Miguel Fernández Ordóñez: Contribution of global banks to financial
stability
Opening speech by Mr Miguel Fernández Ordóñez, Governor of the Bank of Spain, at the
International Capital Markets and Emerging Markets Roundtable, Institute of International
Finance (IIF), Washington DC, 17 April 2011.
* * *
Let me start by thanking the IIF for giving me this opportunity to present my views on global
banks. I will speak from my perspective as Spanish banking supervisor. And I should say
from the outset that in my country global banks have not given us the most problems.
Indeed, the main message of my intervention today is that we should not fall into the trap of
automatically equating "global banks" with "dangerous banks" in terms of financial stability.
This may be an intuitive reaction to the crisis. But it would be a mistaken one, in my view. In
fact, based on our experience, I would like to give you some examples of how global banks
can make a positive contribution to financial stability. Naturally, these are only examples, and
I would certainly not presume to have all of the answers on this complex issue. But I hope
these examples will be illustrative of the point I am trying to make.
First of all, it is true that some global banks have experienced severe problems. We have
seen large, complex and interconnected banks and financial companies on the brink of
bankruptcy, both here in the United States, and across Europe. The taxpayers of some of the
most developed countries of the world have been called on to support global banks
headquartered in their countries. Indeed, after the Lehman bankruptcy, it is fair to say that
the entire global financial system was put at risk by the difficulties of some banks operating
worldwide.
It quickly became clear that an unprecedented and unacceptable level of systemic risk had
built up over the "boom" years. And that a significant amount of taxpayer's money had been
put at risk as a result. This prompted a forceful, and understandable, reaction from all sides.
The public, bank investors, regulators, supervisors and politicians alike all agreed that we
needed a profound overhaul of the treatment of systemic risk.
I believe that the reactions to this challenge from the G-20, at the highest political level, as
well as from the Financial Stability Board (FSB) and the Basel Committee of Banking
Supervisors (BCBS), have been proportionate to the size of the problems and risks we have
encountered since the outbreak of the crisis. The costs have been huge and there is
widespread agreement that we cannot allow this to happen again.
Nevertheless, we should also recognize that a number of global banks have managed to
navigate these rough and unchartered waters without capsizing, Indeed, if you allow me to
extend the metaphor, some have even been able to help to calm the waters. It is important to
learn the lessons from all of our experiences, both good and bad, to help us better shape the
future regulation and supervision of the financial system. And it is with this in mind that I want
to comment on our experience with global banks headquartered in Spain.
As I will stress throughout my intervention, the global nature of systemically important banks
should not be seen as a negative attribute. Globalization allows countries and cultures to
learn from each others' experiences, enriching us in a very broad sense. Of course we want
a safer world, but a key foundation of safety is a world that is able to grow. And growth goes
hand-in-hand with openness and globalization. In fact, globalization has been the engine of
growth in the years before the crisis.
And global banks have played a key role in this process and, therefore, in delivering growth
to our societies. Some banks have become global because they have accompanied
domestic non-financial companies in their international expansion process.
Our largest global banks became international around fifteen years ago. They went first to
Latin America, following their large domestic customers (utilities, oil companies, telecom
firms, construction and technology firms and so on) into those new markets. Once in the new
markets, the banks were able to familiarize themselves with the needs of other local
customers and started to provide banking services to local households and firms. The
beneficiaries of this process were not only Spanish companies, but also firms and
households of the host countries.
This natural expansion process has created benefits in terms of risk and income
diversification for the banks involved, thus reducing their probability of failure and contributing
to a safer financial system worldwide. Moreover, global banks help to better allocate
resources across the planet by contributing to fund investment processes in countries where
savings are insufficient and, in the opposite situation, providing more opportunities for
depositors and savers to channel their funds to better opportunities. This natural expansion
process should continue for banks in emerging countries whose non-financial companies are
expanding abroad into other emerging countries or into more mature countries. We should
not bring this process into a halt, reducing welfare across the board.
And global banks do not only make contributions to growth, but can also act as a stabilizing
force in the financial system, both in the countries in which they operate and at home.
Our experience as supervisors is that our large and global banks have been a stabilizing
factor during the crisis. Of course, our banking system has been affected by the crisis, but
our problems have been concentrated in a limited number of small and medium-sized local
savings banks.
The performance of our large banks during the crisis has been very different from that of this
group of savings banks. Since August 2007, like the rest of the banking sector worldwide
they have taken a hit on their share price. However, they have contributed positively to the
restoration of financial stability worldwide, by helping in the restructuring of other banking
systems, buying banks or pieces of banks that were experiencing difficulties. They thus
contributed to stabilize markets and financial systems in a time of turmoil. Moreover, they have
maintained their commitment to households and firms - both large corporate and SMEs - in
the emerging markets in which they operate. We have not seen any halt in banking
intermediation in those markets or any retrenchment from those markets. And finally, they
are still entering new banking markets, both in Europe and in Asia.
Resilient global banks do not only benefit the host markets in which they operate, in
particular emerging countries. They have also been very beneficial to the home market.
Wide-ranging geographical diversification has helped these banks to withstand our real
estate crisis much better. They have been able to compensate the difficulties in the local
banking market in Spain, resulting from a recession and the ongoing slow recovery, with
much more buoyant and dynamic banking business abroad.
Until now, the benefits that I have mentioned can be said to apply regardless of the legal
structure chosen by the banks for their international expansion. But our large global banks
have also adopted a business model which has some specific strengths that I would like to
highlight. Namely that their international expansion was based on the subsidiary model, as
opposed to the branch model. As a recent paper by IMF staff stresses, a branch model for
internationalization may be cheaper than one based on subsidiaries. However, it may also be
riskier, both for the host and the home markets. Although nobody expects that these banks
will need to be liquidated, we have seen sufficient black swans in recent years to show us
that we need to hope for the best but be prepared for the worst. And if liquidation were
needed, a stand-alone subsidiary model would have important advantages over a branch
model, especially if there is substantial deposit taking activity at the local level. I am not
saying that the liquidation of a global bank organized through subsidiaries would be an easy
task. What I mean is that it would be much easier than for global banks which are deeply
interconnected across countries through branches.
The stand-alone subsidiaries model has an additional advantage, from the perspective of the
supervisor. It is far more symmetric for the local supervisor than the alternative model,
allowing them to really supervise the institution. And as a home supervisor, if a foreign bank
has a significant share of a domestic market, I would rather have the domestic supervisor
deeply involved in the monitoring of that bank. Our experience has taught us that local
supervisors usually have a deeper knowledge and more accurate information on
developments in their home banking sectors than distant parent company supervisors. The
expansion of global banks through subsidiaries provides for this deep involvement of the
local supervisor. This may be a more effective - and therefore safer - arrangement, as it
provides for a double layer of supervision, by both home and local supervisors. Moreover,
from the group's perspective, the combination of decentralized management and strong
controls at the parent company creates as well a double layer of control within the group.
This can have a drawback in terms of higher costs but some international active banks have
demonstrated that it can be compatible with a good efficiency ratio.
The subsidiaries model is one way of approaching this issue, but I am very conscious that it
is not the only one. Nor is it suitable for all banks. It depends on many factors, including the
type of business conducted by the institution - retail, investment banking etc. So let me be
clear that I am not prescribing this model, and that I do not think it is the answer in all
circumstances. But it is a factor that makes certain international groups less dangerous for
the rest of the system in terms of their likely impact in case of difficulties. In other cases, the
institutions concerned may also be able to argue that they have other controls, or business
models, in place which reduce their risks. The validity of all reasonable approaches should
be explored.
In this context, let me mention here the work underway in the FSB and BCBS to deal with the
global SIFIs issue. In my opinion, this work is going in the right direction. For example, we
have a general agreement that not all SIFIs are the same or pose the same degree of risk to
the system, and that the framework should recognize this. Along the same lines, the idea is
to have a system which builds in a sufficient degree of supervisory judgement to reflect
aspects that cannot be quantified, but balanced with "constrained discretion" and a peer
review process to ensure that there is a level playing field. And I think, and others think, that
the resolvability of an institution should be taken into account in determining the systemic risk
of a Global SIFI. For instance, a proper "living will" is a mechanism to reduce the impact of a
bank failure and, therefore, to reduce the systemic risk these institutions pose. Finally, the
FSB places strong emphasis on the importance of intensive supervision.
The aspect of the FSB approach to SIFIs which has attracted most attention is the setting of
higher capital requirements (or "loss absorbing capacity") for SIFIs. We would be extremely
naïve to think that extra capital is the answer to systemic risk. Holding extra capital does not
resolve the problems of poor management or ill-advised risk taking. And we will never be
able to require SIFIs to hold a level of capital sufficient to absorb the huge costs related to
their potential bankruptcy. But capital does help to reinforce the system, because it provides
an incentive for institutions to reduce the risk that they pose to the system. Banks which
show that they are less risky should be subject to lower requirements, thereby incentivizing
responsible and safe behaviour. Instead, those banks that pose higher risks should meet
more stringent requirements.
Let me stress, yet again, that my point is not about having all global banks following this
organizational philosophy. On the contrary, I do believe a diversity of institutions from either a
business model or an organizational perspective is needed to ensure that financial
globalization promotes global growth. But we should also be aware that, if the regulatory
framework in areas such as SIFIs capital surcharge is ill defined, we may end up promoting
the convergence of global banks towards the most complex business model of the current
landscape.
In this respect, I would like to draw your attention to the fact that we have recently raised
core capital requirements - to 8% - for all institutions operating in Spain, in order to boost
the stability of the financial system. However, we have also gone a step further and placed
an additional 2% charge - to reach 10% - on those institutions which could potentially create
more problems for the supervisor. To be more precise, this higher capital requirement will be
applied on those which have less than 20% of their share capital or voting rights with third
parties and that have wholesale funding of more than 20%. These institutions are not the
globally active ones, but they are the locally oriented ones that have created the highest risk
for financial stability in Spain during recent times.
While our largest banks have been more a support factor than a problem, and part of our
savings banks sector is sound and profitable, we have faced serious challenges regarding a
number of the local savings banks. Our experience in this crisis illustrates that we should be
careful not to establish over-simplistic solutions to be applied generally. Instead, we should
concentrate on solving the problems where they really originated. This is precisely the goal of
the measures we have adopted in Spain during the last two years. We are currently dealing
with a deep restructuring process that will end up by transforming those savings banks into
larger commercial banks that, in the future, could also become global banks or a part of a
global foreign bank.
In conclusion, we should not demonise global banks for being global. They can play an
important role in the international economy. Provided they are safe and soundly managed,
they can facilitate the internationalization of non-financial firms, and they can bring greater
competition, efficiency and stability to the markets in which they operate. What we need to do
as supervisors is to make sure that global banks have adequate risk management
capabilities, sufficient loss-absorbing capital, and are subject to intensive and coordinated
supervision, so that we are able to contain the systemic risk they pose without curtailing their
contribution to economic growth worldwide.
We have nothing to fear from global banks which are well-managed, well-capitalised and
well-supervised by home and host authorities. What we should do is prevent the emergence
of badly managed, badly-disciplined banks, whatever their geographical dimension, as they
can expose our financial systems to important risks.
I hope that this humble contribution provides food for thought. As I said at the beginning of
my intervention, I do not have all of the answers. But I do think that we can and should learn
lessons from all experiences, both positive and negative.
My words reflect the experience that we have had with our global banks in the last three
years. But of course, past successes are not, per se, a guarantee of future success.
Sophocles wrote in one of his tragedies that "we cannot call a mortal being happy until he's
passed beyond life free from pain". Following the same principle of precaution, neither
supervisors nor credit institutions should succumb to the temptation of unfounded optimism
about the future. This is the reason why we will continue pushing for a very intense
supervisory process for these global institutions and we will ensure that they are complying
with the highest standards in any field. Supervisors can make several different types of
mistakes, but one they cannot afford is complacency.
Thank you very much for your time and patience.