Global banking, a model promoted for more than 30 years by financial conglomerates cobbled together through cross-border mergers, is colliding with the post-crisis reality of stricter national regulation.
Daniel K. Tarullo, the Federal Reserve governor responsible for bank supervision, announced plans last week to impose the same capital and liquidity requirements on the U.S. operations of foreign lenders as on domestic companies. The U.K. and Switzerland also have proposed banking and capital rules designed to protect their national interests.
Regulators want to curtail risks exposed after global banks such as New York-based Citigroup Inc. (C), Edinburgh-based Royal Bank of Scotland Group Plc and Zurich-based UBS AG (UBSN) took bailouts in the biggest financial crisis since the Great Depression. Forcing lenders to dedicate capital and liquidity to multiple local subsidiaries, rather than a single parent, may undermine the business logic of a multinational structure.
“Being big and spread out all over the world isn’t what it used to be,” said Mayra Rodriguez Valladares, managing principal at New York-based MRV Associates, which trains bank examiners and executives at financial firms. “You’ll see global banks jettison divisions abroad and at home.”
UBS, Citigroup and RBS are among banks already doing just that, reversing decades of global expansion. UBS said in October that it plans to cut about 10,000 jobs and retreat from most fixed-income trading after Switzerland set capital rules for its biggest lenders that are almost double international minimums agreed to by the Basel Committee on Banking Supervision.
Citigroup and Bank of America Corp., the two U.S. lenders that received the most aid during the financial crisis, have been selling foreign operations and retreating from businesses.
Citigroup, whose former Chief Executive Officer Vikram Pandit used to extol the virtues of the bank’s “globality,” said today it plans to cut more than 11,000 jobs and sell or significantly scale back consumer operations in Pakistan, Paraguay, Romania, Turkey and Uruguay. It will also cut branches in Brazil, Hong Kong, Hungary and Korea, as well as the U.S.
RBS, majority owned by the British government since being bailed out in 2008, said it will close or sell its cash- equities, mergers-advisory and equity-capital-markets divisions.
The Fed’s plan is part of a trend by national regulators since the crisis to ensure they can protect local depositors and creditors of global financial institutions in the event of a failure. Even organizations such as the International Monetary Fund and the Basel committee, which have sought to foster global finance, have had to adapt their approaches or have been overruled by national and regional interests.
“Globalization of financial markets took us decades to build, it doesn’t look like it’s going to take us decades to reverse the trend, does it?” Charles Dallara, managing director of the Institute of International Finance, which represents more than 450 financial institutions, said at a meeting with journalists in New York the day after Tarullo’s speech.
Switzerland, whose banking system is five times the size of the nation’s economy, proposed in 2010 to give priority to the domestic units of its two largest lenders if they fail, indicating that overseas businesses might be left on their own. In the U.K., where banks’ assets are also five times gross domestic product, regulators have said they plan to require lenders based in Britain to insulate domestic consumer-banking businesses from investment-banking and foreign operations.
“The likelihood that some home-country governments of significant international firms will backstop their banks’ foreign operations in a crisis appears to have diminished,” Tarullo said on Nov. 28 at Yale University in New Haven, Connecticut. “It also appears that constraints have been placed on the ability of the home offices of some large international banks to provide support to their foreign operations.”
Banks with large trading operations in the U.S., such as Barclays Plc (BARC), Credit Suisse Group AG (CSGN) and Deutsche Bank AG (DBK), probably would be subject to the Fed’s proposed requirements. Tarullo’s plan follows moves by Frankfurt-based Deutsche Bank and London-based Barclays to discard their status as U.S. bank holding companies, thereby evading local capital rules.
The role that foreign banks play in the U.S. has changed in recent years. Through the 1990s, most borrowed from their parent companies to lend in the U.S. and had excess cash reserves to meet local requirements. The trend reversed early last decade, when foreign firms started borrowing in the U.S. to lend overseas. Their trading in the U.S. surged to 50 percent of assets in 2011 from 13 percent in 1995, Tarullo said.
Meeting multiple local requirements could mean global banks will have to maintain more capital than currently dictated by their home countries or international capital minimums established by Basel, according to Kim Olson, a principal at Deloitte & Touche LLP in New York and a former bank supervisor.
“This new standard is going to be very costly for foreign banks,” Olson said. “Some will have to raise additional capital just to comply with U.S. rules. Moving it around from the parent company won’t be enough because they’ll discover they need more than what Basel requires overall.”
Jean-Yves Fillion, the New York-based CEO of BNP Paribas SA (BNP)’s North American corporate and investment bank, said “trends toward Balkanization” make it harder to be a global firm.
“Is the cost of doing business in three or four continents going to go higher?” said Fillion, whose Paris-based bank is the largest in France. “Absolutely.”
The U.K.’s Financial Services Authority published a consultation paper in September that proposes requiring foreign bank branches in the U.K. be organized as subsidiaries under British regulation if the home country has rules giving local depositors priority when a lender becomes insolvent. The move, known as subsidiarization, was a response to banking regulations in the U.S. and other nations providing such preferences.
“For a lot of these banks, business outside of the U.S. is conducted from a booking center, which is their London branch,” said Azad Ali, a financial-regulation attorney at Shearman & Sterling LLP in London. “These London branches are not subject to full-scale U.K. regulatory supervision, it’s shared between the U.K. and the U.S., so I think the way things are developing it is leaning toward subsidiarization.”
Lenders also have to contend with efforts by countries from Brazil to the Philippines that have sought to manage capital inflows inflating their currencies and threatening to create asset bubbles. Brazil, blaming the U.S. for sparking a global “currency war” by keeping interest rates near zero, last year imposed a 6 percent tax on firms that borrowed overseas in an attempt to reduce capital inflows that were causing a jump in the real. Brazil started rolling back the curbs in June.
Organizations such as the IMF have fostered the global banking system by encouraging the elimination of exchange-rate restrictions that hindered trade. This week, the organization reversed its historic support for unrestricted flows of money across borders, saying it would favor the use of capital controls in certain circumstances.
The failure or near-failure of banks in nations such as the U.S., U.K. and Switzerland, as well as smaller countries such as Iceland and Ireland, taught regulators that companies once seen as a source of national pride can lead to hand-wringing over how to protect taxpayers.
“For the foreseeable future, then, our regulatory system must recognize that while internationally active banks live globally, they may well die locally,” Tarullo said.
When Lehman Brothers Holdings Inc. collapsed in 2008, European creditors alleged that $8 billion of cash had been transferred to the firm’s New York headquarters days before the bankruptcy. When Iceland’s banks failed that same year, the government agreed to pay local customers while leaving British and Dutch depositors trying to recoup more than $5 billion.
“When the system blows up, every country ring-fences the assets and liabilities in their jurisdiction anyway,” said Sheila Bair, a former chairman of the Federal Deposit Insurance Corp. who helped stabilize the U.S. financial system. “The Fed’s move is in a way doing that ring-fencing structurally.”
Bank managements probably will fight the moves. Ernest Patrikis, a former Fed official who’s now a partner at White & Case LLP in New York, said he remembers doing just that when he served as general counsel of American International Group Inc. (AIG) before the crisis. Two years after Patrikis left in 2006, AIG, once the world’s biggest insurer, was bailed out by the Fed.
“When I worked for AIG, we fought countries trying to force subsidiary structure on us,” Patrikis said. “Capital gets stuck in each country when you do that. You can’t move it around easily. Liquidity is even harsher. If the local unit has to abide by liquidity rules, it can only take a limited portion of the funds it raises in the U.S. outside.”
Shearman & Sterling’s Ali said that such structures probably will be favored by regulators, who are warier of the risks posed by branches not under local oversight.
“It depends upon how strongly the banks can demonstrate that if subsidiarization was forced upon them that their business model would be decimated and they would not be able to conduct the same amount of business and there would be an adverse consequence upon the markets or the economy and the provision of credit to the economy,” he said. “That’s an argument that needs to be backed up by empirical evidence.”
Ali’s own firm published a Nov. 29 warning that the Fed’s plan could lead to “significantly increased costs of doing U.S. business and threatening the attractiveness of the U.S. dollar as a reserve currency.” Lawyers at Davis Polk & Wardwell LLP in New York wrote in a Dec. 2 memo that it could lead to “higher unemployment, lower output and more political instability.”
The British Empire and the gold standard supported an earlier version of global finance that ended with World War II, said Margaret Tahyar, a partner at Davis Polk who specializes in advising on international transactions and regulation.
“We don’t want to go back to national silos like post- World War II,” Tahyar said. “But there was, in recent years, over-enthusiasm for global finance without having thought through the institutional structures. So faith in that has been shaken.”
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