Financial regulation in transition
FSS shifts focus to 'consumer protection' from 'financial stability'
By Kim Jae-kyoung
The global financial crisis triggered by the U.S. subprime mortgage meltdown in 2008 has changed the landscape of financial markets and regulations. The look of the financial sector has since changed toward “bigger government” and “more regulation.”
The Wall Street crisis has exposed inherent flaws of the free market capitalism, forcing financial regulators to fix their financial systems with public money and to find ways to keep markets afloat.
One of the biggest lessons from the unprecedented crisis was that financial firms, including investment banks, were prospering at the expense of consumers and the whole financial system. In other words, the crisis has shown how poor standards of consumer protection can spread instability throughout the entire financial system.
In short, following the crisis, there has been a major transformation in the financial regulatory scheme worldwide as regulators have shifted the focus of their policies toward “consumer protection” from “financial soundness.”
In Korea, after the country was hit by a couple of financial crisis over the past decade, regulators have placed a top priority on ensuring stability of the financial system and sometimes applied lax regulation to troubled financial firms.
This has led to unwanted outcomes, such as savings bank scandals. Financial firms’ attempts to multiply short-term gains for shareholders have incurred losses for a number of retail investors but in many cases, regulators did not take proper actions under the pretext of protecting financial stability.
However, Korea is now emerging as one of the advanced countries that are taking the lead in this regulatory transformation as the chief of the nation’s top financial watchdog is well aware of urgency for financial regulatory reform.
New era of regulation
“So far we have done our job with too much ease, with too much focus on supervision only on the soundness of financial companies,” Financial Supervisory Service Governor Kwon Hyouk-se said in an interview with Business Focus at his office in Yeoui-do, Seoul on Nov. 17.
“When it comes to regulation, I think that we have been rather in favor of financial firms in the name of ensuring the stability of the financial system, which I believe has diminished consumers’ trust,” he added.
According to him, the savings bank scandal, which has swept through Korea’s political and financial circles, is an example of how a policy decision focusing only on financial soundness makes things worse.
“The savings bank fiasco, I think, is the result of the financial watchdog making a policy decision (issuance of subordinated bonds) to keep troubled savings banks afloat at the expense of consumers,” he said.
“Now it’s an era of consumer protection. Supervising the financial soundness of banks is the foundation for good regulation. The ultimate value we have to pursue, however, is consumer protection. Since we have overlooked this side, the public distrust has been building up,” he added.
In order to address this issue, the FSS has set up a special supervision bureau in charge of consumer protection. “We are now trying to reflect voices of consumers in every decision-making process,” he said.
The comments by the 55-year-old governor imply that the nation’s financial watchdog will tip the balance of its regulatory policies in favor of consumer protection.
The shift in regulatory policies has huge implications for financial firms as it can be taken as a sign that when there is a conflict between consumers and financial firms, on such issues as market manipulation and voice phishing, the financial watchdog will look into cases more from the consumers’ perspective.
The move is in line with global trends in regulation. In an article “Creating Shared Value” to Harvard Business Review in January-February edition, Havard University professor Michael E. Porter and FSG managing director Mark R. Kramer stressed that regulations should be designed to protect not only the financial system but also all the stakeholders.
“Regulation is necessary for well-functioning markets, something that became abundantly clear during the recent financial crisis. However, the ways in which regulations are designed and implemented determine whether they benefit society or work against it,” they wrote
“Regulation will be needed to limit the pursuit of exploitative, unfair, or deceptive practices in which companies benefit at the expense of society. Strict antitrust policy, for example, is essential to ensure that the benefits of company success flow to customers, suppliers, and workers.”
Creating a bigger pie
In Kwon’s view, the purpose of financial firms, including banks, should be redefined as not only creating profits for shareholders but also creating values for all stakeholders in society.
Financial firms in his words should play key roles in minimizing gaps in polarization and thus creating a bigger pie of profits and revenues that benefit the entire society.
“Korea’s financial firms have made money too easily. Such era is gone. They must understand that profitability and financial soundness are not everything that they should pursue,” Kwon said.
Particularly, the career bureaucrat, who took the helm of the FSS in March, criticizes banks for focusing only on maximizing profits when the economy is in difficult situation.
“When banks do business, they should always think about compliance and ethics. They have to make sure that their activities will not harm consumers. Furthermore, they have to return part of their profits to society,” he said.
He also called for local banks to play the bigger role of a corporate citizen by overhauling their corporate social responsibility (CSR) programs.
In the eyes of Governor Kwon, local banks’ corporate social responsibility programs have emerged largely to improve firms’ reputations under external pressure and are treated as necessary expense.
“After the financial crisis, polarization has been deteriorating. I believe that financial firms should play a certain role in addressing this issue. They should pay more attention to CSR activities,” he said.
Kwon suggests that each bank finds a specialized area in CSR activities.
“So far most local lenders’ CSR activities scatter in many areas, which I think is not desirable. Instead they should choose one area and concentrate on it to add actual values to society,” he said.
The governor thinks that boards are not doing their jobs. He emphasized that the boards should play a bigger role to protect consumers and serve as the agent of long-term value creation.
“We need more independent and stronger boards to ensure ethical management at financial firms and expansion of CSR activities.”