Andrew Bailey: Regulating international banks
Speech by Mr Andrew Bailey, Deputy Governor of Prudential Regulation and Chief Executive
Officer of the Prudential Regulation Authority at the Bank of England, at the British Bankers
Association Annual International Banking Conference, London, 17 October 2013.
* * *
Today is the BBA's annual international banking conference, and I therefore want to stick to
that theme and explain the PRA's thinking on issues concerning the pressures on
international banking business and the establishment and supervision of foreign bank
branches in London.
Let me start with the luxury of a wider reflection. Before I joined the Bank of England over
28 years ago, I was an economic historian, with a specialism in nineteenth century economic
history. All a bit esoteric you might say. Well, it is the case that the late nineteenth century
world economy was more open - and, to use a phrase I don't much like, "more globalised" -
than at any time in at least the first fifty years of the twentieth century. Moreover, the rate of
openness in the world economy probably only truly approached late nineteenth century
levels in the last twenty or thirty years. The backlash to greater openness that came in the
first half of the twentieth century is quite often attributed to the actual or perceived
distributional effects of greater cross-border trade, flows of capital and flows of people. The
world economy in many ways went backwards in the first half of the last century.
Why does this historical detour matter? The five or six years since the outbreak of the
financial crisis have seen signs of a reversal of some aspects of the greater openness we
had seen in the 1980s and 1990s. And probably none more so than the decline in
crossborder bank lending. Moreover, the UK experience in terms of lending has been amongst the
more pronounced. But again, does this matter? My answer is yes. First, because many of us
do believe in the economic benefits of free trade and capital flows, as well as the contribution
of migration to balancing supply and demand in the economy. Second, and closer to home,
the City of London and its financial markets benefit hugely from, and are at the hub of, the
open world economy. For example, whatever you think about the more troublesome recent
innovations of banking, basic trade finance remains a core, simple and essential service
provided by banks, and the City has for a very long time been a leading centre for providing
this finance to support world trade.
International wholesale banking is therefore an important part of maintaining and developing
the world economy, just as it was in the nineteenth century. Yet, we have to recognise that in
the last five or six years of the crisis we have gone backwards. Cross-border bank lending
has declined more sharply than overall lending - home preference has set in. And, the
banking system has become more fragmented or "balkanised", with a preference for banks to
subsidiarise in countries beyond their home state, and for regulators to wish for - and
achieve - the location of more capital and larger pools of liquid assets in their jurisdictions.
We should not be surprised by this, but nor should we accept that it is inevitably with us as a
permanent feature. The reasons why we have seen these changes are not hard to explain.
Major concerns about sovereign creditworthiness undermine stable banking activity across
borders, another important lesson of history. Combined with that, as authorities we have had
bad experiences in trying to deal with and resolve failed banks headquartered in other
countries. It is not surprising that the natural reaction is to make sure in future we have "got
the money".
Moreover, no one country is particularly responsible for this trend - the honest thing is to say
that many of us have contributed to it because the alternative available at the time looked
worse. And, writing rules to say that such actions should not be taken, irrespective of the
underlying reasons for them, is not likely to be a success. This amounts to contradicting
basic human nature.
But, and this is the important point, we should not design the world as if fragmentation and
balkanisation are inevitably always likely to be with us. That is a counsel of despair, and it
contradicts everything I said earlier about the benefits of free trade. How, therefore, should
we think about, and act upon, this design challenge? A key issue here is bank resolution.
Indeed, arguably it is the cornerstone of making progress. The reason is that without
confidence in how we would in future resolve banks operating across borders - typically
therefore the larger banks - we are unlikely to break down the trend towards fragmentation.
This is because some of the most difficult legal and structural issues in bank resolution
concern enabling cross-border solutions to take effect, and this is true whether the resolution
plan involves holding the firm together - Single Point of Entry unitary resolution - or breaking
it up under a Multiple Point of Entry resolution. For instance, either way it will be important to
effect a stay on triggering default clauses in contracts.
For me, the big point here is to achieve resolution planning which creates sufficient
confidence among national authorities that there is greater trust, and therefore a greater
willingness to assume, for instance, that capital and liquid assets are moveable and can be
employed across countries when needed. It is an essential pre-condition for confidence in
cross-border bank activity and likewise it provides an important counterweight to policies that
trap capital and liquid assets in host jurisdictions. In turn this allows a more neutral stance on
the subsidiarisation versus branching issue.
Resolution is the toughest nut to crack in the financial reform package, but it is also the one
that I think does more to unlock other issues, including the appropriate steady-state
endpoint for the bank capital regime. Put simply, the answer in my view is different in a world of
effective resolution that ends too big to fail. But in the alternative outcome, where too big to
fail remains with us and there are doubts around the effectiveness of resolution, it is hard to
avoid the conclusion that higher capital requirements will follow, and cross-border
establishment will be through subsidiaries.
Let me also say that we have made more progress on resolution in the last few years than
many people expected. To say that we are not there yet should not conceal the real progress
made. And, an important credit on this goes to Paul Tucker who has led much of the
international policy thinking on resolution. Paul leaves us at the end of the week for the
calmer environment of Harvard - we shall miss him in many ways, and I hope that when we
get to an outcome on bank resolution that meets our wish to reject the permanence of
fragmentation, we will remember how much Paul did to get us there.
The real progress that we have made on resolution issues makes it reasonable to start to
take steps towards planning for a safe resumption of the growth of cross-border banking in
ways that had been in some senses discouraged, and sometimes with a history of
discouragement going back before the onset of the crisis. A good example of this is our
approach towards branches from outside the European Economic Area (remember that EEA
branches are governed by the Single Market legislation). Earlier this week, it was announced
that the PRA will be prepared to see Chinese banks open branches here (recognising that
the Bank of China already has a branch in London).
I want to describe how this change can come about, and in doing so it should be clear that
this is not a special arrangement for China - rather it is part of a broader policy.
Branches of foreign banks (both non-EEA and EEA) have a large presence here in the UK.
Currently, they account for around one third of total UK resident banking assets. Supervision
of branches has therefore always been an important issue for the UK authorities. In the
runup to the launch of the PRA, in April, we set out our approach to supervising subsidiaries and
branches from overseas, and in this context the announcement on China is not a surprise.
Let me read to you the relevant three paragraphs from our Approach document published in
April:
"For UK branches of non-EEA firms, the PRA's authorisation applies to the whole firm. At the
point at which a non-EEA branch seeks initial authorisation in the United Kingdom, the PRA,
will, as a first step, form a judgement on the adequacy of the home regulator, including its
ability and willingness to share confidential information. Where it considers the home
supervisor not to have a regime broadly equivalent to that of the United Kingdom, the PRA
will refuse authorisation of the branch. It may instead decide to authorise a stand-alone
subsidiary, in which case it may limit the interlinkages with the rest of the group or ring-fence
the subsidiary (for example if it considers the home supervisor not to deliver effective
consolidated supervision). In assessing a non-EEA firm against the Threshold Conditions,
the PRA may also have regard to the opinion of an overseas regulator in a country in which
the firm carries on regulated activities. In considering how much weight to attach to such
opinions, the PRA must have regard to the nature and scope of the supervision exercised by
the overseas regulator."
"For existing UK branches of non-EEA firms where the home regime is not considered to be
equivalent, the PRA's supervisory work is aimed at mitigating the risks of non-equivalence in
the relevant areas. Its supervision focuses on issues such as the financial strength of the
whole firm, including the adequacy of its liquidity and the resolution plan for the firm
(collaborating with the Special Resolution Unit and home authorities to develop such plans in
colleges or Crisis Management Groups as applicable), taking into account the importance of
the firm to the PRA's objective."
"For UK branches of non-EEA firms where the PRA is satisfied that the home regulatory
regime is equivalent, and where the PRA has assured itself over resolution plans and the
home regulator's supervisory approach, the PRA relies where possible on the home
regulator's prudential supervision. In these cases, the PRA focuses on collaboration with
home regulators (including via supervisory colleges) and on resolution plans. In addition, the
PRA takes a close interest in liquidity and ensures that there are senior individuals in the
United Kingdom that are clearly responsible for management of both the UK operations and
business booked in the United Kingdom. The PRA discusses and agrees with the home
regulator the areas in which it will seek to rely on the home regulator's supervision".
This Approach document concluded that the PRA would in due course publish a fuller
statement on our approach to the supervision of overseas firms operating in the UK. To take
that forward, over the summer the PRA Board, acting in its new statutory capacity considered
our policy further. It endorsed the account I have read from the Approach Document, but
added one important further condition, namely that we do not wish to see non-EEA branches
undertaking critical retail banking functions (like taking deposits) beyond de minimis levels
unless there is some good reason and importantly there is a very high level of assurance on
resolution. In particular, we think that new non-EEA branches should stick to straightforward
wholesale banking, of the type that supports world trade and capital flows.
Resolution will be a key deciding factor in the PRA's judgements, and it is thus where we will
place emphasis when forming a view on our risk appetite towards branches operating in the
UK. We will therefore expect assurance from the home state regulator over the recovery and
resolution plans and assess if the plans adequately cover the UK branch's activities. For
banks with small UK activities we will expect to gain a level of assurance that is relative to
the scale of the UK activities.
The PRA's policy towards branches is part of our general approach set out in the light of the
experience of the crisis. It places emphasis on recovery and resolution, and we will expect
very clear and credible assurances from the parents of banks wishing to operate as branches
and from the home state authorities. It limits the range of activities that branches can
undertake, but not I think in ways that undermine the ability of such branches to undertake
safer forms of wholesale banking, which is the preference of most banks in that position. We
have a clear policy framework for taking these decisions and our approach to all branches
will be consistent with our objectives of safety and soundness. Our stance is sensibly
cautious, but not I think restrictive. And, let me reiterate that it is a general policy, not a China
policy, and it is consistent with promoting the benefits of an open world economy.