Introduction

The literature on the Asian financial crisis typically contends that financial liberalization and the removal of obstacles to foreign borrowing by banks and the corporate sector, coupled with poor and inadequate prudential supervision, gave rise to the risk of moral hazard and the resulting financial crisis. Consequently and not surprisingly, the enhancement of prudential regulation and supervision¹ of banks through the adoption of international standards or "best practices" was among the recommendations and prerequisites for the recovery of the affected Asian economies. The architecture of financial supervision and any need for change also became an important issue to be addressed. Thus, strengthening the supervisory mechanism under the International Monetary Fund (IMF) programs for Indonesia, the Republic of Korea, and Thailand also required the establishment of integrated prudential regulators (Gochoco-Bautista et al., 1999). However, to date, only the Republic of Korea has managed to completely undertake such a reform. In fact, the desirability of unified regulatory agencies—that is, agencies that supervise two or more of the traditional financial services sectors—has in itself become the focus of significant research recently. The primary reason has been the trend towards the forming of financial conglomerates.

This paper examines the issue of reforming financial regulatory structures from the New Institutional Economics perspective. That is, it investigates how the broader institutional environment prevailing in a developing country like the Philippines may affect the institutional arrangements for financial regulation, and how these might be taken into consideration when designing or reforming financial regulatory structures.

The paper has six sections. Section II describes the state of financial conglomerates in the Philippines and how they are currently supervised to determine whether any significant reform in the financial regulatory structure is warranted. Section II also discusses how the Philippine experience compares to those in other countries in the region. Section III discusses the supervisory implications of financial conglomeration, and the various regulatory approaches that have been adopted to address them. In Section IV, the role of institutions in economic development is discussed, particularly as seen through the New Institutional Economics (NIE) paradigm. The overall institutional environment of the Philippines is also discussed. Drawing on the NIE perspective, alternative approaches taking an institutional perspective to view financial sector issues and policies are then presented in Section V. In particular, the issue of reforming financial regulatory structures is analyzed from the new political economy perspective. Finally, Section VI presents some recommended modifications to the financial regulatory framework in the Philippines.

This paper does not cover the theoretical arguments for and against financial conglomerates or the historical rationale, evolution, and supervision of financial conglomerates in the Philippines. Neither does it analyze the various regulatory approaches, including the trend towards having a single financial regulator model. These approaches have been discussed in an earlier paper.² Current regulatory problems in individual financial sectors that are not directly related to financial conglomerates are mentioned to highlight the key issue with respect to the Philippine financial regulatory framework.

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