Insights

Tackling Market Fragmentation

In Global Banking

Cross-border banking benefits and emerging policy issues

The Financial Stability Board (FSB) and International Organization of Securities Commissions (IOSCO) held a day-long roundtable on market fragmentation in financial services, preparatory to a report to the G20 Finance Ministers and Central Bank Governors meeting in June. This paper summarizes the points Oliver Wyman Partner Douglas Elliott raised as a panelist, focused on impediments to cross-border banking.

The key elements are:


In Doug's view, the G20 leaders should highlight the importance of tackling this issue and should mandate a body to begin a process of global consultation, leading to a new social compact on cross-border banking.

 


Why do we want cross-border banking to work well?·       Efficient use of financial resources.

·       Diversification that increases financial stability.

·       Support for cross-border activity in the rest of the economy.

·       Reduction in inequality across nations.

 

 


How does public policy discourage cross-border banking? 

Investors and bank executives increasingly question the rationale for involvement in cross-border banking and there has been a significant pullback. To see the contribution of the official sector to this, it is important to look at the totality of the impediments, not just individual items.


The following 13 impediment categories are widespread: Answers 13 Questions
  • 1Outright prohibitions.

    In some cases, cross-border banking transactions have simply been disallowed.

  • 2Ring-fencing and forced subsidiarization.

    There are many examples of nations that require foreign banks to ring-fence or subsidiarize their operations in the host country, losing many efficiencies that are present when using branches.

  • 3Capital requirements favoring domestic activity.

    The most overt is the cross-border component of calculations of systemic importance that can trigger higher capital requirements.

  • 4Liquidity requirements favoring domestic activity.

    Quantitative liquidity requirements are newer, but there is clearly room for more favorable treatment of domestic activity than cross-border activity.

  • 5Resolution requirements favoring domestic activity and domestic entities.

    As supervisors and resolution authorities increasingly demand detailed resolution and recovery planning, there is a great deal of room to discourage cross-border ties.

  • 6Data requirements favoring domestic activity.

    This issue is growing in importance as Big Data and machine learning revolutionize aspects of banking while concerns about privacy rights grow in parallel.

  • 7Impediments resulting from the need to understand and to meet many varied national rules.

    Cross-border activity requires banks to meet the mandates of multiple national authorities. Failure to create global standards, or to apply them in the same ways, increases the costs and difficulties of meeting these multiple mandates.

  • 8Extra-territoriality that adds costs and risks and can limit activities.

    The problem of multiple mandates is exacerbated when certain countries or regions apply their rules on a global basis.

  • 9Financial crime rules that can be excessively onerous and excessively varied.

    A few nations have been virtually cut off from the global financial system as a result of severe cutbacks in their correspondent banking relationships as global banks find it hard to justify these ties from a financial point of view, given the compliance costs and large reputational and regulatory risks.

  • 10Legal sanctions and regulatory fines that hit foreign banks harder.

    There is a strong suspicion that domestic banks are treated more leniently when they violate rules or laws than foreign banks are. This is hard to prove, but is certainly a risk. Even the perception serves as a barrier to cross-border activity.

  • 11Supervisory decisions that tend to favor local banks.

    It is clearly the case that in some countries supervisors are significantly more favorable to domestic banks.

  • 12Unofficial support by national governments for “national champions.”

    In some countries, the bias goes further, with a strong, but unofficial, policy of trying to build up one or more of their banks as “national champions” that can take on the world. Foreign banks suffer by comparison.

  • 13Taxes.

    Sometimes tax laws favor domestic banks over foreign ones. Most recently, the US instituted the BEAT tax as part of its major changes to corporate taxation. Most likely unintentionally, some of its provisions are particularly costly for foreign banks given the strong ties between their US operations and their global activities, which create cross-border flows subject to the tax that have no counterpart for domestic banks.

I strongly urge the global policymaking community to tackle this issue holistically as well as at the level of individual policies.
Douglas J. Elliott, Oliver Wyman Partner

There is a temptation to simply deal with this by looking at policies one by one, often in individual countries. This is indeed important, but as the list of impediments shows, there are many tools open to national authorities that choose to disadvantage cross-border activity. We need to find a way to step back and agree on an overall approach that will give authorities sufficient confidence in international cooperation that they will agree to pull back on the use of these barriers.

The Japanese Presidency of the G20 is concerned about market fragmentation. It would be very helpful if the G20 leaders highlighted the need for this global effort and mandated an appropriate body to begin the process.

 

Tackling Market Fragmentation in Global Banking


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