structure. Opponents argue that the current supervisory system has some loopholes that can't be closed in the current system. They propose competitive supervision by allowing inspection rights for an independent body so that it and FSS will operate under checks and balances.

The differing views are the main reason the revised bill for the Bank of Korea Act has been stalled for two years at the National Policy Committee of the National Assembly after passing through the Strategy and Finance Committee. But the debates should not end with which institution will take the initiative. Rather, the focus should be on whether and how to introduce competition into the financial supervision system. 

A failure of oversight can destroy the public`s trust in the financial system, as seen with the savings bank case. Therefore, effective oversight of the financial system is crucial. Considering that effective financial oversight needs the authorities` power over license and penalty, the argument for improving the current system sounds plausible. The inefficiency of overlapping inspection and excessive audit costs cannot be dismissed easily. However, we should consider carefully whether a competitive supervisory system is always inefficient and whether the government should monopolize financial oversight. Although the issue requires thorough and comprehensive study, it might be helpful if we look at the failures. 

No check on supervisory power

The latest crisis involving savings banks is similar to the U.S. Savings & Loan crisis of the mid-1980s in terms of the causes and growth of the problem, as well regulators` moral hazard and corruption. The U.S. crisis finally ended with tremendous costs, wasted taxpayer money injected into the industry, sweeping restructuring, the dismantling of the main regulatory body, harsh penalties on those in charge, and an economic recession.

South Korea seems to have learned few lessons from the case as it has repeated oversight failures several times, including the financial crisis back in 1998 and the savings bank debacle in recent months. I am not the only one who feels it is the same tune with a slightly different verse. All of the cases show the lack of an effective check on existing regulators. 

One of the serious problems unveiled from the savings bank debacle is that the regulators have not taken much pre-emptive action—even when they admittedly anticipated problems. A former ranking official at the FSS testified that auditors at the regulatory body avoided the post overseeing savings banks because they sensed trouble loomed ahead. If true, then oversight failed and there was dereliction of duty. Furthermore, most savings banks set up perfect cases of moral hazard by hiring former FSS officials as auditors. The irregular withdrawals of money by some savers ahead of the business suspension may develop into a serious corruption or law-breaking case.

 

The FSS has proposed eliminating the current auditor system and replacing it with an auditor committee as one of the major reform initiatives. But financial institutions have been encouraged to hire former FSS officials as auditors because they offer expert-level oversight. The financial companies are also motivated to lure former officials because they can be useful shields to investigations and can lobby authorities. Therefore, the current auditor system should be seen as a "revolving door" practice with regulators and those subject to inspection forming a close bond, rather than the so-called "parachute appointment." The practice of former regulators working for private companies will likely continue in a different form, such as auditor committees or outside auditors. When regulatory rules are changed or augmented, the financial companies will try to find loopholes and other ways to get close to regulators.

Competitive oversight is more effective

How to deal with the moral hazard problem goes back to the old question: Who will monitor the monitors? Clearly, the problem of moral hazard or conflicting interests cannot be resolved if the government agencies continue to hold monopoly power over financial oversight. The most effective way, although certainly not perfect, is to introduce competition to the system and conduct random and constant verification of inspection outcomes. 

The change requires overhauling the current monopoly system and allowing an independent body to conduct separate inspections and to verify the findings. It`s a secondary issue of how to define the government agency`s role in financial oversight or who will take the initiative. Policy makers should consider giving independent oversight authority to the Bank of Korea or Korea Deposit Insurance Corp. Cross-inspection or audits with intervals will help reduce the problem of overlapping oversight. Linking the findings to the inspectors` payrolls is another idea. The task force should avoid being entangled in a power struggle among related parties and instead focus more on drafting more specific solutions.

By Jang Dae-hong, professor of fiscal finance at Hallym University

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