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US fires global subsidiarization starting gun

Foreign banks are facing up to the implications of new rules in the US requiring them to hold capital onshore. But subsidiarization is set to become a global phenomenon. Bankers argue they will be hamstrung by trapped liquidity and capital. Customers might lose out as well. What are the true costs of ensuring national safety in a global banking system?

When the embattled management of Lehman Brothers decided to transfer $8 billion of client money from its international subsidiaries to its New York headquarters on Friday, September 12, 2008, they were also signing the death warrant of global banking.

National regulators across the world have spent the last five and a half years figuring out how to make sure that they are never again left with the bill when a foreign bank operating on their turf goes bust. Their answer is subsidiarization: all foreign banks operating in a particular country should conduct business of a certain size through subsidiaries, which are locally capitalized and subject to local regulation.

On February 18 this year this concept finally became reality when the Federal Reserve released its final enhanced prudential standards (EPS) under the Dodd-Frank rule, triggering a fresh wave of speculation as to what their impact will eventually be.

In a joint study published last year, Oliver Wyman and Morgan Stanley predicted that the drag on bank returns on equity caused by regulatory balkanization would be between 2% and 3% – a painful hit for an industry that is struggling to achieve returns in the early double digits.

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