PhD Candidate, Lee Kuan Yew School of Public Policy, National University of Singapore

June 2015

Global Cooperation and Coordination in Resolving Globally Systemically Important Banks: A Developing Country Perspective

The boundary between local and global has become blurred with the latest wave of globalisation. Any local financial turmoil has implications for other countries at varying degrees. As this has become the reality of the contemporary world, global coordination and cooperation is vital for global financial stability.

When globally systematically important banks (G-SIBs) are in trouble, home and host countries experience financial instability stemmed at negative externalities such as bank runs and/or individual or systemic bank failures. For their global and systemic banks, those banks are currently subjected to tighter regulations. Two rounds of Basel regulations before the global crisis in 2007-08 have not guarded the banking sector around the world against negative externalities not only on the whole sector but also on the ‘real’ side of the economy. The updated version (Basel III) aims to address caveats that have become much clearer during the recent global crisis with minimum capital requirements.

Alongside Basel III minimum capital requirements, the Financial Stability Board (FSB) which is mandated by G-20, has developed international standards for resolution of G-SIBs with cooperation of regulatory and supervisory agencies, international banks, credit rating agencies, and scholars. FSB has recently ended its public consultation on its mechanism of resolution of global banks in case of a failure. During the crisis governments had to capitalise banks with taxpayer’s money. Both taxpayers and policy-makers would be less eager to capitalise banks as its burden had been too heavy which can even explain slower recovery in advanced economies since 2008-09. In order to demotivate global banks to take excessive risks, and motivate creditors of G-SIBs to better monitor, FSB formulated international standards to increase the so-called “loss-absorption capacity of globally systemically important banks in resolution”.[i]

The concept of (internal and/or external)[ii] “total loss-absorption capacity” (TLAC) has multi-faceted objectives: complement Basel regulations on minimum capital requirements, limit contagion across countries, reduce the likelihood of global financial instability, limit the size of externalities posed on the “real” side of an economy, and force banks to build stronger buffers with an expectation of not tapping taxpayers’ money in the future.

Although these measures and standards are well-thought, the caveat is that FSB faces a huge challenge. The location of TLAC is ambiguous. Whether it would be the parent and/or material subsidiaries operating in various jurisdictions needs more clarification. The issue of where to locate TLAC also requires cooperation and coordination of global banks and regulatory/supervisory agencies. Local authorities are assigned with the task of resolution strategies according to local realities.[iii] This naturally comes along the concern of supplying global public goods, in that case global financial stability as it needs inputs from all stakeholders. The stakeholders may not necessarily fall into a prisoners’ dilemma because communication between them is available either through third parties such as FSB, or direct ties between them.[iv] However, in a world of economic and political competition, if actors, especially major actors, avoid cooperation, then the result is a pure (global) market failure. Home and host regulators need to work together; while international banks both need to monitor each other, and comply with the local and international regulations.

If we were to make a content analysis of responses international banks, and regulators sent to FSB’s call for views on its proposed regulations, what should we expect? In general international (e.g. Institute of International Finance, Global Financial Markets Association, International Banking Federation), regional (e.g. European Banking Federation), and country-level (e.g. The Hong Kong Association of Banks, British Bankers Association, German Banking Industry Committee, Japanese Bankers Associations) bankers associations; regulators (e.g. Norges Bank, Dubai Financial Services Authority, Bank of Uganda); and G-SIBs (e.g. Crédit Agricole, HSBC, Credit Suisse, UBS) agree that host authorities should  make sure subsidiaries, especially material subsidiaries, have adequate external TLAC so that resolution process would be as smooth as possible.

The problem may arise as the Bank of Uganda (the only Central Bank among developing countries that sent its view on FSB’s consultative document) raised[v] is that in (small) developing countries subsidiaries may not have large operations to qualify as material subsidiaries that will be subjected to tighter regulations. Contagion risk therefore may not be reduced even if other subsidiaries elsewhere are regulated by other local regulators. For host authorities will oversee compliance, G-SIBs operating in various jurisdictions may try to manipulate the process as proposed measures grant some flexibility to regulatory and supervisory authorities. In countries where human and financial resources of these authorities lag behind what is expected from them may leave them vulnerable to individual and systemic shocks. Due to such caveats in the design of the TLAC framework, it would be better to reduce the threshold for each subsidiary to qualify as a material subsidiary to make sure they need to build stronger buffers against a domestic or an international shock in the future. A subsidiary of a G-SIB is labelled as a material subsidiary if it fulfils at least one of the three criteria.[vi] The first two criteria might be reduced so that a more inclusive design could be achieved with the aim of covering as many subsidiaries as possible around the world. This has potential advantages for developing countries and developed countries. From the former’s view, global regulations may complement or even replace inadequate local regulations provided international regulatory bodies fulfil their mandate. From the latter’s view, contagion risk might be reduced because if a non-material subsidiary fails it may produce externalities to the whole G-SIB group.

Besides writing more inclusive and comprehensive international rules, international coordination and cooperation between host and home regulators is crucial. Any international standard cannot replace coordination and cooperation in guarding the international banking sector against various sources of instability. As the recent global financial crisis has shown, all stakeholders can cooperate (Drezner 2014) despite diverging policy preferences. Given such capacity, regulators and international banks should coordinate and cooperate required measures not only when an individual or a systemic failure occurs but more importantly before such distress emerges. Compliance to agreed international rules around the world has life-bearing implications if one takes into account externalities on the ‘real’ side of the world economy. Timely and frequent consultations among domestic and international regulators, particularly among developing and developed countries, tighter public disclosure measures could play a vital role to foster international coordination and cooperation given global and systemic footprint of G-SIBs.

References

Drezner, Daniel W. 2014. The System Worked: How the World Stopped Another Great Depression. Oxford: Oxford University Press.

Hardin, Garrett. 1968. “The Tragedy of the Commons.” Science 162 (3859): 1243-1248.

Olson, Mancur Jr. 1965. The Logic of Collective Action: Public Goods and the Theory of Groups. Cambridge, Mass: Harvard University Press.

Ostrom, Elinor. 1990. Governing the Commons: The Evolution of Institutions for Collective Action. Cambridge & New York: Cambridge University Press.