17 October 2013

BoE/Bailey: Regulating international banks

Speaking at the BBA Annual International Banking Conference, Bailed explained the PRA's thinking on issues concerning the pressures on international banking business and the establishment and supervision of foreign bank branches in London.

The five or six years since the outbreak of the financial crisis have seen signs of a reversal of some aspects of the greater openness we had seen in the 1980s and 1990s. And probably none more so than the decline in cross-border bank lending. Moreover, the UK experience in terms of lending has been amongst the more pronounced. But again, does this matter? My answer is yes. First, because many of us do believe in the economic benefits of free trade and capital flows, as well as the contribution of migration to balancing supply and demand in the economy. Second, and closer to home, the City of London and its financial markets benefit hugely from, and are at the hub of, the open world economy.

International wholesale banking is therefore an important part of maintaining and developing the world economy, just as it was in the 19th century... Yet, we have to recognise that in the last five or six years of the crisis we have gone backwards. Cross-border bank lending has declined more sharply than overall lending – home preference has set in. And, the banking system has become more fragmented or “balkanised”, with a preference for banks to subsidiarise in countries beyond their home state, and for regulators to wish for – and achieve – the location of more capital and larger pools of liquid assets in their jurisdictions. We should not be surprised by this, but nor should we accept that it is inevitably with us as a permanent feature. The reasons why we have seen these changes are not hard to explain. Major concerns about sovereign creditworthiness undermine stable banking activity across borders, another important lesson of history. Combined with that, as authorities we have had bad experiences in trying to deal with and resolve failed banks headquartered in other countries. It is not surprising that the natural reaction is to make sure in future we have “got the money.

But, and this is the important point, we should not design the world as if fragmentation and balkanisation are inevitably always likely to be with us. That is a counsel of despair, and it contradicts everything I said earlier about the benefits of free trade. How, therefore, should we think about, and act upon, this design challenge? A key issue here is bank resolution. Indeed, arguably it is the cornerstone of making progress. The reason is that without confidence in how we would in future resolve banks operating across borders – typically therefore the larger banks – we are unlikely to break down the trend towards fragmentation. This is because some of the most difficult legal and structural issues in bank resolution concern enabling cross-border solutions to take effect, and this is true whether the resolution plan involves holding the firm together – Single Point of Entry unitary resolution – or breaking it up under a Multiple Point of Entry resolution. For instance, either way it will be important to effect a stay on triggering default clauses in contracts.

The big point here is to achieve resolution planning which creates sufficient confidence among national authorities that there is greater trust, and therefore a greater willingness to assume, for instance, that capital and liquid assets are moveable and can be employed across countries when needed. It is an essential pre-condition for confidence in cross-border bank activity and likewise it provides an important counterweight to policies that trap capital and liquid assets in host jurisdictions. In turn this allows a more neutral stance on the subsidiarisation versus branching issue.

Resolution is the toughest nut to crack in the financial reform package, but it is also the one that does more to unlock other issues, including the appropriate steady-state end-point for the bank capital regime. Put simply, the answer is different in a world of effective resolution that ends too big to fail. But in the alternative outcome, where too big to fail remains and there are doubts around the effectiveness of resolution, it is hard to avoid the conclusion that higher capital requirements will follow, and cross-border establishment will be through subsidiaries.

The real progress that PRA has made on resolution issues makes it reasonable to start to take steps towards planning for a safe resumption of the growth of cross-border banking in ways that had been in some senses discouraged, and sometimes with a history of discouragement going back before the onset of the crisis. A good example of this is the PRA’s approach towards branches from outside the European Economic Area. This Approach document concluded that the PRA would in due course publish a fuller statement on the PRA’s approach to the supervision of overseas firms operating in the UK. To take that forward, over the summer the PRA Board, acting in its new statutory capacity considered the PRA’s policy further. It endorsed the account, but added one important further condition, namely that the PRA does not wish to see non-EEA branches undertaking critical retail banking functions (like taking deposits) beyond de minimis levels unless there is some good reason and importantly there is a very high level of assurance on resolution. In particular, the PRA thinks that new non-EEA branches should stick to straightforward wholesale banking, of the type that supports world trade and capital flows.

Resolution will be a key deciding factor in the PRA’s judgements, and it is thus where the PRA will place emphasis when forming a view on its risk appetite towards branches operating in the UK. The PRA will therefore expect assurance from the home state regulator over the recovery and resolution plans and assess if the plans adequately cover the UK branch’s activities. For banks with small UK activities, the PRA will expect to gain a level of assurance that is relative to the scale of the UK activities.

Full speech

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