23 November 2013

The Economist: Global banking - You break it, you own it

The rush to reduce the risks posed by the collapse of big foreign banks is understandable. Regulators are accountable to taxpayers at home. And, given Europe’s tardiness in cleaning up its own banking system, who can blame the Americans for wanting to insulate themselves from its troubles? European banks are still undercapitalised compared with their American peers. In an ideal scenario, forcing Barclays or Deutsche Bank (let alone shakier local German lenders) to put up more capital would make the whole system safer everywhere.

But reality is not that simple. To begin with the Europeans may well retaliate. France’s big banks are already lobbying the European Commission to impose retaliatory restrictions that will keep JPMorgan and Goldman Sachs out of French bond markets (even though the American banks are better capitalised). That will fragment global finance.

Walling off banking systems will increase the costs of borrowing, especially in small or fast-growing economies that need to import capital. It will cut returns to savers in countries with excess saving. McKinsey, a consultancy, reckons that fragmented banking systems could trim global growth by almost 0.5 percentage points a year. And a more fragmented system, even with better-capitalised local banks, is not necessarily safer. Risk will be more concentrated if banks cannot spread it around the world, and failures more common if they cannot move capital to bail out ailing units.

The Fed’s impatience with Europe is understandable. America has cleaned up its banks and Europe has not. European regulators need to use the European Central Bank’s forthcoming asset quality review to show they are serious about doing so.

But even the Americans admit that the best system, for big banks, is a global one—and there are ways of making a global system safer. Banks could be forced into structures that would push losses from their subsidiaries up to the parent and send capital down to struggling subsidiaries. Big cushions of equity and “bail-in” debt held centrally could reassure regulators.

For that to happen, there need to be formal deals between the main financial centres. The Financial Stability Board (FSB), a club of supervisors and central banks, is championing these ideas, but neither the Americans nor the Europeans have done enough to push them. If the Europeans get serious about cleaning up their banks, the Americans should make one final, genuine attempt to get the FSB’s global rules to work.

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