18 April 2013

Dirk Schoenmaker: Fighting financial protectionism

This column discusses 'financial protectionism', offering international banks some governance solutions that may help. These solutions boil down to burden-sharing. In Europe, the first step is banking union.

The costs of financial protectionism can be big, as national subsidiaries need to maintain separate liquidity pools and capital buffers. A first example is a pan-European bank. National supervisors force this bank to keep extra liquidity buffers up to €20 billion in the different countries in which it operates. With an opportunity cost of 1 per cent, the annual cost amounts to €200 million. A second example involves a group of 25 European banks. Applying a shock in the form of a GDP drop of 2 per cent and an interest-rate rise of 2 per cent, Cerutti et al (2010) find that with ringfencing these banks need an additional €45 billion in capital. Without ringfencing, the banks need only €20 billion in extra capital.

A new international governance system

In Governance of International Banking (Schoenmaker 2013), Schoenmaker presents governance solutions for the supervision and resolution of international banks. These solutions keep the integrated business model alive and obviate the need for separate liquidity pools and capital buffers at the national level.

The endgame of resolution sets the incentives for ex ante supervision. In that light, he applies a backward-solving approach, illustrated by the backward arrow for the fiscal backstop in Figure 2. The design of global governance thus starts with mobilising the funds for resolution, the so-called fiscal backstop. At the European level, the European Stability Mechanism (ESM) is fulfilling the role of the European crisis fund for countries and is now on the verge of expanding that role to banks.

A European governance system may therefore consist of the following building blocks: the European Commission as European rulemaker, the ECB as European supervisor and lender of last resort, a new European Deposit Insurance and Resolution Authority, and the European Stability Mechanism as fiscal backstop. The European Deposit Insurance and Resolution Authority will be the new player in this governance system. To minimise the cost for taxpayers and maximise private-sector involvement, this new authority should apply bail-in and build a fund, funded by risk-based premiums levied on the European banks. Only after that fund is exhausted would the European Deposit Insurance and Resolution Authority have access to the ESM.

A bigger role for the IMF

Moving to the global level, the IMF is the international financial institution with resources for crisis management. The IMF would broaden its global support from sovereign countries to global banks and thus become the International Resolution Authority for global banks. The IMF already has the governance arrangements in place for involvement of, and accountability to, the ministers of finance who provide the resources to the IMF. While many observers would also give the role of international supervisor of global banks to the IMF, Schoenmaker argues for the Bank for International Settlements for two reasons.

• First, supervisory independence, one of the core principles for effective banking supervision, would be violated: as ministries of finance play a dominant role in the governance of the IMF, the IMF cannot act independently from government.

• Second, the functions of supervision and resolution should be separated: supervisors have a tendency towards forbearance hoping for better times, while resolution authorities aim for timely intervention to minimise the costs.

Conclusions

In the aftermath of the Global Crisis, national supervisors seem to go down the path of financial protectionism. To counter this, politicians need to come up with fresh solutions for international governance. These solutions boil down to burden sharing for the resolution of cross-border banks. In Europe, the first step is taken with a move towards banking union.

Full article

© VoxEU.org