As global credit markets seized up in late 2008, European banks with U.S. operations borrowed heavily from the U.S. Federal Reserve discount window, the primary program for providing cash to banks facing a liquidity squeeze. At the time, these foreign lenders didn’t have to meet Fed capital rules to cover losses on American-based units provided their parent company was properly capitalized. They competed and borrowed in the U.S.—but didn’t have to play by the house rules.
That game is up: On Nov. 28, Federal Reserve Governor Daniel Tarullo, who oversees bank supervision, announced plans to impose the same capital and liquidity rules on the U.S. operations of foreign lenders that apply to American institutions. The new rules, he added, won’t be as strict for foreign banks with small U.S. units. The U.K. and Switzerland have also proposed rules on international banks designed to gain more control. “For the foreseeable future, then, our regulatory system must recognize that while internationally active banks live globally, they may well die locally,” Tarullo said in a speech at Yale University.
Forcing lenders to dedicate capital to local subsidiaries in multiple countries could undermine the business rationale for global banks operating across all asset classes and national boundaries. Citigroup and Bank of America, the two U.S. lenders that received the most aid during the financial crisis, have been selling foreign operations. Citi, whose former chief executive officer Vikram Pandit used to extol the virtues of the bank’s “globality,” announced on Dec. 5 that it plans to cut more than 11,000 jobs worldwide and sell or significantly scale back consumer operations in several countries. Tarullo’s speech “throws into question this whole globalization of these firms,” BlackRock head Larry Fink said at a conference in New York on Dec. 4.
At some foreign banks, too, the retreat is already under way. UBS said in October that it plans to cut about 10,000 jobs and eliminate most fixed-income trading. Royal Bank of Scotland, majority owned by the British government since being bailed out in 2008, announced in January it will close or sell its cash equities, mergers advisory, and equity capital markets divisions worldwide. “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?” said Charles Dallara, managing director of the Institute of International Finance, which represents more than 450 financial firms, the day after Tarullo’s speech.
Tarullo’s plan follows moves by Frankfurt-based Deutsche Bank and London-based Barclays to discard their status as U.S. bank holding companies in anticipation of new American capital rules. The role foreign banks play in the U.S. has changed in recent years: Through the 1990s, most borrowed from parent companies to lend in the U.S. and had excess cash reserves to meet local requirements. Early in the last decade the trend reversed, and investment banking supplanted lending to become 50 percent of the top 10 foreign banks’ U.S. assets in 2011, up from 13 percent in 1995, according to Tarullo.
Meeting multiple local capital requirements will drive up overall cash needs, says Kim Olson, a principal at Deloitte & Touche in New York and a former bank supervisor. “This new standard is going to be very costly for foreign banks,” Olson says. Jean-Yves Fillion, the New York-based CEO of BNP Paribas’s North American corporate and investment bank, says “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?” asks Fillion, whose Paris-based bank is the largest in France. “Absolutely.”
Bank regulators want to be able to control the financial firms in their jurisdiction. A paper published in September by the U.K.’s Financial Services Authority proposes requiring foreign bank branches in the U.K. to organize as subsidiaries under British law if the home country has rules giving local depositors priority when a lender becomes insolvent. The aim is to give British authorities the legal tools they need to seize the assets or manage the failure of a foreign bank that economically harms its citizens. When Lehman Brothers collapsed in 2008, European creditors alleged that $8 billion of cash had been transferred from London to the firm’s New York headquarters days before the bankruptcy.
Count on lobbyists to push back on foreign banking restrictions, says Ernest Patrikis, a former Fed official who’s now a partner at White & Case in New York. “When I worked for AIG, we fought countries trying to force” tighter regulations on the company, Patrikis says. “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.”
New York law firm Shearman & Sterling, which represents several Wall Street banks, said in a Nov. 29 note to clients that Tarullo’s plan could lead to “significantly increased costs of doing U.S. business” and threaten “the attractiveness of the U.S. dollar as a reserve currency.” Yet Azad Ali, a financial regulation attorney at Shearman, says research shows stricter capital requirements can help banks by giving creditors and customers more confidence in their stability. “We don’t want to go back to national silos like post-World War II,” says Margaret Tahyar, a partner at Davis Polk & Wardwell in New York who advises on international transactions and regulation. “But there was, in recent years, overenthusiasm for global finance without having thought through the institutional structures. So faith in that has been shaken.”