Trends in international banking and regulatory challenges

OECD Experts Meeting on Financial Services

Paris, November 30th

Santiago Fernández de Lis Chief Economist for Financial Systems and Regulation

OECD, Paris 2012

Page 2

1. Regulation and global banking

2. The trend towards fragmentation

3. Macroprudential policies and capital controls

4. Banking resolution: a key concern in cross-border banking activities

Index

OECD, Paris 2012

The strengthening of regulation is necessary, but its wide scope creates uncertainty on the overall impact . Challenging environment for global banks

Mitigate system’s complexity/risks

Minimize taxpayers’ fiscal

burden

Increase banks solvency

Basel III

Crisis Management

OTC derivatives Effective supervision

Rating Agencies

SIFIs

Structural reforms

Shadow banking

OTC derivatives

Macroprudential

Financial taxation

Section 1

Regulation and global banking

OECD, Paris 2012

• Basel harmonization based on minimum levels …

• … only works in the good times, when there is a race to the bottom in regulation…

• … but not in the bad times, when there is a race to the top

• Risk of exacerbating pro-cyclicality

• Asymmetric market discipline and gold-plating

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Section 1

Regulation and global banking

OECD, Paris 2012

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Section 1

Regulation and global banking: Impact on EMEs

• Could worsen deleveraging and increase the costs of global banks that operate in EMEs • Trade finance is penalized by Basel III

Capital Requirements

• Liquidity ratios particularly difficult to implement in EMEs • Credit rating could penalize sovereign debt of EMEs in consolidated requirements

Liquidity Requirements

• Could penalize the subsidiary model vs. branch model • Coherence between global and local frameworks is not ensured

SIBs Regulation (domestic and global)

• Extraterritoriality • Effects on liquidity of non-US sovereign debt,

Volker Rule (US)

• EMEs affected by reform in home and host countries-

• Retrenchment of global banks → risks for financial inclusion in EMEs

OECD, Paris 2012

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1. Regulation and global banking

2. The trend towards fragmentation

3. Macroprudential policies and capital controls

4. Banking resolution: a key concern in cross-border banking activities

Index

OECD, Paris 2012

Page 7

Section 2

The trend towards fragmentation • Last decade: increase of globalization. Internationally active foreign banks gained

importance, especially in LATAM and Eastern Europe …

• … but recent signs of a reversal of this trend, partly as a result of the perception of public support and the cost of banking crises: temporary or structural? Regional differences

* Claessens, S. and van Horen, N. (2012), “Foreign Banks: Trends, Impact and Financial Stability”, IMF Working Paper No.12/10

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OECD, Paris 2012

Page 8

Section 2

The trend towards fragmentation The fragmentation is more worrying in the Eurozone: re-nationalization of financial markets puts at risk the euro

Collateral used in credit operations (Euro system) (%) Source: ECB

European Banks: Average exposures to EU members (dollars) Source: BIS

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3 Triggers Market-driven segmentation 1

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Regulation (mostly moral suasion) 3

After LTRO, rise in domestic interbank transactions but drop in

cross-border

OECD, Paris 2012

Two tings need to be fixed for global banks to recover their role:

1. Macro prudential policies available to protect EMEs from bubbles originated from excess capital inflows

2. Cross border resolution mechanisms that permit to deal with the failure of global SIBs

Page 9

Section 2

The trend towards fragmentation

OECD, Paris 2012

Page 10

1. Regulation and global banking

2. The trend towards fragmentation

3. Macroprudential policies and capital controls

4. Banking resolution: a key concern in cross-border banking activities

Index

OECD, Paris 2012

Page11

Eastern Europe: vast increase in credit growth

• Massive foreign lending through banking system

• Mostly channeled to the real estate sector.

• Increasing external indebtedness

• Foreign banks relying on centralized funding by parent institution played a key role

• FX mortgages particularly risky. Several measures adopted, but in some countries too late

Section 3

Macroprudential policies and capital controls

• Asia: successful (but intrusive) macroprudential policies

• Eastern Europe: mixed results. Late response by the authorities in some cases

• Latam: more recent experience, results to be seen

Asia: successful macoprudential policies:

• LTV and DTI limits used to limit housing booms

• Countercyclical buffers

• Dynamic provisions

• Consistency of the overall policy setting (monetary, fiscal and macroprudential

• No reliance on foreign indetedness

• Lessons from Asian crisis.were learned

• Recent focus of regulatory debates, but more solid analytical framework is needed to design adequate policies

• More interesting experience in EMEs

OECD, Paris 2012

Page 12

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Section 3

Macroprudential policies and capital controls

Latam: very active use of macroprudential policies in recent years. Results to be seen

• Macroprudential policies are necessary to deal with credit bubbles

• Important (but difficult) to distinguish some macroprudential policies from capital controls

• Right calibration and early adoption are key

OECD, Paris 2012

Page 13

1. Regulation and global banking

2. The trend towards fragmentation

3. Macroprudential policies and capital controls

4. Banking resolution: a key concern in cross-border banking

Index

OECD, Paris 2012

Lehman Brothers

Fortis

Icelandic Banks

• Highly complex structure and interconnectedness. Difficulties is disentangling trades

• No substitutability. Loss of access to key services, such as payment and settlement services

Disorderly bankruptcies must be avoided because they can trigger systemic crises

• Problems in foreign branches exceed their home country’s capacity to offer support

• No rules for coordination and burden sharing in big cross-border banks (not even in the EU)

Need for international clarification & coordination on creditors preference, bail in and the limits of DGS

Specific mechanisms to deal with cross border resolution in the EU

Section 4

Resolution is key

• Recent cases of cross-border banking crises raise concerns and provide a justification for cross-border barriers …

• … especially when huge public funds are injected

OECD, Paris 2012

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• Cross- border resolution seen as too complicated. No agreed burden-sharing mechanisms

• Need to clarify rules for resolution of SIBs • Coordination between home-host supervisors and burden sharing

agreements • Supervisory Colleges and Crisis Managements Groups

• Recent progress: • Towards a resolution framework. Bail in instead of taxpayers money • Recovery and resolution plans (RRPs) • Recent FSB paper: significant progress towards an operational

resolution framework. Two models: • Single Point of Entry (SPE) • Multiple Point of Entry (MPE)

• Decentralized model of stand-alone subsidiaries more resilient and less prone to contagion (Latam vs CEE).

Section 4

Resolution is key

OECD, Paris 2012

Page 16

Key Messages • The ongoing regulatory reform is necessary to avoid a repeat of the international financial crisis.

The proliferation of reforms and the decreasing harmonization in implementation creates, however, uncertainty over the overall impact.

• Although designed as a gradual process, the market pressure is introducing a bias towards frontloading adoption. This can have unintended procyclical effects in a context of vulnerability in significant segments of the global financial system.

• Emerging markets are subject to the combined impact of reforms in home and host countries which implies a risk for the progress in financial inclusion.

• The crisis and the reform are leading to a fragmentation of global financial systems, although with different regional impact. This fragmentation is particularly worrying for the Eurozone.

• This environment is challenging for global banks. For them to continue playing a role, progress is necessary in two areas:

• Sound macroprudential policies should protect national financial systems from bubbles, in particular those resulting from huge capital inflows. It is important to distinguish these policies from others unduly limiting international capital flows.

• Progress in cross-border resolution of international banks is key to limit contagion and for a fair burden sharing of international crises. The decentralized model of stand alone subsidiaries has proven more resilient from the point of view of global financial stability.

Thanks!

OECD Experts Meeting on Financial Services

Paris, November 30th

Santiago Fernández de Lis Chief Economist for Financial Systems and Regulation

sfernandezdelis@bbva.com