Chained but Untamed

SPECIAL REPORT INTERNATIONAL BANKING May 14th 2011 Chained but untamed SRInternationalBanking2011.indd 1 03/05/2011 17:40 S PECIAL REPORT I NTERNATIONAL BANKING Chained but untamed The world’s banking industry faces massive upheaval as post•crisis reforms start to bite. They may make it only a little safer but much less protable, says Jonathan Rosenthal THE NEAR•COLLAPSE of the world’s banking system two•and•a•half years ago has prompted a fundamental reassessment of the industry. Per• haps the biggest casualty of the crisis has been the idea that nancial markets are inherently self•correcting and best left to their own devices. After decades of deregulation in most rich countries, nance is entering a new age of reregulation. This special report will focus on these regula• tory changes, which will be the main determinant of the banks’ prot• ability over the next few years. Start with the additional capital that banks around the world will have to hold. Bigger capital cushions will make the system somewhat saf• er, but they may also reduce banks’ protability by as much as a third. In addition, they may push up borrowing costs and slow economic growth. Worse, higher capital requirements for banks may drive risk into the darker corners of nan• C ONTENTS cial markets where it may cause even greater harm. 3 Reregulation Supervisors and regulators almost everywhere are A dangerous embrace still trying to nd ways to deal with banks that have be• come too big or too interconnected to be allowed to fail. 5 Japanese banks If anything, the crisis has exacerbated this problem. Don’t sit on your hands Some of those banks have become even bigger or more 6 Capital interconnected. And governments made good on the How much is enough? implicit guarantees o ered to banks, encouraging them to take even bigger risks. 9 Investment banks In America the rules to implement the Dodd•Frank Where angels fear to trade act are beginning to take shape. Passed last year, the law 12 Remuneration runs to 2,319 pages, but it is little more than a statement of Fantasy paypackets intent. Before it can take e ect, 11di erent agencies have to write the detailed regulations. These will redene 13 Retail banks much of the industry in America and around the world, In vogue reversing decades of deregulation in nance in the 15 The problems of size world’s biggest economy. Survival of the fattest One key provision is the separation of investment banking from commercial banking, known as the 17 Small banks A CKNOWLEDGMENTS Volcker rule. It will restore some elements of the Depression•era regula• Better be big This special report beneted from tory regime that was meant to ensure that commercial banks did not 18 After the reforms the time and insight of many speculate with protected deposits by forbidding them from trading se• Safer, but not yet safe people in addition to those curities. Other regulations in America will set the fees that some of the enough mentioned in the text. The author would like to thank in world’s biggest retail banks can charge when one of their customers particular: Andrew Bailey, Tom swipes a debit card. These make no pretence to making banking safer, but Budd, Kevin Buehler, Toos reect politicians’ anger at banks and suspicions of those who run them. Daruvala, Laurent Desmangles, Wilson Ervin, Robert Feldman, Britain, for long the most enthusiastic champion of nancial dereg• Andrew Freeman, Akinari Horii, ulation, is going further still, pondering whether banks’ retail arms Thomas Huertas, Kiyoto Ido, Jung Kim, Akash Lal, Nick Malik, should be so tightly regulated that they become little more than public Hironari Nozaki, Adam Posen, utilities. Mervyn King, the governor of the Bank of England, in a recent Michael Poulos, Jörg Rocholl, speech in New York wondered aloud whether the use of deposits to fund Glenn Schorr, Anthony Stevens, loans should be outlawed. In essence, he was questioning a basic build• Joe Straehle, Steven Thogmartin, A list of sources is at Renny Thomas, Naoki Togashi, ing block of modern banking. In April a government•appointed commis• Economist.com/specialreports Paul Tucker, Adair Turner, Kazuo sion said that Britain’s banks should wall o their retail arms so they Ueda, William Vereker, Mark Weil An audio interview with and others who wished to remain could be salvaged if the rest of the business were to collapse. It is also try• the author is at anonymous. ing to devise resolution regimes and living wills to reduce the harm done Economist.com/audiovideo/ when banks collapse, and it wants more competition in retail banking. specialreports The Economist May 14th 2011 1 S PECIAL REPORT I NTERNATIONAL BANKING Households with a deposit account, 2009, % of total In brief <25 25 - <50 50 - <75 >75 No data Key terms: Basel 1-3 A series of international agreements on the minimum amount of capital that banks have to hold as a proportion of the loans they have made. Shadow banking Activities similar to banking, such as taking deposits or making loans, that take place outside the regulated banking system. Resolution regimes Special legal forms of bankruptcy for banks designed to keep essential services going even as the rest of the bank is wound up. Living wills Advance provisions made by banks for how to proceed in the event of failure, to minimise damage to outsiders. World’s unbanked adult population, 2010 Developing Top ten countries, m Size of financial markets, 2009, $trn Between countries China 597 Equity Debt Bank assets 10.0 1994 and 2010 2.4bn India 395 (62%) Indonesia 97 the combined market share Pakistan 87 15.1 32.8 by deposits of the top five 13.1 Brazil 77 American banks increased from Bangladesh 68 17.6 31.6 Total world 46.4 7.9% to Nigeria 67 Developed 54 27.0 countries (12%) Mexico bn 14.2 Vietnam 42 2.5 Asia: 58 United States: 61 European Union: 89 . % 95m Philippines 40 34 3 Sources: Consultative Group to Assist the Poor; IMF; Federal Deposit Insurance Corporation; Honohan (2008), UNDP and AllianceBernstein; Morgan Stanley; Hanson, Kashyap and Stein (2011); Berger, Herring and Szegö (1995); D. Sheppard (1971); Bank of England; Bank for International Settlements; Reinhart and Reinhart (2010); comScore; national sources; The Economist 2 Bt ri ain is not alone in reacting strongly. Switzerland, which stead of reducing it across the global nancial system. In some grew rich as its buccaneering international banks sailed the tides ways they have exacerbated the dangers. Dodd•Frank, in its zeal of capital owing around the world, is now downsizing its glo• to prevent any more taxpayer•funded bank bail•outs, has curbed bal banking ambitions. It plans to impose such strict capital stan• the Federal Reserve’s ability to provide cash to banks that are dards on its biggest banks that their investment•banking arms fundamentally sound but su ering a shortage of liquidity. That will be forced to shrink or leave the country. has made it harder for the central bank to act as a lender of last The wave of new regulation comes as many banks are still resort, a principle of central banking established almost 140 struggling to regain their footing after the crisis. Across much of years ago by Walter Bagehot, a former editor of this newspaper. Europe, bad debts held by banks are impairing the balance• The unwelcome consequences of some of the other new sheets of their governments. Ireland and Spain are trying to con• rules now being introduced may be greater yet. For example, the vince bondholders that they can and will repay their national European Commission’s decision to regulate bankers’ bonuses debts, despite the losses incurred by their bankers. Doubts about in a bid to limit risk•taking may have the perverse e ect of driv• those two countries’ creditworthiness, as well as that of Greece ing up banks’ costs and making their earnings more volatile. and Portugal, are spreading across the continent’s banks, raising borrowing costs and unsettling markets everywhere. The bright spots In America big banks are healthier, having largely rebuilt Banks in emerging markets face di erent and far more excit• their balance sheets. Yet not all have recovered. The country’s ing challenges. They need to grow quickly enough to keep pace smaller regional and community banks include some 800 trou• with economies racing ahead at breakneck speed and to reach bled institutions at risk of being seized by regulators if their capi• the legions of potential customers in villages and slums who are tal ratios fall. In both America and Britain households are deeply hungry for banking. Rapid growth and the spread of computing indebted. For banks, growth in these markets, as across much of and communications technologies have turned these markets the rest of the rich world, is likely to be slow. In Japan banks are into huge laboratories of innovation. This special report will ar• well into their second decade of a slow•motion crisis, while in gue that banks in countries such as India and Kenya have much China ocials fret that banks are growing too quickly. to teach those in the rich world. These lessons could come in There is much that regulators around the world are doing handy, for the torrent of reregulation in developed countries will well, yet many of their actions have been piecemeal. As a result, soon be raising banks’ costs, trimming their prots and forcing they tend to shue risk around from one country to the next in• some of their customers to look for cheaper banking services.

Load more