BF 350: REGULATORY FRAMEWORK

OF FINANCIAL INSTITITUTIONS

LECTURE NOTES: UNIVERSITY OF

LUSAKA
 COURSE OBJECTIVES
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 To Examine the structure of regulation of financial

markets in Zambia
 To provide the basic principles relating to regulation
of financial markets
 To consider the challenges posed by the current
structure and legal framework for regulating
financial markets in Zambia

Bank of Zambia 23-Oct-19

 Concept of Financial Markets
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 Financial markets are markets in which banks and

other financial Instititutions provide a variety of
financial services and products which facilitate the
production, distribution and consumption of goods
and services as well as the distribution of income
and, crucially, entitlements to income

Bank of Zambia 23-Oct-19

 Financial Markets: Overview
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Money Markets(1)

Capital Markets(2)
Monetary Financial
Authority(6) Market
Foreign Exchange
Markets

Financial
Derivatives Market

Bank of Zambia 23-Oct-19

 Nature of the Financial Markets
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 What do financial markets do? (1)(2)

- provide investment finance
- improve allocative efficiency
 The nature of financial intermediaries (3)(4)

Bank of Zambia 23-Oct-19

 Regulation of Financial Markets
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 The evolution of financial markets has been

particularly significant in the last decades with
regard to intermediaries and financial instruments.
 Structural changes have mainly involved the more
traditional financial operators in banking,
investment firms and insurance companies.
 Regulatory arrangements have also been an object of
significant change in response to developments in
the financial system.

Bank of Zambia 23-Oct-19

 Models for financial market regulation and Supervision
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1.0 Financial Market Regulation

 The theoretical underpinning for public intervention
matters is traditionally based on the need to correct
market imperfections and unfair distribution of
resources.
 Three more general objectives of public intervention
include: the pursuit of stability, equity in the distribution
of resources and the efficient use of resources.
 The regulation of financial system can be viewed as a
particularly important case of public control over the
economy

Bank of Zambia 23-Oct-19

 Continued
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 The accumulation of capital and the allocation of

financial resources constitute an essential aspect in the
process of economic development.
 The peculiarities of the financial intermediation and of
the operators who perform this function justify the
existence of a broader system of controls with respect to
other forms of economic activity.
 Various theoretical motivations have been advanced to
support the opportunity of a particularly stringent
regulation for banks and other financial intermediaries.
Such motivations are based on the existence of particular
forms of market failure in the financial system(1)

Bank of Zambia 23-Oct-19

 Objectives of financial market regulation
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 The definition of the term “financial market” has traditionally

included the banking, financial and insurance segments.
 The bounds dividing institutions, instruments and markets
were clear-cut, so that further distinctions were drawn within
the different classes of intermediaries (with banks specialized
in short or medium/long term maturities, or along
functional/commercial operations etc.)
 However, the bounds dividing the various types of financial
institutions are becoming increasingly blurred.
 In general financial markets could be referred to as an
economic space wherein operators of various kinds (banks,
Mutual funds, insurance companies and pension funds) offer
financial instruments and services.

Bank of Zambia 23-Oct-19

 Cont’d
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 A primary objective of financial market regulation is the

pursuit of macroeconomic and microeconomic stability.
 Safeguarding of the stability of the system translates into
macro controls over the financial system.
 Measures pertaining to the micro stability of the
intermediaries could be divided into two; general rules on the
stability of all business enterprises and entrepreneurial
activities, such as the legally required amount of capital,
borrowing limits and integrity requirements; and more specific
rules due to the special nature of financial intermediation,
such as risk based capital ratios, limits to portfolio investments
and the regulation of off-balance sheet activities.

Bank of Zambia 23-Oct-19

 Cont’d
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 A second objective of financial regulation is transparency in the market

and in intermediaries and investor protection. This is linked to the more
general objective of equity in the distribution of the available resources and
may be mapped into the search for “equity in the distribution of
information as a precious good” among operators.
 At a macro level, transparency rules impose equal treatment and the
correct dissemination of information.
 At the micro level, such rules seek non-discrimination in relationships
among intermediaries and different customers (conduct of business rules).
 A third objective of financial market regulation, linked with the general
objective of efficiency, is the safeguarding and promotion of competition in
the financial intermediation sector. This requires rules for control over the
structure of competition in the markets and at micro level, regulations in
the matter of concentrations, cartels and abuse of dominant positions
 Specific controls over the financial system is justified by the forms that
competition can assume and are related to the promotion of competition as
well as to limiting possible destabilization excesses generated by
competition itself

Bank of Zambia 23-Oct-19

 Financial market supervisory models
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 There is neither a unique theoretical model nor just

one practical approach to the regulation and
supervision of the financial markets.
 Significant differences are found in the literature in
terms of both definition and classification of
regulatory models and techniques.
 There are generally four recognized
approaches to financial market regulation and
supervision: “institutional supervision”, ‘Supervision
by objectives”, “Functional supervision” and “Single-
Regulator Supervision.

Bank of Zambia 23-Oct-19

 Institutional Supervision
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 In the more traditional “institutional approach”, supervision is

performed over each single category of operator (or over each single
segment of the financial market) and is assigned to a distinct agency
for the entire complex of activities. In this regulatory model, which
follows the traditional segmentation of the financial system into
three markets, there are three supervisory authorities. As is the case
in Zambia, the three regulators are the Bank of Zambia for the
banking and non-bank financial institutions, Securities and
Exchange Commission for the Capital markets and the Pensions and
Insurance Authority providing regulatory oversight for insurance
and pensions fund businesses. The authorities control
intermediaries and markets through entry selection
processes(licensing, authorizations), constant monitoring of their
business activities (controls, inspections and sanctions and eventual
orderly exits from the market (suspensions, liquidations etc.)

Bank of Zambia 23-Oct-19

 Cont’d
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 Institutional regulation facilitates the effective realisation of controls being

performed with regards to regulated entities as to every aspect of their
activity and so as to all the objectives of regulation.
 Each intermediary and market has only one supervisory authority as a
counterpart.
 The latter, in turn, is highly specialized. As a result, duplication of controls
is avoided and the costs of regulation can be considerably reduced.
 The institutional approach seems to be particularly effective in cases of
intermediaries of a very similar type and that do operate in just one of the
three traditional segments of financial intermediation.
 Institutional model may also give rise , in the presence of more subjects
entitled to perform the same financial intermediation activities, to
distortions in the supervisory activity caused by the enforcement of
different dispositions for operations of the same nature that are executed
by different entities.
 The disadvantages of this approach are represented by the previously
mentioned trend toward multiple sector activities and by the progressive
de-specialization of the intermediaries.

Bank of Zambia 23-Oct-19

 Functional Supervision
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 The third regulatory model is the functional

supervision or supervision by activity. It considers as
“given” the economic functions performed in the
financial system; unlike other lines of thought
regarding supervisory activities, this approach does
not postulate that existing institutions whether
operative or regulatory

Bank of Zambia 23-Oct-19

 Supervision by Objectives
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 The supervisory model by objectives (or by finalities) postulates that all intermediaries and markets are
subjected to the control of more than one authority, each single authority being responsible for one objective
of regulation regardless of both the legal form of the intermediaries and of the functions or activities
performed. According to this schemes, an authority is to watch over both market stability and the solvency of
each intermediary, whether in banking or insurance or the capital markets; another authority will be
responsible for the transparency of financial markets and will control the behavior of banks, financial
intermediaries and insurance companies towards customers; a third authority will guarantee and safeguard
competition over the entire financial market and among intermediaries.
 The basic advantage of this regulatory model lies in the fact that it is particularly effective in a highly
integrated market context and in the presence of polifuntional operators, conglomerates and groups operating
in a variety of different business sectors. Similarly, it does not require an excessive proliferation of control
units.
 The most attractive feature of this approach is that it provides uniform regulation for different subjects
engaged in similar activities.
 When compared to the institutional model, a regulatory framework organised by objectives may produce a
certain degree of multiplication of the controls. And sometimes it could lead to the lack of certain controls.
 Indeed, the specific assignment of competencies with respect t the objectives of regulation is not necessarily
univocal and all-inclusive in practice
 In such a model, each intermediary is subject to the control of more than one authority, and this may be more
costly. The intermediaries might in fact be required to produce several reports relating to supervision, often
containing identical or similar information.
 At the same time, the intermediaries may have to justify the same action to a whole set of authorities
contemporaneously, even though for different reasons.
 Equally, a deficit of controls might occur whenever exact areas of responsibility are not clearly identifiable in
specific cases.

Bank of Zambia 23-Oct-19

 -The End-
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Thank You!

Bank of Zambia 23-Oct-19