For release on delivery
12:00 p.m. EDT
September 26, 2019
Government of Union: Achieving Certainty in Cross-Border Finance
Remarks by
Randal K. Quarles
Vice Chair for Supervision
Board of Governors of the Federal Reserve System
Chair
Financial Stability Board
at
Financial Stability Board Workshop on Pre-Positioning, Ring-Fencing, and Market
Fragmentation
Philadelphia, Pennsylvania
September 26, 2019
Regulatory and supervisory colleagues, members of the Financial Stability
Board's (FSB) Resolution Steering Group (ReSG) and Standing Committee on
Supervisory and Regulatory Cooperation (SRC), representatives from academia, and the
private sector: Thank you for being here, and for taking part in today's workshop on pre-
positioning, ring-fencing, and market fragmentation. I particularly want to thank Ryozo
Himino, our new SRC chair, for his leadership in highlighting these issues; his remarks
and efforts around market fragmentation are especially timely, as we begin the difficult
task of examining the post-crisis reforms. I also want to recognize and thank Sir Jon
Cunliffe, for proposing a workshop where we can explore these issues together; as he
recently said, quoting Ben Franklin, "we must all hang together, or most assuredly, we
shall all hang separately."1 Finally, I want to thank the leadership and staff of the Federal
Reserve Bank of Philadelphia, for not just accommodating us, but making us feel
welcome in the nation's first capital.2
The Philadelphia Fed is three blocks north, and another three west, from the
birthplace of American central banking. That birthplace is not the site of the First or
Second Banks of the United States, whose neoclassical headquarters are still standing and
open to the public.3 Instead, the first national bank sat just west of North 3rd Street and
Chestnut: the Bank of North America.4
1
John Bartlett, Familiar Quotations (10th ed., 1919), https://www.bartleby.com/100/245.21.html.
2
U.S. Senate, "The Nine Capitals of the United States" (citing Robert Fortenbaugh, The Nine Capitals of
the United States (1948), at 9),
https://www.senate.gov/reference/reference_item/Nine_Capitals_of_the_United_States.htm.
3
National Park Service, "First Bank of the United States" (October 18, 2016),
https://www.nps.gov/inde/learn/historyculture/places-firstbank.htm; National Park Service, "Second Bank
of the United States" (April 12, 2017),
https://www.nps.gov/inde/learn/historyculture/placessecondbank.htm.
4
Library of Congress, "Bank of North America, 305-307 Chestnut Street, Philadelphia, Philadelphia
County, PA" (documentation compiled after 1933), https://www.loc.gov/item/pa1098/.
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Its charter came from a new nation on the verge of bankruptcy.5 Six years of war
had drained an already-short supply of domestic specie, a necessity for international
trade. So little specie remained in the treasury that the "continentals," used to finance the
war, had depreciated to about two cents on the dollar. The United States lacked a
common, sound currency to settle its debts, and without federal authority to levy taxes, it
lacked a ready path back to solvency. (Another Franklin quote applies: "Glass, China,
and Reputation, are easily crack'd, and never well mended."6)
In desperation, the Founding Fathers made a successful Philadelphia merchant,
Robert Morris, their new superintendent of finance. Drawing on a plan from Alexander
Hamilton, Morris proposed a new institution, with the power to issue notes backed by
$400,000 in private capital. When it could muster only a fraction of that in subscriptions,
the country turned overseas. A substantial loan in French bullion financed the new bank
and saved the republic from collapse. America could declare independence, but she
could not secure it without credit from abroad.
That lesson was both hard earned and short-lived. Four years later, a new
Pennsylvania legislature claimed that dividends to foreign creditors were draining much-
needed specie from America's shores. James Wilson, Pennsylvania's representative to
the Continental Congress, wrote an impassioned legal and political defense of the bank,
emphasizing its role in international commerce. He quoted Sir James Steuart, one of the
world's first economists, calling banking "that branch of credit which best deserves the
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attention of a statesman."7 It wasn't enough. The charter was repealed-a pattern that
would repeat with two more national banks, with even more disruptive results.8
International banking is a very different enterprise than two centuries ago, but it
still "best deserves the attention of a statesman." Cross-border finance is an essential part
of the international economic infrastructure. It is a conduit to direct financial resources to
their most efficient use, regardless of national borders. It channels capital to places and
projects it could not otherwise reach, fostering innovation, international ties, and the
exchange of ideas. At its best, it is also self-sustaining, extending the financial and
technical capacity of emerging economies, and expanding their role in the global
economy.
America's experience, however, reminds us that the benefits of international
banking are not automatic. Cross-border finance is a common good, and like any
common good, sustaining it requires collective action from a range of parties.9 These
parties are both public and private, elected and appointed-not just central banks and
supervisors, but finance ministries, legislatures, and commercial banking organizations.
Each has a distinct mission and a duty to serve a distinct set of stakeholders. When those
duties conflict, trust alone cannot sustain cooperation; only a careful configuration that
7
James Wilson, Considerations on the Bank of North-America (1785) (quoting Sir James Steuart, An
Inquiry into the Principles of Political Oeconomy [sic]: Being an Essay on the Science of Domestic Policy
in Free Nations, in which are particularly considered Population, Agriculture, Trade, Industry, Money,
Coin, Interest, Circulation, Banks, Exchange, Public Credit, and Taxes," Vol. 2 (1770), at 358).
Supporters also produced more popular literature. In a satire in the Pennsylvania Gazette, a critic of the
bank complains: "All honest men should support their country, by cheating their creditors: Creditors are
the bane of a young country: So here is confusion to them all-a tender-law forever!" Janet Wilson, supra
note 5, at 12 quoting Pennsylvania Gazette (September 21, 1785).
8
Unlike its successors, the bank's headquarters no longer stands; it was demolished sometime after 1959.
See Library of Congress, supra note 4.
9
See Elinor Ostrom and Oliver E. Williamson, "Beyond Markets and States: Polycentric Governance of
Complex Economic Systems," Nobel Prize Lecture delivered at Aula Magna, Stockholm University,
Stockholm, Sweden (December 8, 2009),
https://www.nobelprize.org/prizes/economicsciences/2009/ostrom/lecture/.
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recognizes mutual and separate interests can do so. With such a configuration, the cross-
border financial system can be open, stable, and safe; without it, the system can become
unpredictable and dangerous.
"Ring-fencing" often serves as a catch-all for this dynamic, capturing any and all
impediments to the free flow of finance, however and whenever they arise. However, as
I have noted previously, that term obscures a distinction that plays a vital role in cross-
border finance-between prudently placing a constrained amount of capital and liquidity
within jurisdictions and legal entities before a crisis, and competitively seizing capital
and liquidity during a crisis. This distinction determines more than just the possibility of
an orderly cross-border resolution. Pre-positioning of resources-when properly
calibrated-can also provide the certainty that lets cross-border finance occur at all.
Certainty is the critical ingredient in achieving the careful configuration of
interests I described. Financial institutions need some certainty about the requirements
they face by participating in cross-border activity. Supervisors need some certainty about
safety and soundness, not just of the foreign banks they host, but of their domestic banks
operating overseas. Creditors and investors need some certainty that a foreign authority
won't abrogate their contracts. Elected officials need certainty that their constituents are
not unfairly disadvantaged. All these parties-and the public-need some certainty that
the resources promised to them won't disappear at the first sign of stress.
Certainty fosters financial stability. It supports clear monitoring and thoughtful
planning, by both institutions and their regulators. It signals the clear intention of
authorities to cooperate, during normal times and in an emergency. It increases the odds
that a cross-border financial institution will keep operating through a crisis. It fosters
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more and deeper cross-border financial activity, by decreasing its risks and increasing its
benefits, both to participants and to the global economy.
Certainty does require tradeoffs. None of us has perfect foresight. If we pursue
certainty to the complete exclusion of any flexibility to respond to future events, we may
end up undermining our ultimate goal: maintaining a financial system that is resilient to
unexpected shocks.
However, this workshop begins by revisiting the consequences when certainty
disappears. These consequences were on full display during the financial crisis-the
collapse in cross-border activity, when trust broke down; the rush to secure assets and
prioritize domestic claims; the ambiguous relationship between banks' resources and
their needs; and the long, halting return to a more integrated financial system. Today's
panelists will also revisit the steps that the international community took to address those
consequences. The workshop also examines the effect those steps have had on cross-
border financial intermediation and the management of global financial institutions. The
panelists will provide their views on whether we have achieved the right balance among
certainty, the kinds of economic opportunity that cross-border finance promotes, and the
flexibility to manage through a future disruption.
This decade-long account is the latest chapter in a much older story, whose moral
is clear: in regulating cross-border finance, expectations matter. When capital and
liquidity requirements are imposed only at the level of the consolidated institution, they
create a good deal of flexibility, but they cannot reassure host supervisors that sufficient
resources will truly be available in a time of need. Opaque, vague, and uncertain
requirements for pre-positioning and reporting, and lack of clarity on when they may be
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imposed, make compliance difficult, costly, and potentially disruptive. Pre-positioning,
at levels that go beyond what may be needed in a given jurisdiction in stress, can also
create rigidity and limit growth opportunities. The consequence of getting the balance
between these considerations wrong is a less integrated and less resilient global financial
system.
These details are as complex as they are important, and I commend my FSB
colleagues, particularly the ReSG, for exploring them in the context of the too-big-to-fail
reforms.10 The FSB's work brings together a wide range of experts to better understand
the intent, implementation, and effects of our post-crisis work. As with market
fragmentation, the broader context of this work matters immensely, including the desired
impact of the reforms and their anticipated and unanticipated consequences.
Within the Federal Reserve Board, we are considering similar questions-not
only what level of loss-absorbing capacity is appropriate for the material legal entities
within a large, cross-border financial institution, but also what tools we and other
supervisors use to ensure such capacity exists.
The roles that supervision and regulation play in addressing these issues are
important. There are clear advantages to setting liquidity and capital pre-positioning
requirements through regulation. Regulation ensures consistency and clarity; provides a
conduit for improvement, through public notice and comment; and offers a clear rational
basis for any measures imposed. There is also a role for supervision, not just in
addressing the particular conditions at a given firm, but in generating and sharing better
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information on how stress may manifest, not just in the firm overall, but in each
jurisdiction where it operates. More information sharing by home to host supervisors
may help convince host supervisors that they need fewer pre-positioned resources in their
jurisdiction.
Today's workshop is a worthy step forward in discussing these issues, and
towards preserving and expanding the benefits of cross-border finance. We are all
ultimately responsible for creating the conditions where capital can flow freely, giving
rise to genuine opportunity and sustainable growth. We should patiently and thoughtfully
examine how best to create those conditions. As William Penn put it, "business can
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never be well done, that is not well understood: Which cannot be without patience." I
look forward to engaging together, rigorously and openly, in the work ahead.