The US approach to regulating foreign banks risks fragmenting global regulation and could trigger a "protectionist reaction", worsening the financial stability threats it is designed to address, warns Michel Barnier, the European commissioner for internal markets.
In a letter sent to Federal Reserve chairman Ben Bernanke, Barnier expressed concern about the unintended consequences of rules for foreign banks with operations in the US. The rules have not yet been finalised, but a notice of proposed rulemaking issued by the Fed crucially specified that foreign banks would have to establish an "intermediate holding company" (IHC) in the US.
This formed the centre of Barnier's objections. The IHC would face the same prudential standards as US bank holding companies, even if the bank's home country had already applied the same standards. This imposed an unnecessary cost on banks, Barnier said, which would be compounded by the cost of setting up the IHC and by the reduced flexibility of capital and liquidity management at the group level.
These costs were likely to put non-US banks at a competitive disadvantage at the global level, Barnier said. Deutsche Bank, one European bank likely to be hard-hit if the rules are implemented, seemed to agree. In its annual report, published on April 15, the bank welcomed Basel III, but said: "We remain concerned that regulation which challenges the universal banking model, or which distorts the global regulatory "level playing field" in a way that disadvantages European banks, may have unintended and harmful consequences."
A recent report by Oliver Wyman and Morgan Stanley attempted to quantify the cost of such distortion. The report predicted that a failure to harmonise regulation globally would impose an overall drag on banks' return on equity of 2–3 percentage points. The effect was worse in the US, however, where the rules for foreign banks could increase the drag to 2–4 percentage points.
Anger at the rules was unlikely to be limited to banks, and could provoke a "protectionist reaction" from other jurisdictions, Barnier said, potentially having a "substantial negative impact" on the global recovery. Barnier feared that retaliatory rule-making would cause both banking markets and regulatory frameworks to fragment, "with foreseeable consequences in terms of higher concentration of markets and lower levels of competition".
Barnier urged the US to adopt a European model, and allow banks to avoid meeting the additional requirements if their home country had implemented comparable regulation. If this condition did not hold, the US would be justified in imposing the IHC, he said.
Furthermore, in their current "territorial" format, the rules precluded the possibility of resolving a globally systemically important bank in a co-ordinated fashion using a ‘single point of entry strategy', Barnier said. "This is clearly in contradiction with the international standards on cross-border co-operation in bank resolution adopted by the Financial Stability Board and endorsed by the G-20," he added.
The US has been coming under increasing pressure to stop imposing regulation beyond its borders. On April 21, eight finance ministers and the European Commission sent a letter to US treasury secretary Jack Lew criticising US attempts to impose domestic rules on over-the-counter derivatives trades conducted by US firms abroad.
"An approach in which jurisdictions require that their own domestic regulatory rules be applied to their firms' derivatives transactions taking place in broadly equivalent regulatory regimes abroad is not sustainable," the letter said. It was signed by the finance ministers of Brazil, France, Germany, Japan, Russia, South Africa, Switzerland and the UK, as well as commissioner Barnier.
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