If banks and insurers could improve transparency, it would yield benefits around regulatory capital requirements, according to an actuarial study conducted by Ernst & Young.
Differences exist in the treatment of products that are economically equivalent and may create regulatory arbitrage opportunities and market distortions, according to the research project, which was chaired by actuary Tony Coleman.
“In some instances, inconsistencies may result in a product provider choosing to manage a product from a part of a group where lower capital standards apply and therefore where a higher return on equity could be achieved,” Coleman said.
Materially different regulatory capital requirements exist in the area of term deposits and term certain annuities, where both products provide guaranteed returns for consumers, but annuities have higher capital requirements because they are provided by life insurers rather than banks.
Higher capital requirements have the effect of lowering the overall return and relative attractiveness of term certain annuities, which needs to be considered in the context of broader public policy, the research found.
At a framework level, provisioning is treated differently between banks and insurers, despite conceptually seeking to achieve a similar purpose.
“The research also sought to recognise that any proposed regulatory reforms focused on greater consistency must also consider the interconnected nature of the financial system and the potential for systemic risks,” Coleman said.
Achieving consistency between sectors is not straightforward, particularly since the Australian Prudential Regulation Authority (APRA) is constrained by history as well as international regulatory developments, the paper noted.
Increased transparency would also benefit both the banking and insurance sectors and would allow a better understanding of the impact of current regulatory reform, highlight areas of potential regulatory arbitrage, enhance decision making within the sectors by increasing awareness of best practice, and improve understanding of the quantum of capital buffers that would assist in risk/reward decisions, according to the research.
