Designing the Financial Future – Beyond One Size Fits All: Tailored Suits

An analysis of the modernization of prudential frameworks in the Dominican financial system and the need for differentiated regulation according to each institution’s business model.

“Just as a doctor would not apply the same protocol to treat heart, neurological and digestive problems, the Dominican financial system requires prudential frameworks designed specifically for each type of institution.”

The strategic potential of the Dominican Republic calls for a joint and deliberate effort to harness it sustainably. While this is a comprehensive commitment of all industries, the development and growth of the financial sector, especially the capital market, is recognized by the World Bank as a driver of economic development.

We have witnessed milestones that show this trend of development and confidence in the Dominican financial sector, including the opening of digital banks, the first share issuances, and bond issuances with exposure to international markets. Continuing that growth is a shared will of the private sector, regulators and investors.

The path toward strengthening the financial market is a tangible one and will inevitably guide part of the country’s strategic development and use of its potential. Like a doctor safeguarding the health of a patient, the International Monetary Fund (IMF) viewed positively initiatives such as implementing mark-to-market in the banking sector in 2026 and the future adoption of Basel II and III standards for capital requirements, capital buffers and liquidity.

The imminent modernization of prudential frameworks is not something isolated to banking; the Securities Market Superintendency has also taken important and calculated steps with a view to sustaining the sustainability of growth.

How far can it be harmonized?

There is a positive opportunity in that the prudential frameworks of the different financial players are being evaluated at the same time, which allows synergies and lessons to be leveraged.

However, the crucial question is: to what extent should institutions’ prudential or regulatory frameworks be harmonized?

Based on international understanding and experience, modernizing prudential frameworks should not aim to regulate more, but to regulate better. Protect depositors, investors and members, maintain the stability of the financial system, and allow each type of institution to operate under rules that recognize its real risks.

That means moving from static ratios to countercyclical requirements, capital buffers that vary according to risk exposures, forward-looking provisions and more sophisticated liquidity requirements.

Common factors: Building trust

While full harmonization would be ineffective – like using the same medical protocol to treat a heart, neurological and digestive problem – there are factors that can and should be common to the entire system:

• Corporate governance: Independent boards, risk/audit committees.
• Risk management: Identification, measurement, control, monitoring.
• Transparency: Regular reporting to supervisors and the public.
• Customer/member protection: Clear information, prohibition of abusive practices.
• Conflicts of interest: Mandatory identification and management.
• External audit: Annual, by qualified firms.
• Cybersecurity: Robust protocols against digital threats.

Recognizing Structural differences

Modernization must recognize the structural differences between business models. This includes how institutions create value, how they generate revenue, and the nature of their assets and funding sources.

Comparison of Functions and Revenue Sources of Key Financial Institutions

These fundamental differences in business models have direct implications for appropriate regulatory design.

1. The case of the AFPs: Operational Risk, not solvency

For Pension Fund Administrators (AFPs) and SAFIs, a fiduciary framework that recognizes these characteristics is required:

• They have no leverage.
• They do not own the assets they manage.
• Their risk is operational and conduct-related, not solvency.
• Their systemic impact comes from poor management of future pensions and/or assets under management.

2. Banks: Maturity Transformers and Credit Risk

The main objective of a commercial bank revolves around taking deposits and lending. They act as intermediaries by transforming short-term deposits into longer-term loans.

• The main source of income is the Net Income from the difference in rates.
• Their balance sheet structure and funding sources are characterized by large loan portfolios on the asset side with a stable and diversified deposit base that they use as their main source of funding.
• The use of instruments such as Repos is usually tied to short-term liquidity management, funding specific assets or acting as a market maker in Repos themselves as cash providers.
• The use of instruments such as Securities Lending is usually tied to balance sheet optimization through generating income from the institution’s investment portfolio.
• Credit risk focuses on comprehensive credit assessment processes for borrowers, sound loan underwriting standards, portfolio diversification, provisions for bad debts and stress testing. In addition, counterparty credit risk management for financial market activities. This is critically important given that the business focuses on lending.
• Their regulatory frameworks depend largely on capital adequacy, liquidity requirements, consumer protection and systemic risk. A Leverage Ratio is used with the aim of absorbing losses from lending activities, market movements and operational failures, protecting depositors and ensuring continued financial intermediation.

3. Securities Intermediaries: Trading and Market Risk

In the Dominican Republic, the operating structure and business model of Securities Intermediaries can be classified into two large groups:

a. Proprietary trading intermediaries: These intermediaries actively trade securities for their own account, taking market positions to generate profits. Their business model depends heavily on market timing, sophisticated trading strategies and the risk management of their own capital. These are the ones that could have dedicated units for quantitative analysis, algorithmic trading and portfolio management.

b. Client facilitation intermediaries: While they may take part in some principal transactions, their main focus is executing transactions for clients, providing research and offering advisory services. Their participation in funding transactions such as repos and securities lending is often driven by clients (for example, helping clients borrow securities to sell short or lend out their long positions) or by managing their own balance sheet for liquidity and funding purposes related to client activities.

To carry out the exercise of comparing against the same criteria as for banks, if we use the Securities Intermediaries that rely on proprietary trading we observe that they hold a base of self-owned securities trading that generates profits from market movements, arbitrage and related activities.

• The main source of income being trading gains and fees from related services.
• Their balance sheet structure and funding sources are characterized by having a large proportion of their portfolio in tradable assets and instruments. They depend heavily on the financial market, in particular on short-term secured or unsecured funding, Repos, SBBs, uncommitted credit lines and, at times, long-term debt. This suggests that they do not have a stable deposit base.
• The use of instruments such as Repos is usually related to funding their long positions or lending cash to create a synthetic short position. It is a critical part of managing their leveraged trading books and optimizing funding costs.
• The use of instruments such as Securities Lending is usually used to generate incremental yield on own instruments held for long periods or to obtain specific instruments for short positions or hedging positions.
• Credit risk focuses on assessing counterparty credit risk, collateral management and the legal enforceability of netting agreements. Since it is not a lending-focused business model, it is less important than in the banking sector, where exposure is concentrated in trading counterparties.
• Their regulatory frameworks usually revolve around market conduct, capital adequacy for trading risks, investor protection and systemic risk. Risk-based capital (e.g. IFR in Europe). The purpose is to ensure that the institution has enough capital to manage losses from trading, operating costs and to meet its commitments to clients.

Prudential Framework Approaches

For Banks a Basel-type approach is appropriate because they lend money and transform maturities. This framework answers the question “How much direct credit risk do you have?” or “How much capital do I need to absorb loan defaults?” under the oversimplified logic that these illiquid assets require a large buffer in order to keep operating.

For Brokerage Firms an approach is needed that answers the question “What risks does your business model generate?” or “How much capital do I need to wind down in an orderly way without harming clients?”, given that brokerage firms do not lend massively and the logic that illiquid assets plus a proportion of fixed expenses must be quantified to allow an orderly closure.

A similar analysis to the above led to the proposal of the Investment Firms Regulation (IFR) (Regulation (EU) 2019/2033) and the Directive (IFD) (Directive (EU) 2019/2034) in the European Union. This prudential framework is tailored to investment firms, with a risk-adjusted classification system that distinguishes three classes of institutions:

“Tailored Suits”: a bet on maintaining a solid future

It is clear that a modernization of prudential frameworks in the Dominican financial system must have common concepts that leverage shared synergies and lessons.

But it must also consider the structural differences that the different business models create and their material risks.

This modernization is not a race to be run separately, much less one size fits all. It is the construction of tailored suits between the market and the monetary and financial regulators, who recognize the similarities and differences that allow our financial sector to grow in a solid, stable and specialized way in step with the country’s potential.

Author: Priscilla Morales

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Member of the Market and Liquidity Risk Committee of the Dominican Republic Risk Management Club (CGRRD).

Risk specialist with broad experience and a track record in the Capital Markets and Banking industries. With skills in Financial Risk, Risk Management, Corporate Finance, Financial Regulation, Prudential Standards, Corporate Governance and Risk-Based Supervision.