European banks warn of regulatory fragmentation
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European banks warn of regulatory fragmentation

HSBC’s Flint sees tension rise between home and host regulators; Deutsche says balkanization threatens financial stability.

Douglas Flint, group chairman of HSBC

Douglas Flint, group chairman of HSBC, expressed his frustration at continued regulatory uncertainty in a speech outlining the bank’s capital planning strategy at HSBC’s own FIG conference in London on Tuesday. “We are only now getting to the heart of where the debate on regulation probably should have started,” he said. “For some time it’s been all about capital definition and sufficiency, liquidity buffers and ring-fencing, perhaps because these are easy to measure and evidence.

“But much tougher and more central issues, like agreed protocols for cross-border resolution, are still being explored and defined. And in the absence of global agreement on cross-border resolution, national regulators are increasingly looking to protect local tax-payers and local political constituents.”

He continued: “Host country regulators are looking at the extent to which home regulators might downstream capital in the event of a stress event at the group level and in addition, even if there is agreement among regulators on protocols for cross-border resolution, there is a fear of possible political interference that might unpick these.

“You sense increasing tension among host country regulators that don’t see full transparency yet in home country regulators’ resolution planning. And so you see some balkanization and fragmentation. It’s actually quite rational that host country regulators might want higher capital and liquidity retention at the local subsidiary level.”

HSBC can be quite sanguine about this, given that it has long run a subsidiarized model and even dared to suggest, in the immediate aftermath of the financial crisis five years ago, that the whole industry might move this way: an unpopular point of view at many of its peers. It is slowly coming true, though.

One of the biggest uncertainties today is over the potential for US regulators to demand much more dedicated capital and liquidity be allocated locally to foreign banks’ US operations.

This would leave those such as Deutsche, Barclays and others with the unenviable choice of finding that capital or shrinking their businesses in the US, where economic revival seems to be much closer than in Europe and where they have invested heavily to win a share of the largest national fee pool in global investment banking.

On the same day it raised nearly €3 billion in new equity capital at the end of April, Deutsche responded to the Federal Reserve’s request for comment on proposed enhanced prudential standards for foreign banking organizations, arguing that: “The proposal’s unilateral implementation of an approach for which no international agreement yet exists might reduce momentum for global regulatory cooperation.

“We fear that the proposal may [...] encourage other host jurisdictions to take similar unilateral actions. These actions could accelerate a growing trend not only towards balkanization generally, but also towards national approaches that differ by country and that may be inconsistent in important respects. If these trends are not reversed, financial stability will suffer.”

What does this mean in plain English?

One senior banker said: “The message of the more belligerent European banks to chairman [Ben] Bernanke and [Daniel] Tarullo [member of the board of governors of the Federal Reserve] is to be careful what they wish for. It is in none of our interests for this to become some kind of trade war. Citi, for example, operates in 85 countries. If it were required to separately capitalize on a subsidiarized model in 85 countries, how much more capital would it require?”

European bankers sense the competitive landscape tilting in favour of the American banks and are as much frustrated at their own local regulators as at US regulators.

Another senior European banker said: “Europe needs to decide: do we want to have global banking players based here? We now have to face the financial transactions tax which, as proposed, will be a disaster. We have Liikanen and Vickers. We have laws limiting bankers’ pay. None of this has even been thought of in the US, while the cumulative effect of what is being proposed in Europe tilts the playing field in favour of the Americans.”

Flint at HSBC is much more measured than this. “Our own capital planning with regard to high-return subsidiaries, for us mainly in Asia, is to negotiate release of capital in excess of what’s needed there through the group,” he said.

“In low-returning subsidiaries, such as the US, it makes sense to put in excess capital to avoid regulators getting worried about potential stress events and through their questions perhaps exacerbating concerns.”

He continued: “There’s been times when we’ve taken capital from where we were generating it in the good times and put it where we needed it. But we’ve always shown an ability to put that capital back, in the bad times.”

However, even the thoughtful Flint has profound reservations on ring-fencing. “There seems to be an idea that separating a bank into ring-fenced and non-ring-fenced pieces is fairly simple,” he said. “But there is a huge issue over the operational separation of shared services which, if they in turn had to be separately capitalized, would present a cost that is ultimately unsustainable.

“There is already the potentially perverse outcome that a UK ring-fenced bank with a higher leverage ratio than a non-ring-fenced bank would have the incentive to put on much riskier assets. That’s surely not the intention.”

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