Balancing supervisory practices and economic development

By Andreas Charalambous and Omiros Pissarides

In recent years, and especially after the global crisis of 2008, supervisory requirements in the financial sector have been strengthened significantly. Taking into account the potential economic and political cost, and in an effort to protect their citizens from the risk of sudden and unpredictable socio-economic upheavals, many governments have introduced new and enhanced legislative and other regulatory requirements for investment firms, banks, insurance companies, provident funds, etc.

Based on the experience of the last couple of decades, it would be difficult to express, either from an ideological or any other point of view, serious criticism against strict supervision. The questions, however, that warrant an answer are to what extent supervision is implemented in a proportionate way and if it serves the purpose for which it was created, i.e. whether well-meaning intentions actually lead to the desired outcome and contribute to economic development. To answer these questions, three factors must be considered:

First, whether the increased costs required to comply with the expanding supervisory requirements are commensurate with the benefits.

Second, whether the increased requirements create conditions that favour larger companies and/or larger states, thereby restricting healthy competition. In the EU, for example, supervisory requirements are applicable in an identical manner to all member states, from Germany to the smaller countries.

Third, globalisation facilitates access of financial institutions to multiple jurisdictions, potentially creating conditions for asymmetric competition given the absence of universally accepted regulatory standards.

In such a context, it is obvious that the balancing of different objectives is required. Over the last few years, it has become evident that, from a short-term and medium-term perspective, an economy cannot be open and simultaneously grow rapidly under conditions of economic stability. Worldwide experience confirms that, of these three features, only two can apply at the same time. An economy that is open and stable is typically characterised by a relatively low rate of economic growth. A fast-growing, stable economy is often associated with the imposition of trade constraints, such as that of China. Finally, an economy that is open and expanding rapidly is generally characterised by instability, as has been observed many times e.g. in the USA. The appropriate approach to the latter example is strict supervision, which does not seem to have a particularly negative effect on economic growth prospects.

In conclusion, the answer to the above identified trilemma seems to be the pursuit of a balanced and rational approach. The goal should be the establishment of an economic system that facilitates the functioning of an open economy with a reasonable growth rate, based on a stable supervisory framework.

In Cyprus, we should take into account the lessons of the past decades and set up an operational framework which is supported by a stable long-term strategy that combines a vision for growth and economic stability with a modern supervisory and business friendly framework.

Andreas Charalambous is an economist and a former director in the Ministry of Finance.

Omiros Pissarides is the managing director of PricewaterhouseCoopers Investment Services.