LONDON – When Mark Carney replaces Mervyn King as Governor of the Bank of England in July 2013, the world will be deprived of King’s witty public utterances. My personal favorite came when, commenting on strong retail-sales figures during one Christmas period, he cast doubt on their significance for assessing the state of the economy. “The true meaning of the story of Christmas” he solemnly intoned, “will not be revealed until Easter, or possibly much later.” A new career on the stage, or in the pulpit, surely beckons.
King’s most quoted phrase is that “global banking institutions are global in life, but national in death.” They trade globally, across porous borders, attaching little significance to the geographical location of capital and liquidity. But, when the music stops, it is the home regulator, and the home central bank, that picks up the tab, even if the losses were incurred elsewhere. By the same token, a failing bank may leave behind a mess in third countries, which its home authorities may not clean up.
Icelandic banks, for example, took deposits in the United Kingdom and the Netherlands, and swept them back to Reykjavik, leaving the host countries out of pocket. Likewise, the collapse of Lehman Brothers left European creditors more exposed than those in the US, whose funds had been wired home to New York on the Friday before the end.
Regulators have been wrestling with this problem for years, without conspicuous success. In mid-December, the Bank of England (BoE) and the United States Federal Deposit Insurance Corporation (FDIC) announced what seemed like a breakthrough, at least concerning the major banks headquartered in the US or the UK – that is, 12 of the 28 institutions regarded by the Financial Stability Board as globally systemic. In their case, a resolution authority, in London or Washington, would take control of the parent company, remove senior management, and apportion losses to shareholders and unsecured creditors.
It sounded plausible. BoE officials declared firmly that they were prepared to trust their American counterparts, and would not step in to grab subsidiaries or assets based in the UK. “This is a journey that involves trust,” said BoE Deputy Governor Paul Tucker. But the Anglo-American love-in quickly soured when the FDIC chairman was asked to give the same assurances of confidence in the British authorities. According to the Financial Times, he “laughingly declined.”
Indeed, while the FDIC and the BoE were working on their plan, the US Federal Reserve was developing proposals that will expose overseas banks in the US to a far tighter set of controls, and closer supervision, than they have hitherto experienced. The Fed is seeking to oblige foreign banks to create a holding company to own their separately capitalized subsidiaries, effectively giving the Fed direct oversight of their business. They will also be required to maintain stronger capital and liquidity positions in the US.
The justification offered for these new impositions is that overseas banks have moved beyond their traditional lending business to engage in substantial and often complex capital-market activities. “The crisis revealed the resulting risks to US financial stability,” said Fed Governor Daniel Tarullo. The UK’s Financial Services Authority has been invoking the same rationale for requiring foreign banks to establish local subsidiaries, rather than taking deposits or lending through a branch of the parent bank.
On the face of it, these moves appear to be well justified, given the mayhem created by poorly regulated banks in the major financial centers. But we should be clear that these changes are not just tinkering at the edges. They amount to a reversal of decades of policy by American and British regulators.
Ernest Patrikis, a former Fed supervisor, points to the clear implication that in the US domestic banks will have a strong advantage over foreign banks. More dramatically, he asserts that “subsidiarization would be the end of international banking.”
Larry Fink, the CEO of the multinational investment-management firm BlackRock, takes a similar view: “It really throws into question [the] whole globalization of these firms,” with “each country for [itself].” He adds: “I wouldn’t call it a trade war, but I would certainly call it a high level of protectionism.” One delicious irony in Europe is that Chinese banks are contesting the requirement to subsidiarize in London on precisely those grounds.
For now, high-octane worries about protectionism are probably overdone. And it is difficult to deny that the Fed should take a close interest in the funding strategies of foreign banks operating in the US. Another Fed governor, Jeremy Stein, has pointed out that foreign banks have dollar liabilities of roughly $8 trillion, much of it short-term wholesale funding.
But there is a risk that these interventions are the thin end of a dangerous wedge. Forced subsidiarization causes capital and liquidity to be trapped in local legal entities, reducing the effectiveness with which that capital is used. At a time when bank capital is scarce, that impediment carries significant economic costs.
Moreover, tools that may be used wisely and well by institutions with a global outlook, like the Fed and the Bank of England, could take on a different character in countries where a commitment to free and open markets cannot be taken for granted. So we must hope that the US and British authorities move carefully and do not use their new powers to freeze out foreign competition. “Be careful what you wish for” is wise advice in the regulatory world, as it is elsewhere.