The latest idea out of the G20, that of creating an international regulatory structure for the biggest international banks, sounds like progress but I doubt it will prove to be.
Some regulators took note of the dangers posed by globe-spanning financial behemoths prior to the crisis. The Bank of England, in its April 2007 Financial Stability Report, singled out 16 “large complex financial institutions” as having the potential to put the financial system at risk. It also noted smaller concerns could pose a threat by virtue of their position in key markets.
The list seems to have grown. Per the Financial Times:
The Financial Stability Board, the global body that implements the G20’s communiqués and which comprises senior international regulators, has been working on a list for more than a year. The banks on the original list were Goldman Sachs, JPMorgan Chase, Morgan Stanley, Bank of America Merrill Lynch and Citigroup of the US; Royal Bank of Canada; UK groups HSBC, Barclays, Royal Bank of Scotland and Standard Chartered; UBS and Credit Suisse of Switzerland; France’s Société Générale and BNP Paribas; Santander and BBVA from Spain; Japan’s Mizuho, Sumitomo Mitsui, Nomura and Mitsubishi UFJ; Italy’s UniCredit and Banca Intesa; Germany’s Deutsche Bank; and Dutch group ING. Legal experts said the likes of Mizuho, Sumitomo Mitsui and MUFJ could be removed from that list, leaving their oversight to local regulators.
Banca Intesa is on this list and not AIG? Admittedly, this list is construed to be that of banks, but if the Financial Stability Board takes its name seriously, the omission of AIG reveals the same sort of blinkered thinking that enabled the crisis.
The biggest problem with the idea of international oversight is that bankruptcy is still a national affair. Unless the international authority has the financial firepower either to bail out a faltering behemoth or provide it bridge financing while it is being wound down, an international body is likely to merely be a defacto nagger and coordinator of local regulators (financing is often important in the resolution process; the US authority in the S&L crisis, had to get an $50 billion authorization from Congress for working capital, and this was for a passel of little, individually easy to wind down institutions). Indeed, the Financial Times report indicates that most of the work will indeed remain in the hand of national regulators .We have a more passive version of that in Basel III, which are standards that are promulgated internationally but adopted and implemented by national banking regulators.
The G20 also appears about to punt (under the cover of deferring) on one move that might have given an international authority a wee bit of clout, that of putting a surcharge on the activities of banks deemed to be systemically important. The idea of a charge is to provide disincentives against being so large, plus to help fund various remediation activities.
The problem, as the Bank of England’s Andrew Haldane wrote in a must-read paper, The $100 Billion Question, is that global banking as now constituted is economically destructive. There’s no economic justification for banks larger than $100 billion; they are cost inefficient relative to smaller banks (well, actually, there is an economic justification: bank CEO pay is highly correlated with total assets of the bank). Financial crises impose costs on the rest of the economy, meaning innocent bystanders. The output losses of the last crisis were somewhere between 1 and 5 times global GDP. If you take the low estimate, assume a 20 year time frame to recover the costs via a tax, it would require a levy of over $1.5 trillion per year. The market cap of the biggest banks is only $1.2 trillion.
Haldane’s analysis is devastating. It says that finance as now constituted is monstrously destructive. Its social costs dwarf its value as a business. This cost/benefit tradeoff says the biggest financial players need to be radically restructured, or regulated very aggressively. But instead, the Financial Stability Forum spends a year debating who ought to be regulated, a Nero-esque fiddling while financial firms use cheap central bank provided liquidity to hunt for new risky, potentially economy-wrecking adventures.
Given the immovable object of nation-based bankruptcy processes, a seemingly more modest step would actually do more to reduce systemic risk. Right now, capital adequacy is the responsibility of the home country regulator. For instance, aside from certain operations, like broker-dealers (which are regulated on a national level), if banking operations in a foreign country get in trouble, the home country operations are supposed to provide support. Thus, for instance, the TARP infusions were also for the benefit of the overseas operations of JP Morgan, Citi, and the other recipients; the Swiss rescue of UBS was in part for the benefit of its US businesses.
Regulators could instead insist that all financial firms operating in their country have enough capital in that national entity (no parent guarantees) to satisfy local rules. This would effectively require banks to start segregating their operations on a country-by-country basis (each would presumably need to have its own Treasury operations, for instance, which still could coordinate with a regional or global treasury function). It would also make national regulators far more attentive to the size of the banking system relative to their economy and give them incentives not to have an outsized banking sector. Having banks more compartmentalized by country would make them far easier to resolve and reduce the need for global coordination (the sort of US-UK misunderstandings that scotched the last-ditch effort to rescue Lehman, for instance).
Now admittedly, finance has evolved in such a way as to defy this template. The biggest firms have trading books that they manage on a global basis, and Citibank had a global payments business that would be very hard to house in nation-based banking regimes. But quite a few businesses can be hived out and operated on this basis (retail and institutional lending, private equity, for starters) and any steps to build more buffers in the banking system and make it easier to wind down banks would be a considerable step forward.