The growing debate about the most effective way to regulate international banks has intensified with the impending implementation of the Basel II accords. The debate, however, goes beyond Basel II implementation and touches international securities firms and accounting firms, as well as banking groups.
Recently, Federal Reserve Board Governor Susan Schmidt Bies said that the cross-border implementation of Basel II could create challenges for banks operating in multiple jurisdictions. This is exacerbated by the fact that some countries plan to introduce Basel II more broadly than the US, where only the large international banks will be initially affected. Gov. Bies quickly added that it is entirely appropriate for all Basel-member countries to have their own rollout timelines and their own ways of addressing matters left to national discretion under the Accord.
Since the issue is bigger than Basel II, it has to be placed in the proper context. The growing prevalence of large banks and securities firms operating in a number of countries has led to an effort to find the most effective means of regulating these international institutions. An increasingly popular approach has been designating a lead regulator for the global bank or firm. Under the lead regulator approach, the bank or securities firm is supervised by the regulator of the country where it is headquartered or has its principal place of business. Even if a bank did extensive business in another country, the host country, it would still be exclusively regulated by its home country regulator. For example, while Deutsche Bank is one of the largest players in the U.K. markets, its lead regulator would be the German BaFin. Similarly, U.S. global banks and securities firms would be regulated solely by the Federal Reserve Board and the SEC despite their substantial activities in the U.K. or Germany.
Returning to the cross-border implementation of Basel II, Gov. Bies advised banks to pay close attention to the Basel Committee’s recent guidance on the sharing of information between host and home jurisdictions in the Basel II environment. Indeed, the effective implementation of Basel II depends on such cross-border information sharing. The Basel Committee developed a number of principles to guide this essential information-sharing process. While the Basel Committee guidance is designed for banks, the principles are broad enough to have some value when applied to other international entities.
One principle is that the respective roles of home and host country regulators should be clearly communicated to banks with significant cross-border operations in multiple jurisdictions. The home country regulator would lead this coordination effort in cooperation with the host country regulators. In addition, information-sharing arrangements should focus on information that is relevant for regulators to carry out their duties; and such information should be provided in a timely manner. In the case of a host regulator this would primarily be information enabling it to monitor, assess and deal with the material risks to which the bank in its jurisdiction is exposed. A home country regulator would generally need information concerning risks that would have a material impact on the banking group as a whole. In any request for information from another regulator, the requesting regulator should be prepared to explain why it needs the information in order to ensure that the most appropriate information is supplied.
The Basel Committee sees a difference between factual and judgmental information, such as examination reports and assessments of rating systems. Judgmental information, which can be provided only by regulators, can be the most valuable part of the information exchange.
Since a pragmatic approach to home-host information sharing implies that the arrangements should be flexible and tailored to the particular circumstances, the Basel Committee envisions a menu of options. The principles underline the need to avoid redundant or uncoordinated qualification and approval work, reasoned the committee, and it is expected that the group-wide Basel II implementation exercises will shed light on what particular procedures may be appropriate for specific banking groups.
Returning to the broader debate over whether it is effective to designate a lead regulator, UK FSA chair, Sir Callum McCarthy has noted that, while the lead regulator approach has the advantage of simplicity, it also poses a number of significant concerns. For example, different regulators have differing levels of power and resources to deal with global firms that may pose systemic risk in the countries in which they operate. And not all countries have the same approach to financial regulation. For example, there could be a problem with transparency and standards in some offshore jurisdictions. But even aside from well known egregious cases, there remain questions about the implementation of international rules and standards, whether from global organizations such as IOSCO or from EU directives. There is a further problem in that compensation schemes are not uniform. For example, deposit insurance in the US applies to deposits payable in the US, but does not extend to deposits in branches of US banks that are payable outside the US.
For these reasons, the chairman is extremely wary about concentrating power in the hands of a single lead regulator unless the concept allows for some dialogue between home and host regulators. The simplicity for the bank or firm that would be achieved by having only one worldwide regulator is highly desirable, he admitted, but the approach must deal with a range of issues.
One issue is to recognize the reality that there are varying levels of risk. A lead regulator must recognize, for example, the widely different risk levels inherent in a small bank operating only in wholesale markets and in a large bank whose failure would pose a systemic risk to the host country. In this regard, the chairman called for the development of protocols as to the duties of both the lead regulator and the host country regulator on issues such as exchanging information and taking joint action.
As an example of the cooperative approach he favors, the chairman praised a system developed with regard to two global Swiss banks under which there are twice a year meetings of the Swiss Banking Commission, their lead regulator, and the Federal Reserve Bank of New York and the FSA, which together comprise the three most relevant regulators in the three capital markets of most importance to the banks. At the meetings, views are compared, information exchanged and actions coordinated.