Banking Crisis: regulation and supervision - Treasury Contents

6  International dimensions

Global initiatives

122.  Banking has become increasingly international in recent decades, with many large banks operating across several continents. This globalisation has bought benefits through improving the efficiency with which capital flows are intermediated between customers in different countries, and enabled bank customers to access banking services more easily around the world. But the globalisation of finance also presents enormous challenges for national regulators, central banks and governments. For good economic and historical reasons, finance is regulated very differently in different countries, but banks may have a very multinational business model, be geographically mobile and indeed, in some cases, structured to take advantage of these variances in regulation between countries.

123.  We asked Lord Turner what was achievable at the international level in terms of financial supervision. He told us that it was important to recognise what could be done at each of the national, European, and global levels. The ideal was to achieve as much agreement internationally as possible, but Lord Turner recognised that this would not be straightforward and would require a lot of energy and activity. Because none of the global bodies in the realm of financial supervision had any legal powers, progress towards reform has been dependent on consensus, so has tended to be "glacial". Lord Turner was adamant though that the FSA would do all it could to force the pace of change.[191]

124.  In April 2009, at the London Summit, the G20 agreed principles for dealing globally with impaired assets, repairing the financial system to restore lending, strengthening financial regulation to rebuild trust, and funding and reforming international financial institutions, both to overcome the current crisis and to prevent future crises. In particular, the G20 agreed to establish a new Financial Stability Board with a strengthened mandate and more members, as a successor to the Financial Stability Forum; to extend regulation and oversight to all systemically important financial institutions, instruments and markets; and to strengthen international standards of prudential regulation.[192] Many of these initiatives have to be made through international agreements if the world is to avoid creating new opportunities for regulatory arbitrage by firms.


125.  The Government's White Paper argued that a "key part" of the new global framework would be agreed at EU level, believing that "Europe's ability to identify and manage system-wide prudential risks needs to be enhanced" and that "the EU needs to develop the quality and scope of rules applying to firms, and ensure their proper enforcement". Reforms to financial regulation have been driven forward by the report of the High-Level Group on Financial Supervision in the EU, chaired by Jacques de Larosière. This report, published in February 2009, proposed a new framework for European supervision, including steps to reduce risk and improve risk management, reduce procyclicality, improve systemic shock absorbers, improve financial markets incentives, strengthen the co-ordination of supervision between national authorities and build crisis management procedures. Several of these proposals are now being taken forward by the European bodies. In June 2009 the European Council acted to strengthen the supervisory system and rebuild trust by creating

  • a European Systemic Risk Board (ESRB) to assess continuously the stability of the financial system as a whole. Where necessary, it will issue risk warnings and recommendations to policy makers and supervisors, and monitor their follow-up;
  • three European supervisory authorities, dealing with the banking, insurance and securities industries, working in a network with national supervisors, inter alia in preparing technical standards, ensuring the consistent application of EU law and resolving disputes between national supervisors.

126.  The Governor thought that the ESRB might prove a useful forum for discussion and presented another opportunity for UK policy makers to push their argument at the European level.[193] However, the tepidity of his enthusiasm for the new body was revealed in a later remark:

Whether this body turns out to be a mere talking shop or a useful talking shop, in terms of an exchange of views and ideas being generated, remains to be seen—that is up to the people who sit on it. We will see. I go to vast numbers of international meetings and I cannot claim that most of them live up to the billing that one would hope. Nevertheless, as I said, hope springs eternal—cautious, moderate hope for this committee—and we will do our best to try and raise the level of debate.[194]

127.   The three new European Supervisory Authorities, which will replace the existing EU Committees of supervisors, will be charged with ensuring that a "single set of harmonised rules and consistent supervisory practices is applied by national supervisors".[195] They will not have any fiscal powers over member states, but will have the final say in binding mediation in disputes between national regulators regarding the application of EU regulations such as the Capital Requirements Directive (CRD).[196] Dr Alexander lamented the absence of such a mediator in the past, because different national regulators have had an opportunity to use quite different interpretations of the CRD without any fear of sanction. He argued that it was entirely appropriate to have a European policy input to issues regarding the implementation of EU law.[197] The granting of binding mediation powers to the European Supervisory Authorities does, of course, have implications for the FSA. It could find itself in dispute with another national regulator, and, ultimately, the mediation process could result in a change of approach from the FSA. But Lord Turner was unconcerned about this possibility. He told us that the objective of the new bodies was to put pressure on the regulators in small countries to make sure tight standards were being applied, and not to tell regulators in large countries, such as the FSA, what to do. Lord Turner conceded that "under some circumstances" there was a case for binding mediation, as long as it was about a regulator's general approach rather than its supervision of a particular firm.[198] In fact, binding mediation would be essential to avoid a repeat of a situation developing like the fallout suffered by the UK from the Icelandic banking crisis.[199] Lord Turner was confident that the FSA would be on the right side of any mediation disputes:

Mr Fallon: It is a very British point of view, is it not, to see this as one-way. What would happen if the Icelandic authorities or the Latvian authorities queried a decision that you had taken here?

Lord Turner of Ecchinswell: ... one would have to make sure that one was adequately involved in the process and that the thing was set up sufficiently professionally that one would be sure that that was only occurring if that challenge was reasonable. Of course the challenge has to be both ways; but we will be extensively involved, in detail, in helping create the professional standards and the technical competence of this regulatory authority.[200]

128.  Lord Turner was "absolutely confident" that the supervisory capabilities of the FSA would be extremely unlikely to be challenged, "because we think that we would be setting the standard of what that professionalism is".[201] He added that "it would be odd if the supervisor of Europe's biggest and most important financial centre was not a beacon of high quality supervisory standards and was more likely to be the institution pushing to make sure that there were excellent supervisory standards in all other countries of the European Union, rather than being one which was criticised".[202]

Regulating cross-border firms

129.  The Governor recounted a tale from the G7 meeting in 2008 held in Tokyo:

I said around the table to my colleagues, …"What happens if a named particular large global investment bank one day rang up and said that they were bust? What would we do?" There was laughter round the table because it was unimaginable and we had not got any idea what to do. Now people know that it could happen and we have to have an idea what to do.[203]

130.  Recently, 'supervisory colleges' have been established for the largest cross-border firms which should lead to a better understanding of firm-specific risks, and cross-border crisis management facilities should improve information sharing between national authorities, addressing cross-border spill-overs.[204] Dr Jon Danielsson, of the London School of Economics, described the establishment of supervisory colleges as a "positive development".[205] He argued that banks had been able to operate across boundaries without any regulator "really understanding what they were up to", which clearly needed to be prevented. There was considerable scope, he argued, for regulatory co-operation through supervisory colleges.[206]

131.  The Governor told us that authorities around the world were no longer as clueless as they had been in Tokyo about dealing with cross-border banks, claiming that through the new Financial Stability Board, and through the supervisory colleges for large firms, there was "a real impetus" behind the idea that large international banks cannot be allowed "to wander around the world in a situation where no-one can afford to let them fail but no-one has any idea how to resolve them if they do other than put lots of money in". The will to tackle that problem was infinitely greater now than it had been 15 months previously.[207]

132.  Lord Turner believed that regulators around the world may have been "too lenient" in accepting the proliferation of legal structures devised by large interconnected cross-border investment banks for tax and regulatory arbitrage reasons.[208] In the case of global universal banks such as HSBC and Banco Santander, he saw merit in the idea of requiring each national operation of such banks to be a stand-alone legal entity, prudentially regulated by the host country, rather than the home country. Then, if the global holding company were to fail, national regulators could have the responsibility and power to deal with the problems at a local level.[209] The downside to this argument is that there may be efficiency losses from preventing global capital and liquidity management by the banks, but the upside gain would be an improvement in financial stability.

133.  The existence of large, complex, cross-border banks brings both benefits and dangers. Such institutions benefit the consumer by simplifying banking transactions and act as a lubricant to global capital flows. However, the risks they present to the global financial system are considerable. As the Governor has said, whilst banks may be global in life, they are national in death, because if such a bank were to fail, the regulator in the bank's home state would have the responsibility of resolving the firm. Not only would this be an unenviable task for the home state authorities, it would also present problems for host states, as they would have very little control over the fate of the firm's banking operations within their countries. This makes all the more critical the insistence on a 'will' for any bank operating in the UK. Colleges of supervisors are certainly a good idea, as they will provide a forum through which information about large banks can be shared, but we doubt that they are enough on their own. We support the idea that the national banking units of global banks should be obliged to establish as stand-alone subsidiaries of the parent group, regulated and supervised by the host state regulator. The capital of these stand-alone banking units would need to be ring-fenced to prevent the parent group snatching it away upon failure of the global bank. We recommend that the FSA should consider how feasible such a system would be, including whether or not it could be implemented unilaterally without international agreement. Sacrifices to efficiency of global firms in peacetime would be a price worth paying for the reassurance that a possible crisis could be contained within national boundaries if the firm failed.

The future of the City of London

134.  Professor Buiter told us that the City of London was likely to be the first victim of an inevitable retrenchment of cross-border banking brought about by regulators seeking more control over banking activities conducted within their jurisdictions. But Dr Danielsson viewed things differently, believing that there would be a "re-emergence of securitisation" from which London would benefit, because it was the most advanced in this field of finance.[210]

135.  The financial services sector is one of the UK economy's most significant industries. It employs more than one million people, accounts for around 8% of UK output and has contributed over £250 billion to the public finances in tax over the last nine years.[211]

136.  Some have questioned whether the UK financial services sector has actually grown too large.[212] Mr Andy Haldane, the Bank of England's Executive Director for Financial Stability, recently made a speech in which he analysed the source of the 'excess returns' to finance during the 20 year period up to the financial crisis. Over that period, UK banks' return on assets had changed little; instead the remarkable increase in UK banks' return on equity (and subsequent decline in 2008) could be fully accounted for by bank leverage. In other words, the excess returns from banks over the last 20 years were entirely down to "gambler's luck" rather than skill.[213] The Governor of the Bank of England has, on earlier occasions, voiced concern that the City of London appears to be siphoning off too much graduate talent away from other sectors of the economy, as many very able science, maths and engineering graduates opt for a career in the City, rather than manufacturing or other sectors of the economy:

I do think it is rather unattractive that so many young people when contemplating careers look at the compensation packages available in the City and think that these dominate almost any other kind of career—that is not an attractive position to be in. Such a high proportion of our talented young people naturally think of the City as the first place to work in. It should not be. It should be one of the places, but not the only one.[214]

137.  But a recent report co-chaired by Sir Win Bischoff, the former Chairman of Citigroup, and the Chancellor of the Exchequer cast aside these concerns, on the grounds that the sector's 8 per cent share of the economy was comparable to that of the USA and other European countries (although in his Mansion House speech the Governor said that the UK banking sector was, as a proportion of GDP, five times greater than that of the US)[215] significantly less than Hong Kong and Singapore, and significantly less than the UK output share of the manufacturing sector.[216]

138.  The White Paper did recognise that, as has become clear over the last two years, financial markets can operate in ways that can have a "negative impact" on the economy. It concluded that a "strong, thriving financial sector can make a positive contribution to the economy", but its growth will need to be managed in a way that supported sustainability and long-term growth.[217]

139.  We believe that the Government should take the issue of over-reliance on financial services much more seriously than it currently does, and should commission a review by an independent figure from outside the financial community to consider the City's impact on the wider economy and public finances. This is not to suggest it is sensible for any Government to decide the right size of an industry as a proportion of the economy, but rather to ensure that the risks as well as the benefits of specialisation are articulated, understood, and prepared for.

191   Q 98 Back

192   Reforming financial markets, pp 8, 95 Back

193   Q 154 Back

194   Q 157 Back

195   European Commission press release 10737/09 "2948th Council Meeting Economic and Financial Affairs", 9 June 2009 Back

196   The Capital Requirements Directive is the instrument through which Basel capital rules have been applied in the EU. Back

197   Q 19 Back

198   Q 73 Back

199   Qq 67-70 Back

200   Q 71 Back

201   Q 73 Back

202   Q 105 Back

203   Q 151 Back

204   Reforming financial markets, p 99 Back

205   Banking Crisis: International Dimensions, Q 89 Back

206   Ibid., Q 91 Back

207   Q 151 Back

208   Q 92 Back

209   Ibid. Back

210   Banking Crisis: International Dimensions, Q 92 Back

211   Reforming financial markets, p 18 Back

212   See for example Rebalancing the UK economy: a long time coming, Ernst & Young ITEM Club, May 2009 Back

213   Speech by Andrew Haldane at the Federal Reserve Bank of Chicago 45th Annual Conference, 8 May 2009 Back

214   Tenth Report from the Treasury Committee, Re-appointment of Mervyn King as Governor of the Bank of England, Session 2007-08, HC 524-II, Q 13 Back

215   Speech by Mervyn King, Governor of the Bank of England at the Lord Mayor's Banquet for Bankers and Merchants of the City of London at the Mansion House, 17 June 2009 Back

216   UK international financial services-the future: A report from UK based financial services leaders to the Government, HN Treasury, May 2009, p 19 Back

217   Reforming financial markets, p 18 Back

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