Text size:

  • Small
  • Normal
  • Large
Sir Mervyn King, the Bank of England governor, will be replaced by Mark Carney in July. Chris Ratcliffe / Bloomberg
Sir Mervyn King, the Bank of England governor, will be replaced by Mark Carney in July. Chris Ratcliffe / Bloomberg

Who picks up the bill when the music stops?

A failing bank can leave behind a mess in a host of countries which its home authorities may not clean up. Regulators have wrestled with the problem for years.

When Canada's top banker Mark Carney replaces Sir Mervyn King as the governor of the Bank of England in July, the world will be deprived of Sir Mervyn's witty public utterances.

My personal favourite came when, commenting on strong retail sales figures during one Christmas period, he cast doubt on their significance for assessing the state of the economy. "The true meaning of the story of Christmas," he solemnly intoned, "will not be revealed until Easter, or possibly much later". A new career on stage, or in the pulpit, surely beckons.

Sir Mervyn's most quoted phrase is that "global banking institutions are global in life, but national in death". They trade globally, across porous borders, attaching little significance to the geographical location of capital and liquidity. But, when the music stops, it is the home regulator, and the home central bank, that picks up the tab, even if the losses were incurred elsewhere.

By the same token, a failing bank may leave behind a mess in countries, which its home authorities may not clean up.

Icelandic banks, for example, took deposits in the United Kingdom and the Netherlands, and swept them back to Reykjavk, leaving the host countries out of pocket. Likewise, the collapse of Lehman Brothers left European creditors more exposed than those in the United States, whose funds had been wired home to New York on the Friday before the ceiling fell.

Regulators have been wrestling with this problem for years, without conspicuous success. In mid-December, the Bank of England and the United States Federal Deposit Insurance Corporation (FDIC) announced what seemed like a breakthrough, at least concerning the major banks headquartered in the US or the UK - that is, 12 of the 28 institutions regarded by the Financial Stability Board as globally systemic.

In their case, a resolution authority, in London or Washington, would take control of the parent company, remove senior management, and apportion losses to shareholders and unsecured creditors.

It sounded plausible. Bank of England officials declared firmly that they were prepared to trust their American counterparts, and would not step in to grab subsidiaries or assets based in the UK. "This is a journey that involves trust," said the Bank of England deputy governor Paul Tucker. But the Anglo-American love-in quickly soured when the FDIC chairman was asked to give the same assurances of confidence in the British authorities. According to the Financial Times, he "laughingly declined".

Indeed, while the FDIC and the Bank of England were working on their plan, the Federal Reserve was developing proposals that will expose overseas banks in the US to a far tighter set of controls, and closer supervision than they have hitherto experienced. The Fed is seeking to oblige foreign banks to create a holding company to own their separately capitalised subsidiaries, effectively giving the Fed direct oversight of their business.

The banks will also be required to maintain stronger capital and liquidity positions in the US.

The justification offered for these new impositions is that overseas banks have moved beyond their traditional lending business to engage in substantial and often complex capital-market activities. "The crisis revealed the resulting risks to US financial stability," said Daniel Tarullo, a Fed governor. The UK's Financial Services Authority has been invoking the same rationale for requiring foreign banks to establish local subsidiaries, rather than taking deposits or lending through a branch of the parent bank.

On the face of it, these moves appear to be well justified, given the mayhem created by poorly regulated banks in the major financial centres. But we should be clear that these changes are not just tinkering at the edges. They amount to a reversal of decades of policy by American and British regulators. Ernest Patrikis, a former Fed supervisor, points to the clear implication that in the US domestic banks will have a strong advantage over foreign banks. More dramatically, he asserts that "subsidiarisation would be the end of international banking".

Larry Fink, the chief executive of the multinational investment-management firm BlackRock, takes a similar view: "It really throws into question [the] whole globalisation of these firms," with "each country for [itself]". He adds: "I wouldn't call it a trade war, but I would certainly call it a high level of protectionism." One delicious irony in Europe is that Chinese banks are contesting the requirement to subsidiarise in London on precisely those grounds.

For now, high-octane worries about protectionism are probably overdone. And it is difficult to deny that the Fed should take a close interest in the funding strategies of foreign banks operating in the US. Another Fed governor, Jeremy Stein, has pointed out that foreign banks have dollar liabilities of roughly US$8 trillion (Dh29.38tn), much of it short-term wholesale funding.

But there is a risk that these interventions are the thin end of a dangerous wedge. Forced subsidiarisation causes capital and liquidity to be trapped in local legal entities, reducing the effectiveness with which that capital is used.

At a time when bank capital is scarce, that impediment carries significant economic costs.

Moreover, tools that may be used wisely and well by institutions with a global outlook, like the Fed and the Bank of England, could take on a different character in countries where a commitment to free and open markets cannot be taken for granted. So we must hope that the US and British authorities move carefully and do not use their new powers to freeze out foreign competition. "Be careful what you wish for" is wise advice in the regulatory world, as it is elsewhere.

Sir Howard Davies, a professor at Sciences Po in Paris, was the deputy governor of the Bank of England

Back to the top

More articles

Editor's Picks

 The Greens, villas: Q1 no change. 3BR - Dh210-250,000. 4BR - Dh210-260,000. 5BR - Dh220-300,000. Q1 2013-Q1 2014 5% rise. Pawan Singh / The National

In pictures: Where Dubai rents have risen and fallen, Q1 2014

Find out how rental prices in the prime locations in Dubai have altered during the first three months of the year and the current rates you will pay according to data provided by Asteco.

 Miele coffee maker making Cappuccino at Miele Gallery in Sama Tower in Dubai. The cost of this coffee maker is around Dh 17,000. Pawan Singh / The National

Space-age coffee comes at a price from Miele

Miele have taken the coffee machine to a new level with its Dh17,000 offering that is built into your kitchen.

 The bridge of Seajacks Hydra, as the wind farm installation vessel undergoes finishing touches and testing works at Lamprell’s Hamriyah facility in Sharjah before its planned delivery on June 2, 2014. Jeffrey E Biteng / The National

In pictures: Building the Seajacks Hydra

The Seajacks Hydra, a wind farm installation vessel, is undergoing finishing touches and testing works at Lamprell’s Hamriyah facility in Sharjah before its planned delivery on June 2, 2014.

 The Wind, Energy, Technology and Environment Exhibition takes place from April 14 to April 16. Above, the Dewa showroom during last year’s Wetex. Jaime Puebla / The National

April corporate and economic calendar for the UAE and overseas

From Cityscape to Wetex to stock-market holidays to nations reporting first-quarter GDP figures, here is our helpful calendar of April's business events in the UAE and internationally.

 The rush of new supply of hotel rooms pushed Dubai occupancy rates down to 87 per cent. Sarah Dea / The National

Dubai hotel room rates rise 10 per cent

The rush of new supply pushed occupancy rates down to 87 per cent, a dip of 2.6 per cent from the previous year. Winter months are the strongest for Dubai hotels, with occupancy and prices falling to half their peaks by July.

 Get the latest information on credit cards, bank accounts and loan products in the UAE. Mark Lennihan / AP Photo

Rates report: Latest on UAE loans, accounts and credit cards

Souqamal.com brings you the latest interest rates on banking products in the UAE.


To add your event to The National listings, click here

Get the most from The National