14 November 2011

Erik Berglof: Cross-border banking in the balance

Berglof writes in Project Syndicate that no region of the world has benefited more from cross-border banking, yet these achievements are now at risk – and with them the European bank groups themselves.

When the global crisis erupted in 2008, there was no regulatory framework to protect the cross-border networks, and large vulnerabilities, in the form of excessive leverage and foreign exchange, were exposed. Much has been achieved since then: balance sheets have been strengthened and funding models adjusted. Along with institutional reforms at the European level – particularly the creation of the European Systemic Risk Board and the European Banking Authority – regulation and supervision have been reinforced in subsidiaries’ host countries.

Even so, the threat to financial stability is possibly even graver today than it was in 2008, as the capacity of Western European governments to backstop banking systems is clearly reaching its limits. Allowing foreign banks’ subsidiaries to become orphaned amid a worsening crisis in home countries would undermine confidence in emerging Europe’s financial systems, which could trigger asset-price declines and precipitous contractions in credit. Ultimately, this would boomerang back on Western European banks, given their deep financial and real linkages with the region.

In 2008, such a catastrophic scenario was narrowly avoided, owing to policy intervention, including the coordination effort under the so-called Vienna Initiative (in which the European Bank for Reconstruction and Development, among others, was involved). A new pact to secure the achievements of financial integration is now urgently needed. Authorities from these banks’ home and host countries must sit down together.

As with the Vienna Initiative, a “Vienna 2.0” would require commitments by all concerned parties. In responding to the higher capital requirements imposed by authorities, and choosing whether to raise more capital or sell off assets, the banks must take into account the important role that their subsidiaries play in many countries. For many banks, this happens naturally – their subsidiaries, as important value creators, are critical to their business models. For some, however, the subsidiaries are smaller relative to the parents’ size – and thus less central to their strategies.

Home countries must also contribute. Within the eurozone, any recapitalisation, guarantees, and other funds offered to parent banks should be made available to subsidiaries in equal measure. Any restructuring requested in return for capital support should take into account the cross-border nature of the groups and not discriminate against subsidiaries abroad.

Subsidiaries’ host countries, for their part, must reassure parent banks that financial regulation will remain predictable. Some of the recent abrupt – and at times overly ambitious – measures to tax the industry or redistribute the burden of foreign-currency loans have undermined capital cushions and set back recovery in credit and growth.

All of this requires coordination. The European Banking Authority has a chance to establish itself. It must ensure that national interests do not undermine the integrity of the cross-border bank groups. Ultimately, we need a Europe-wide deposit insurance and bank-resolution authority that can take over and restructure failed banks.

Just as the eurozone has fostered financial development and economic growth among its members, the current crisis now risks inflicting severe collateral damage far beyond its borders. Any sustainable solution to the crisis must ensure the integrity of the bank groups and respect the interests of these banks’ home and host countries. Ultimately, it is cross-border banking that is in the balance.

Full article

© Project Syndicate