December 29, 2016 / 12:18 PM / 9 months ago

Banking whales have had their day

The moon rises over the HSBC building in the Canary Wharf financial district of London, a day before the "supermoon" spectacle, in London, Britain November 13, 2016. REUTERS/Hannah McKay

LONDON (Reuters Breakingviews) - In November 2015, Mark Carney signalled the end of “too big to fail”. Globally harmonised regulation centred on new-fangled “bail-in” innovations would allow megabanks to collapse without ruining their host countries, the Bank of England boss said proudly. Yet the rules keep coming, and cross-border cohesion is splintering. In 2017, the twin imperatives of being safe and efficient will get even further apart. Following the 2008 financial crisis, a legitimate response to the billions of dollars spent on emergency bank recapitalisations would have been to break banks with trillion-dollar balance sheets up into smaller chunks.

Instead, figures like Carney and his global regulatory colleagues on the Financial Stability Board – some of whom had worked for the biggest banks – opted for something different. As long as banks were much better capitalised and could fail without impoverishing their host nations, it didn’t matter how big they were. The Bank of England governor made this explicit in a speech back in October 2013: he envisaged the UK financial sector reaching nine times GDP, helped by the ability of banks to receive ready liquidity and fail safely.

The first bit, making sure banks had more padding, went well at first. Between 2011 and end-2015, the major banks grew their capital compared to their risk-adjusted assets to almost 12 percent from 7 percent, according to the Basel Committee on Banking Supervision. Meanwhile, regulators made progress in ensuring the quality of this so-called core Tier 1 capital was harmonised and cleansed of bogus, non-loss-absorbing fare to ensure what’s left would actually be able to offset shocks.

Unfortunately, a high-water mark has been reached. Attempts to create a transatlantic consensus on the denominator of the capital ratio – by standardising risk-weighted assets – are dragging on. European politicians in particular are worried about the effect that a big jump in capital requirements will have on banks who are already failing to generate the minimum returns shareholders should expect.

Bank resolution – the process of winding up a bank without scorching the earth around it – also faces challenges. The idealised view of resolution, set out in a joint paper by the Bank of England and U.S. Federal Deposit Insurance Corporation in December 2012, had big banks holding stocks of loss-absorbent debt at the level of their holding companies. If they got into trouble, the home regulator would turn some of the debt into equity, and see the affected country was supported. Global banks could be efficient, massive and safe all at once.

The trust between regulators that this vision requires just hasn’t materialised. Scarred by Lehman Brothers’ demise, many bank overseers have demanded that between 75 percent and 90 percent of the debt that they might one day demand be “bailed in” is kept within their own borders. For regulators, that might seem rational – they wouldn’t have to worry about their peers reneging on the deal in a crisis. For banks it traps capital in each jurisdiction, making it less efficient to be global.

In 2017 this will add to new strains, such as Britain’s exit from the European Union and the anti-free trade rhetoric of U.S. President-elect Donald Trump – especially for banks that are already struggling to make an economic profit. HSBC, the archetypal global trade financier, still makes a return on equity of less than 2 percent on half its $171 billion of capital, Deutsche Bank analysts reckon. A more balkanised regulatory world with smaller trade flows will increase the pressure to downsize further, especially in the United States.

American rules requiring large foreign banks to set up intermediate holding companies with their own boards and stress-test requirements are one reason why HSBC looks relatively overcapitalised there. In November, the European Commission laid out regulations that will in turn reduce the capital flexibility of U.S. banks in Europe.

The new rules could even hit big cross-border European lenders like Credit Agricole and UniCredit. Despite the fact they are supervised by a single, Frankfurt-based regulator, they could still have to trap capital in separate pockets around the 19 states of the euro zone. Worse, wary regulators might in future insist on ever-higher levels of trapped capital in their jurisdictions to protect their own markets, making it even harder to compete effectively against local competitors.

The less trust in a global system, the harder it will be for global banks to satisfy their investors. Compared to pre-2008, the biggest banks now face not only capital balkanisation, but tougher penalties for misbehaviour too. Trump may signal less collegial international cooperation, but he probably won’t do much to change extraterritorial American laws holding banks criminally liable for wrongdoing in far-off lands – as happened to HSBC in Mexico. The rosy vision of a global harmony that benefits banks, regulators and shareholders belongs to another era.

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