When Mark Carney replaces Mervyn King as Governor of theBank 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 figuresduring one Christmas period, he cast doubt on their significance for assessingthe state of the economy. “The true meaning of the story of Christmas” he solemnly intoned, “will not be revealed until Easter, orpossibly much later.” A new career on the stage, or in the pulpit, surely beckons.
King’s most quoted phrase is that “global bankinginstitutions are global in life, but national in death.” They trade globally,across porous borders, attaching littlesignificance to the geographical location of capital and liquidity. But, whenthe music stops, it is the home regulator, and the home central bank, thatpicks up the tab, even if the losses were incurred elsewhere. By the same token, a failing bank may leave behind a mess inthird countries, which its home authorities may not clean up.
Icelandic banks, for example, took deposits in the UnitedKingdom and the Netherlands, and swept them back to Reykjavik, leaving the hostcountries out of pocket. Likewise, the collapse of Lehman Brothers leftEuropean creditors more exposed than those in the US, whose funds had beenwired home to New York on the Friday before the end.
Regulators have been wrestling withthis problem for years, without conspicuoussuccess. In mid-December, the Bank of England (BoE) and the United States Federal Deposit Insurance Corporation (FDIC)announced what seemed like a breakthrough, at leastconcerning the major banks headquartered in the US or the UK – that is, 12 ofthe 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, removesenior management, and apportion losses toshareholders and unsecured creditors.
It sounded plausible. BoE officials declared firmly thatthey were prepared to trust their American counterparts, and would not step in to grab subsidiaries or assets based in theUK. “This is a journey that involves trust,” said BoE Deputy Governor PaulTucker. But the Anglo-American love-in quicklysoured when the FDIC chairman was asked to give the same assurances ofconfidence in the British authorities. According to the Financial Times, he “laughingly declined.”
Indeed, while the FDIC and the BoE were working on theirplan, the US Federal Reserve was developing proposals that will expose overseasbanks in the US to a far tighter set of controls, and closer supervision, thanthey have hitherto experienced. The Fed is seeking to obligeforeign banks to create a holding company to own their separately capitalizedsubsidiaries, effectively giving the Fed direct oversight of their business.They will also be required to maintain stronger capital and liquidity positionsin the US.
The justification offered for these newimpositions is that overseas banks have moved beyond their traditional lendingbusiness to engage in substantial and often complex capital-market activities. “The crisis revealed the resulting risks to US financialstability,” said Fed Governor Daniel Tarullo. The UK’s Financial ServicesAuthority has been invoking the same rationalefor requiring foreign banks to establish local subsidiaries, rather than takingdeposits 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 regulatedbanks in the major financial centers. But we should be clear that these changesare not just tinkering at the edges. They amount to a reversal of decades of policy by Americanand British regulators.
Ernest Patrikis, a former Fed supervisor, points to theclear implication that in the US domestic banks will have a strong advantageover foreign banks. More dramatically, he asserts that “subsidiarization would be the end of international banking.”
Larry Fink, the CEO of the multinationalinvestment-management firm BlackRock, takes a similar view: “It really throwsinto 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 callit a high level of protectionism.” One delicious irony in Europe is thatChinese banks are contesting the requirement tosubsidiarize in London on precisely those grounds.
For now, high-octane worriesabout protectionism are probably overdone. And it is difficult to deny that theFed should take a close interest in the funding strategies of foreign banksoperating in the US. Another Fed governor, Jeremy Stein, has pointed out that foreign banks have dollar liabilities ofroughly $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 locallegal entities, reducing the effectiveness with which that capital is used. Ata time when bank capital is scarce, that impedimentcarries significant economic costs.
Moreover, tools that may be used wisely and well byinstitutions with a global outlook, like the Fed and the Bank of England, couldtake on a different character in countries where a commitment to free and openmarkets cannot be taken for granted. So we must hope that the US and Britishauthorities move carefully and do not use their new powers to freeze outforeign competition. “Be careful what you wish for” is wise advice in theregulatory world, as it is elsewhere.