Yesterday, the FT published a stunning survey of U.K. M.P.s who – regardless of party or preference – overwhelmingly favored “electrifying” the Vickers ring-fence designed to separate retail from investment banking. In the U.S., we call this the Glass-Steagall Act and, so far, it’s consigned to history. But, even so, I think the structure of banking in the U.S. is set for a makeover at least as dramatic as the British redo. Despairing of international comity on global regulation, U.S. regulators are implementing what a ghastly neologism has dubbed subsidiarization. In English, this means barriers between corporate entities in a complex banking organization. In dollars, this means a wholesale rewrite of the strategic premises of global banking. In reality, all of this can happen without another Act of Congress and, I think, much of it will in 2013.
What are the indicators of the rewrite under way? There are several in the current regulatory agenda, but the two most dramatic are the single-point-of-entry (SPE) resolution protocol and the new regime proposed for foreign banking organizations (FBOs) doing business in the U.S. Although no U.S. proposal pries banks here into component pieces by business line a la Vickers, these proposals combine with the activity bans epitomized by the Volcker Rule and U.S. living wills to force finance into freestanding entities wrenched from the interstices of integrated cross-sectoral, cross-border financial conglomerates.
It’s sometimes hard to see the subsidiarization forest because U.S. regulation is strewn with so many detailed trees. This is particularly true in the Federal Reserve’s mammoth proposal that rewrites the rules for FBOs. The NPR details demanding new capital, liquidity, stress-testing, exposure, and governance standards that – stepping back from all the specifics – essentially tell FBOs that the U.S. is now a “my way or the highway” banking regime. Understanding how upset this would make FBOs and many of their governments, the Fed quickly assured all that nothing in the new rule establishes a quarantine against foreign banks doing business here through branches and agencies. These assurances ring hollow, though, when the rule is read in its entirety. In essence, an FBO using branches would need to ensure that the branches comply with virtually all of the rules that would apply to them as separate subsidiaries. The U.S. “highway” thus will have two mandatory lanes on it, one for the new “intermediate holding companies” and one for branches with only a dotted line between them. FBOs will then have to drive according to all of the Fed’s new prudential standards. Banks that like the Autobahn will need either to slow down fast or take the exit.
For all the focus on its role in orderly resolution, SPE is also a subsidiarization-based approach. As I discussed last week, SPE is the plan agreed upon by the FDIC and Bank of England as the way to go if a big bank doing business across their borders comes undone. SPE means that the resolution authority comes in at the top-tier holding company to restructure operating subsidiaries within it so that financial operations continue without systemic market volatility or interruptions even as parent-company shareholders and other parties face the large losses intended to avert moral hazard. This is an over-simple description of a complex resolution strategy, but it’s correct as far as it goes and makes clear that, for all the details, SPE requires a parent holding company and clearly-defined operating entities. In short, SPE spells subsidiarization.
Why has the U.S. settled on subsidiarization? Regulators here have lost faith in the ability or willingness of most of their global colleagues to implement stringent prudential standards enforced with discipline. Two years on and the Basel III capital rules are largely incomplete and the liquidity rules still just a hope. Even if key regimes (e.g., the EU) implement the standards along Basel’s lines – unlikely – the rules will depart from the new U.S. framework in both substance and supervisory scrutiny. To be sure, the U.S. is among the Basel laggards, but its capital rules are already among the toughest and sure to get still more stringent in the forthcoming final U.S. Basel standards.
The U.S. is also a long way from happy with how other nations are handling systemic risk. Many nations – e.g., Japan, China – have systemic banks that (despite nominal Basel III adherence) operate under prudential rules not to the Fed’s liking, and big banks in many nations are not just still too big to fail, but also so large a percentage of home-country GDP as to be too-big-to-save bastions of economic nationalism. This fundamental structural difference between the U.S. and many major nations is proving the impediment to harmonious, homogeneous regulation skeptics like myself long feared.
As the preamble to the Fed’s new FBO rule makes strikingly clear, the U.S. is done negotiating. Now, it’s demanding: to do business here, big banks need to do it our way or else. In response, other nations may lay down a similar ultimatum to U.S. banks. I’ve in the past outlined a way to craft a harmonious global bank-regulatory regime that isn’t premised on homogeneous rules. The way things are shaping up, it’s turning into a first-order priority if banking isn’t to be forced to retreat behind each nation’s borders.