Idea of global banking under siege as regulators seek to protect national interest

One of the lessons of the current financial crisis is that large banks operate globally and die locally.

As a result, policymakers are looking for ways to avoid responsibility for and exposure to losses incurred that are outside of the host country.  In Europe, this is reinforcing the unscrambling of the eurozone banking system as banks are retreating within national boundaries.

This begs the question:  is this a good result?

How you answer that question depends on how you answer the following:  are there any benefits to the financial system from having global banks?

According to a Bloomberg article, regulators are focusing on the "subsidiary model" to reduce the local exposure to losses.  Under this model, banks are required to hold capital in their subsidiaries, rather than at the bank holding company level.

Regulators like this model because in theory the capital is there to absorb the losses incurred within the host country.

Banks dislike this model because they see it as requiring them to hold excess capital (once capital goes into a subsidiary, it is very difficult to get it out).

Your humble blogger's problem with the "subsidiary model" is it ignores the elephant in the room.  The elephant is how much risk is being taken by the bank.  As the current financial crisis has shown, banks are fully capable of losing much more money than they have book capital to absorb.

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.... 

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.... 

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. ... 

“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 .... 

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.”...

Jean-Yves Fillion, the New York-based chief executive officer of BNP Paribas SA (BNP)’s North American corporate and investment bank, said “trends toward Balkanization” make it harder to be a global firm....

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....

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 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.”... 

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.”