Strong local units good for bank reform

November 2, 2009

The debate about reforming the financial system is often presented as an argument between regulators on one side and banks on the other. But it is also beginning to throw up some differences among banks. One such rift has been exposed by the suggestion that banks should be forced to hold greater reserves of liquidity and capital in national subsidiaries.

Regulators see this as a way of dealing with the future failure of a big bank. Rather than relying on the bank’s home government to pick up the tab — something it may not be able or willing to do — each country where the institution operates could take responsibility for its local subsidiary.

Josef Ackermann, chief executive of Deutsche Bank, is concerned that this approach will lead to the fragmentation of the financial system. On Monday, he warned a conference organised by the Financial Services Authority of Britain that it would make markets less efficient and lead to lower economic growth.

However, the chief executive of Abbey, the subsidiary of Spanish giant Santander, told the same conference that his bank already operates along the lines envisaged by regulators: its British, Brazilian, Mexican and Portuguese subsidiaries are all separately capitalised.

António Horta-Osório acknowledged this might be less efficient, but said the structure creates a “firewall” that limits contagion if one part of the bank were to run into trouble. HSBC is organised in a similar way.

Indeed, such an approach may even support globalisation.  According to Adair Turner, the FSA’s chairman, integrated global banks were quickest to withdraw liquidity from emerging markets when the crisis struck. Those with local subsidiaries stayed put.

True, a federal structure may be better suited to retail banks, which are more likely to have matching assets and liabilities in the same country. Investment banks are less easy to carve up.

One of their main functions is to match buyers and sellers of risk around the world. This would be harder to do efficiently if, say, each derivatives trade had to be booked in a local subsidiary. It would also make it more difficult for banks to manage their overall exposure.

Nevertheless, Santander’s approach shows that what regulators are proposing is not impossible. Ackermann may be right that a system of local subsidiaries is less efficient. But he should also recognise that globally integrated banks are inherently more risky.

Taxpayers are rightly suspicious of underwriting banks’ global ambitions. Short of breaking up big banks, a federal structure may be the best compromise on offer.

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