FOR THE RECORD 9 Greg Baer, BPI THE QUARTERLY JOURNAL OF THE CLEARING HOUSE AND BANK POLICY INSTITUTE OUR PERSPECTIVE 14 Stephanie Heller & Rob Hunter, TCH, and Richard Taffet, Morgan Lewis

Q3 2018, VOLUME 6, ISSUE 3 STATE OF BANKING 16 Andy Cecere, U.S. Bancorp

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UPFRONT FEATURED ARTICLES

For the Record Do Ring Fences Make 9 The regulatory and examination regime applied to 28 Good Neighbors? foreign banks operating in the U.S. seems difficult A decade has passed since the financial crisis, and to justify based on any historical experience or it’s an appropriate time to determine if ring-fencing reasoned analysis. makes sense. by Greg Baer, CEO, Bank Policy Institute by H. Rodgin Cohen, Sullivan & Cromwell Our Perspective 14 The plan to create a ubiquitous faster payments Ring-Fencing’s Global Impact capability in the United States in order to promote A Basel Committee perspective on the implications for efficient commerce and facilitate innovation. 36 policymaking and international cooperation. by Stephanie Heller, EVP & General Counsel, and Rob Hunter, Executive Managing Director & Deputy by William Coen, General Counsel, TCH, and Richard Taffet, Partner, Basel Committee on Banking Supervision Morgan Lewis Ring-Fencing: Escape from 44 the Prisoner’s Dilemma Widespread ring-fencing can increase the risk of bank failure, in some cases dramatically. by Wilson Ervin, Credit Suisse

Ring-Fencing for 56 Bank Resolution and Crisis Response Present practices are preventing the emergence of cross-border banking groups. by Edouard Fernandez-Bollo, Autorité de Contrôle Prudentiel et de Résolution

STATE OF BANKING On the Resiliency of U.S. 62 Operations of Foreign Banks Andy Cecere, U.S.-based operations of foreign banks, which are 16 U.S. Bancorp resilient and well positioned to weather the next economic downturn, also play a key role in the economy by Andy Cecere, chairman, president, and CEO of providing an important source of funding for businesses. U.S. Bancorp, discusses changes in the banking by Francisco Covas, Myya McGregory, industry, the effects of the financial crisis, and real- and Robert Lindgren, Bank Policy Institute time payments with Greg Baer, CEO of BPI.

4 BANKING PERSPECTIVES QUARTER 3 2018 EDITOR Greg MacSweeney

DESIGN & PRODUCTION Big Yellow Taxi, Inc.

Banking Perspectives is the quarterly journal of The Clearing House and the Bank Policy Institute. Its aim is to inform financial industry leaders and the policymaking community on developments in bank policy and payments. The journal is a forum for thought leadership from banking industry executives, regulators, academics, policy experts, and industry observers.

68 Established in 1853, The Clearing House is the oldest payments company in the United States. It is owned by the world’s largest Personal Financial Data: commercial banks, which collectively hold more than half of all 68 Consumer Views on U.S. deposits and which employ over 1 million people in the Data Aggregation United States and more than 2 million people worldwide. Its affiliate, The Clearing House Payments Company L.L.C., which is Survey shows consumers want to control third-party data access, ready to follow U.S. banks’ lead. regulated as a systemically important financial market utility, owns and operates payments technology infrastructure that provides by Dave Fortney, TCH, and Rajesh John, A.T. Kearney safe and efficient payment, clearing, and settlement services to financial institutions. It clears almost $2 trillion each day.

The Bank Policy Institute (BPI) is a nonpartisan public policy, DEPARTMENTS research, and advocacy group, representing the nation’s leading banks and their customers. BPI’s members include Contributors universal banks, regional banks, and the major foreign 6 Information on the authors from this edition. banks doing business in the United States. Collectively, BPI’s members employ almost 2 million Americans, make nearly half A Note from BPI & TCH of the nation’s small business loans, and are an engine for financial innovation and economic growth. 8 A letter from the CEOs of BPI & TCH about the future co-publishing model for Banking Perspectives. Copyright 2018 The Clearing House Association L.L.C. All rights reserved. All content is owned by The Clearing House Association Bank Conditions Index L.L.C. or its licensors. The views expressed herein are not 74 A quantitative assessment of the resiliency of the U.S. necessarily those of The Clearing House Association L.L.C., its banking sector. affiliates, customers, or owners. Any use or reproduction of any of the contents hereof without the express written permission of The Research Rundown Clearing House Association L.L.C. is strictly prohibited. 78 Highlights from academic research on banking issues. The Clearing House Bank Policy Institute Featured Moments 1114 Avenue of the Americas 600 13th Street NW 84 Images from the Bank Policy Institute’s Launch Party. 17th floor Suite 400 New York, NY 10036 Washington, D.C. 20005 212.613.0100 202.289.4322

BANKING PERSPECTIVES QUARTER 3 2018 5 Contributors

William Coen practice is regulatory, enforcement, Prior to joining The Clearing House in 2016, acquisition, and securities law matters for Covas was an assistant director of the Division As Secretary General, U.S. and non-U.S. financial institutions and of Monetary Affairs at the Federal Reserve William Coen directs the their trade associations, and corporate Board, where he supervised a team focused work of the Basel governance matters for a wide variety on the effects of changes in bank regulation Committee on Banking of organizations. on monetary policy, the role of banks in the Supervision and transmission of monetary policy, and the manages its Secretariat. Cohen advises the financial services development and validation of stress-testing Coen chairs the industry on the full range of regulatory, models. Prior to that, he was an economist Committee’s Policy Development Group and compliance, enforcement, and merger and in the Division of Banking Supervision & the Committee’s Coherence and Calibration acquisition matters, including multiagency Regulation and focused on a range of capital, Task Force. He also chaired the Committee’s investigations relating to compliance with liquidity, and other regulatory initiatives. Corporate Governance Task Force and is a anti-money laundering and sanctions member of the IFRS Advisory Council. issues. He frequently works with all the Covas earned a Ph.D. in economics from bank regulatory agencies as well as University of California, San Diego, in 2004 Prior to his appointment as Secretary General multiple other governmental agencies. and a B.A. from the Universidade Nova de in 2014, Coen served from 2007 as Deputy Key recent matters include the Volcker Lisboa, Portugal, in 1997. He has written Secretary General. His responsibilities focused Rule, numerous other provisions of the extensively on liquidity rules, capital regula- on the Committee’s response to the global Dodd-Frank Act, international capital tion, and stress testing and has published financial crisis, including the coordination of and liquidity standards, resolution and research in a wide range of journals, includ- the Committee’s various Basel III initiatives. resolution planning, and cybersecurity. ing American Economic Review, Journal of He provides corporate governance advice Money Credit and Banking, and Internation- Coen joined the Committee’s Secretariat to a large number of financial and non- al Journal of Forecasting. in 1999 and had previously worked for the financial institutions, both regular clients Board of Governors of the Federal Reserve and as special assignments, and is also a Wilson Ervin System in Washington, D.C., as well as for the frequent adviser on the rise of strategic and U.S. Office of the Comptroller of the Currency. corporate governance activism. Wilson Ervin is a Vice He began his career as a credit officer at a Chairman at Credit New York City-based bank. He is a native of Francisco Covas Suisse in the group New York City and received his MBA degree executive office. He from Fordham University and a B.S. from Francisco Covas is works on a variety of Manhattan College. currently Senior Vice strategic projects, President, Head of especially policy H. Rodgin Cohen Research, at the Bank reforms related to bank capital and ending Policy Institute. Prior to “too-big-to-fail.” Ervin also chairs the Credit H. Rodgin Cohen is joining BPI, he served Suisse Americas Foundation and the Impact Senior Chairman of as Senior Vice Presi- Investment Advisory Council. Prior to his Sullivan & Cromwell dent and Deputy Head of Research at The current role, Ervin was the Chief Risk Officer LLP; he served as Clearing House Association, where he of Credit Suisse, a member of the Executive Chairman from 2000 to helped oversee research and analysis to Board, and chair of the Capital Allocation 2009. The primary support the advocacy of the association on and Risk Management Committee. From focus of Cohen’s behalf of the owner banks. 1990 to 1998, he worked at Credit Suisse

6 BANKING PERSPECTIVES QUARTER 3 2018 Financial Products, where he headed new Dave Fortney transformation in the financial services product development. Before 1990, he held sector. Recently, he has led open banking various roles in capital markets (both fixed Dave Fortney is EVP, and data aggregation strategic reviews income and equity), including Australia Product Development across the globe. Previously, John was with investment banking, and the Mergers & and Management, for Alix Partners and has had startup/leadership Acquisitions group at Credit Suisse. Ervin The Clearing House and roles at Portrait Software, Bonita Software, received his A.B., summa cum laude, in is responsible for EPIK Communications, and Lucent. John economics from Princeton University. defining strategy, holds a Bachelor of Science degree from identifying synergistic Cornell University. Edouard Fernandez-Bollo opportunities, and overseeing the development of new products for the Robert Lindgren After post-graduate company. Currently, Fortney is leading TCH’s studies at the Ecole initiative to develop, pilot, and launch a Robert Lindgren is an Normale Supérieure de secure digital payments tokenization system. Assistant Vice Saint-Cloud, Section President and Research Humanities and Social Fortney has expertise in conceptualizing and Analyst at BPI, where Sciences, and growing innovative e-finance ventures for he contributes to experiences in different financial institutions, financial technology economic research on branches of the French civil service, Edouard providers, and emerging payments companies. banking policy and Fernandez-Bollo joined the Banque de France, Prior to joining TCH, he held executive roles at regulation. Prior to joining BPI, Lindgren the French central bank, in 1988. He has Metavante Corporation, including President and served as a research assistant in areas occupied different posts related to banking General Manager of the organization’s ePayment including asset pricing, education policy, regulation and licensing, European Solutions Division. Previously, he served as EVP and microeconomic theory. He earned B.A. harmonization, and banking resolution issues. and CTO of Paytrust, an online bill management degrees in mathematical economics and After 2000, he was in charge of the legal company, and as SVP of Payments and Access philosophy from Temple University. secretariat of the Commission bancaire, the Strategy for Bank of America French supervisory authority, and of its Myya McGregory anti-money laundering policy unit. In 2004, he A Morehead Scholar at the University of became its General Counsel, and in 2008, its North Carolina, Fortney graduated with a Myya McGregory is an Deputy General Secretary. Since 2007, he has Bachelor of Science in mathematics and Assistant Vice President chaired the Basel Committee Expert group on earned a master’s degree in operations and Research Analyst work related to anti-money laundering efforts research from Stanford University. at BPI, where she and combating the financing of terrorism. supports research on From 2010 to 2013, he was Deputy General Rajesh John the economic Secretary of the new Autorité de contrôle implications of banking prudentiel, the integrated French prudential Rajesh John is a regulations. Prior to joining BPI and after supervisor. Since January 2014, he has been principal with the obtaining her B.A. in economics and Secretary General of the Autorité de contrôle management consulting chemistry from Williams College, McGregory prudentiel et de resolution, and of the Basel firm A.T. Kearney and is worked in a variety of roles on custom Committee on Banking Supervision. Since focused on strategic research projects encompassing topics that 2015, he is a management board member of growth, innovation, and ranged from global economic development the European Banking Authority. large digital to local government policy. n

BANKING PERSPECTIVES QUARTER 3 2018 7 A Note from BPI & TCH

SINCE BANKING PERSPECTIVES was founded in 2013, the mission of this journal has been to provide a valuable platform for viewpoints on the critical issues that face the banking industry, including balancing regulation with the essential role of banks in the economy and operating dynamic payments systems that provide for safety, efficiency, and innovation.

With this, the journal’s 20th issue, Banking Perspectives will now be co-published by two organizations: The Clearing House (TCH), under which this publication was founded, and the newly formed Bank Policy Institute (BPI). BPI, which launched in July, is the result of joining the prudential advocacy functions of The Clearing House Association and the Financial Services Roundtable. BPI’s 48 members include universal banks, regional banks, and major foreign banks doing business in the United States, and it’s worth noting that all 25 TCH member banks are BPI members as well.

Moving forward, Banking Perspectives will continue to provide features by banking industry experts – including senior banking executives, regulators, academics, members of the bank regulatory bar, consultancies, and other thought leaders focused on banking, the future of payments, and the health of the financial system. Ultimately, as has always been the case, Banking Perspectives will serve as a publication in which to share thought-provoking ideas and well-researched articles on the most important issues facing the banking industry today. This range of issues includes the role of new technology in banking; the Simpact of regulation and how it should be properly calibrated to foster economic growth and job creation; and how new payments technologies will enable businesses, consumers, and the overall economy to innovate while operating safely and efficiently.

We are confident that the TCH-BPI partnership will continue to enhance the value of this publication, one that we hope is already an important read for you. For instance, BPI, as a new organization representing a slightly broader set of the nation’s leading banks, provides Banking Perspectives with access to an even wider set of opinions and, yes, additional perspectives on key issues for the country’s commercial banks, the economy, and the financial system at large. TCH, likewise, will continue to deliver key views on payments, technology, innovation, and the regulatory issues that affect these aspects of commercial banking and the financial landscape.

On behalf of both TCH and BPI, we look forward to continuing to work to promote a healthy, vibrant banking system that is able to fully serve its essential role in fueling economic growth and job creation. Along these same lines, we hope that Banking Perspectives continues to contribute to promoting an honest debate on important banking topics through in-depth journal articles on the issues that matter most to the banking industry and, by extension, to the nation’s economy.

Jim Aramanda Greg Baer President & CEO CEO The Clearing House Bank Policy Institute

8 BANKING PERSPECTIVES QUARTER 3 2018 OUR PERSPECTIVE STATE OF BANKING STEPHANIE HELLER, ROB ANDY CECERE HUNTER, TCH & RICHARD The chairman & CEO of U.S. Bancorp TAFFET, MORGAN LEWIS discusses the changing industry, RTP, Ubiquitous Faster Payments and fostering innovation in banking. PAGE 14 UPFRONT PAGE 18

FOR THE RECORD The Post-Crisis Regulatory Tariff Regime BY GREG BAER, BANK POLICY INSTITUTE

Recently, tariffs and the Accordingly, the WTO has announced that it is required internationally active banks to cordon potential for trade wars and “seeking to encourage the revival of the complex off a large part of their operations in the United reductions in global economic links and networks involved in the trade finance States, removing much of the efficiency and risk- growth have been much in the market in order to keep finance flowing for mitigation benefits of having global operations news. News reports convey trade, thereby mitigating at least one reason for in the first place. That regime has some benefits constant, growing alarm, and the shrinkage of trade flows.” because it is designed to reduce some clear risks politicians and policymakers that presented themselves in the financial crisis, are highly focused on the issue. Here is a recommendation for the WTO: but it also has significant costs. And it has also Meanwhile, though, global bank Take a look at post-crisis banking regulation. been applied to entities where there seemingly regulators are quietly instituting a tariff regime of Global banks play an extraordinarily large role are no benefits at all. Other jurisdictions are their own, which should raise similar concerns. in facilitating global trade. The major reason following suit. we have international banks is because we All seem to agree that global trade makes have international companies. Banks follow This edition of Banking Perspectives contains all countries better off. While there may their customers around the world, where they articles from three respected thinkers in this be significant differences about whether a lend clients money, manage their currency and area: H. Rodgin Cohen, Senior Chairman of particular tariff will have a net benefit or cost for interest rate risk, provide custody services, and Sullivan & Cromwell; William Coen, Secretary the country imposing it, no one disputes that if bank their employees. They finance cross-border General of the Basel Committee; and Wilson high tariffs were imposed by all countries, global trades. The largest commercial banks, on the Ervin, Vice Chairman, Credit Suisse. They trade would shrink and we would all be poorer – other hand (those with $50 billion in assets provide background on these important policy in fact, a lot poorer. or more), wrote approximately $265 billion in issues and some potential solutions. standby letters of credit in the first quarter of And yet more global trade may be affected this year. The volume of these commitments, POST-CRISIS REGULATORY TARIFFS by the level of trade finance than by the level of which are most commonly used in the execution As each of our authors notes, the push for tariffs. The World Trade Organization (WTO) of international trade and other high-value ring-fencing in the United States stemmed from estimates that 80% to 90% of world trade contracts, indicates that the largest banks provide legitimate concerns during the financial crisis. relies on trade finance.1 That includes credit, considerable financing toward trade and global First, foreign banks operating in the United guarantees, letters of credit, insurance, and economic growth. States were in a substantial “due from” position other products. Meanwhile, as of 2016, import with their home-country parents because they tariffs affected just over 8% of G20 exports.2,3 Nonetheless, global regulators – to date, were a source of dollar funding; when market mostly U.S. regulators – have enacted post-crisis sources of funding dried up, they then turned regulatory regimes to “ring-fence” banks and to the Federal Reserve’s discount window. GREG BAER is the Chief Executive Officer at the Bank significantly hinder their ability to serve their Moreover, when the Fed wound down its Policy Institute. clients. In particular, the Federal Reserve has discount window lending as the crisis eased, a

BANKING PERSPECTIVES QUARTER 3 2018 9 The Post-Crisis Regulatory Tariff Regime

few foreign banks were the last to repay. Second, there was simple solution: Just raise aggregate capital and liquidity concern that the U.S. operations of foreign entities would requirements significantly higher. So, allow every host to be ring-fenced ex post due to lack of support from the home ring-fence as much as it likes, and then raise the home- country. The risk of ex post ring-fencing combined with country capital or liquidity requirements so that there is imperfect supervisory cooperation to establish an incentive as much capital as ever held at the top tier and available for each jurisdiction to ring-fence ex ante. for deployment.

Import tariffs and regulatory tariffs have a lot in This is an extremely poor solution. There is no dispute common. First, both are designed to serve a national that higher capital requirements reduce economic growth, interest: Import tariffs protect local industries by making and liquidity requirements come with their own set of costs. their products less expensive than foreign imports, Every evaluation of the cost and benefits – including those boosting domestic businesses; regulatory ring-fencing done by the Bank for International Settlements4 (the parent ensures that foreign banks operating in the United States of the Basel Committee on Banking Supervision), the will not require U.S. taxpayer support. Second, both an Federal Reserve,5 the Bank of England,6 the International import tariff and a regulatory tariff can be advantageous Monetary Fund,7 and the Minneapolis Fed8 – begin by for a first mover: An import tariff will benefit a national estimating the decline in lending and economic activity industry seeking to grow or defend against foreign that are caused by higher capital requirements.9 By failing competition and is particularly beneficial to developing to resolve home-host tensions and simply opting for higher economies; ring-fencing, as Ervin explains, will benefit requirements, regulators are hurting economic growth a first-mover host country by guaranteeing a local bank needlessly. Thus, as the articles in this issue illustrate, the adequate resources but still leaving substantial resources push for reconciling home versus host concerns continues. freely available at the home-country headquarters to deploy to meet any additional capital or liquidity needs of RING FENCING AND SOLVING A its local institution. PROBLEM TWICE As well described by Cohen and Coen, the primary The final, unfortunate, similarity is the tragedy of the reaction to crisis concerns has been the Federal Reserve’s commons: Both import tariffs and regulatory ring-fencing requirement that foreign banks establish an intermediate generally prompt a corresponding response, with any first- holding company (IHC) to conduct most of their U.S. mover advantage lost and everyone left worse off. Because operations, with enhanced capital (including stress testing), multiple countries impose import tariffs, competitive liquidity, and risk management standards imposed. This has advantage is lost, and the only effect is to reduce the contributed to the shrinking presence of foreign banks in volume of trade and its corresponding economic benefits. the U.S. From the third quarter of 2016 (when foreign banks Similarly, as each host country ring-fences capital and were first required to have IHCs established) to the first liquidity in its jurisdiction, the resiliency of the firm is quarter of 2018, IHCs reduced their total assets by 10%. Over reduced; there are no free resources left to support a the same period, U.S. bank holding companies increased troubled subsidiary anywhere; and no host is better off. their total assets by 3%. Additionally, foreign-owned U.S. (To use an analogy, the commonly funded fire department broker-dealers shrank by more than half between 2010 and is closed when each home decides to rely solely on 2017. While ring-fencing is not the sole cause of this shift, it more-costly, and almost certainly less-effective, sprinkler very likely played a role. systems and fire extinguishers.) These requirements would be more difficult to There is one difference between regulatory and understand if an entirely separate regulatory regime import tariffs. When presented with the tragedy of the had not been constructed to satisfy the same concerns. commons, the reaction of many regulators is to provide a Extraordinary regulatory and bank resources have been

10 BANKING PERSPECTIVES QUARTER 3 2018 UPFRONT

devoted to developing and implementing a single-point-of The regulatory and examination regime entry (SPOE) resolution regime. As initially conceived, this regime made ring-fencing at host countries unnecessary, currently applied to foreign banks given the abundance of holding company loss-absorbing operating in the United States seems difficult resources available for distribution. to justify based on any historical Thus, the core assumption of every such resolution plan experience or reasoned analysis. (living will) is that while creditors of the holding company are bailed in and absorb loss, all material subsidiaries (domestic and foreign) remain open and operating. Taking Lehman Brothers as the paradigm for risk to host countries from a powerful incentive for foreign banks to move assets out of international operations, a central feature of the post-crisis the United States, which is what they have been doing. regulatory regime is a legal requirement that a parent holding company like Lehman hold massive loss absorbency at the Notably, some ring-fencing is not even imposed by holding company level, with those creditors clearly in a first host countries. Here again, the U.S. leads (if that is the (equity) and second (long-term debt) loss position, so that any right word) the rest of the world. Through the living-will Lehman subsidiaries around the world could be recapitalized process, the Federal Reserve and FDIC have created a in bankruptcy or resolution. (Not incidentally, the FDIC secret liquidity regime for internationally active banks that now has the authority to resolve a parent company like has never received public notice, let alone comment. That Lehman – authority it lacked in the crisis.) And the purpose regime requires ring-fencing of liquidity at each overseas of crisis management groups established post-crisis was material subsidiary. Many, if not most, of the affected banks to ensure cooperation on living wills and engender trust. have reported that this regime, not the liquidity coverage Imposing ring-fencing on top of these actions seems akin to ratio, is their binding constraint for liquidity. Similarly, the a country with a trade surplus erecting high import tariffs. Edge Act specifically allows U.S. banks to conduct a wide Furthermore, it bespeaks a wholesale failure of the Crisis range of activities through special subsidiaries abroad, Management Groups to achieve their goal. People happy with but usage of that law has been strongly disfavored by the their trade balances do not raise tariffs and start trade wars. Federal Reserve post-crisis (though there was no crisis-era experience to motivate such action); instead, the Fed has As one illustration, the Financial Stability Board pushed U.S. firms to conduct all their overseas activities in mandated that host countries hold internal TLAC – pre- holding company affiliates, effectively ring-fencing those positioned, ring-fenced loss absorbency between 75% and activities outside of their bank subsidiaries. 90% of holding company loss absorbency, with the exact percentage to be determined by Crisis Management Groups. Even if nothing had been done on resolution, certain As Cohen describes, this was significantly more than was aspects of the regime would be difficult to justify. As an necessary to achieving the stated goal of internal TLAC: example, consider foreign banks operating in the United ensuring that home country resolution authorities do not States through bank subsidiaries. Sixty-two percent of abandon a significant overseas subsidiary and allow it to Banco Santander’s domestic IHC’s assets are composed of fail in a disorderly way. Even then, the Federal Reserve in the activities of two U.S. commercial banks housed under its 2016 set the floor at 90% for all foreign banks operating IHC, Santander Holdings USA, while the rest is generated in the United States. Worse yet, by one estimate (and the from a host of other U.S.-based lending businesses. BNP only estimate we have seen), the other enhanced capital Paribas operates Bank of the West and First Hawaiian standards imposed by the Federal Reserve have resulted in stateside, which account for 75% of BNP Paribas’ domestic an average de facto internal TLAC requirement of 140% of IHC’s total assets. These subsidiary banks are from any home-country holding company requirements.10 This creates legitimate regulatory perspective indistinguishable from

BANKING PERSPECTIVES QUARTER 3 2018 11 The Post-Crisis Regulatory Tariff Regime Bank Policy Institute is a new nonpartisan public policy, research and advocacy group, regional banks of the same size. They are subject to the same described above, though it may be part of the larger trend representing the nation’s capital and liquidity regimes, the same examination regime, of examination as management consulting. In either event, and, if they fail, they will be resolved by the FDIC in the same the effect is the same: a tariff on operating a branch in the leading banks. way as any other insured depository institution. And yet they United States. (And one that eventually will be imposed by have been swept into the Federal Reserve’s IHC regime. the European Central Bank, the Bank of England, and other global regulators on U.S. banks operating branches abroad.) Global regulators – to date, mostly CONCLUSION U.S. regulators – have enacted In sum, the regulatory and examination regime currently post-crisis regulatory regimes to ‘ring-fence’ applied to foreign banks operating in the United States seems difficult to justify based on any historical experience banks and significantly hinder their or reasoned analysis. Taken individually, each element of ability to serve their clients. the ring-fencing regime may make sense to help address home-host trust concerns that could arise in a crisis. Taken cumulatively, however, they effectively undermine the carefully crafted SPOE resolution regime, and they Consider also branches of foreign banks. As Cohen rightly undercut U.S. economic growth by discouraging foreign notes, the Federal Reserve did not require branches to be part bank financing of U.S. activity. Worse yet, they appear of the IHC. (Or put another way, the Federal Reserve did not unreasonably punitive and protectionist, thereby inviting outlaw branching by foreign banks because a branch that inevitable retaliation against U.S.-headquartered banks is part of a separately incorporated subsidiary simply isn’t a operating abroad. Particularly at a time when the importance branch anymore.) The justification is clear, as branches are of global trade is much in focus, it would seem appropriate part of their home-country bank, which has their liabilities for bank regulators to revisit their tariffs. A recent address on its books. For reference, any Office of the Comptroller of by Fed Vice Chairman Randal Quarles indicates that he is the Currency proposal to require U.S. banks to separately interested in this topic and receptive to public comment. We capitalize each branch would be seen as bizarre because each hope that this issue of Banking Perspectives will assist him branch is on the books of its parent, and its liabilities are the and others willing to take a fresh look. n parent’s liabilities. Thus, while there are limits to what activities a foreign bank can conduct through a branch, as a de jure ENDNOTES matter, the Fed has not ring-fenced branches of foreign banks. 1 World Trade Organization. https://www.wto.org/english/thewto_e/ coher_e/tr_finance_e.htm 2 Simon J. Evenett and Johannes Fritz, “Will Awe Trump Rules?,” Global Our economists, Alas, de facto kicks the butt of de jure every time. While Trade Alert, July 4, 2017. https://www.globaltradealert.org/reports/42 foreign branches are exempt from the IHC requirement, 3 Brian Caplan, “Trump’s Trade Tariffs Miss the Point,” The Banker, June 26, 2018. https://www.thebanker.com/Comment-Profiles/Editor-s- attorneys, and policy they remain subject to the Federal Reserve’s combined U.S. Blog/Trump-s-trade-tariffs-miss-the-point operations requirements. A common complaint we hear 4 https://www.bis.org/publ/bcbs173.pdf experts aim to shape 5 https://www.federalreserve.gov/econres/feds/files/2017034pap.pdf from foreign banks is that U.S. regulators increasingly are 6 https://www.bankofengland.co.uk/financial-stability-paper/2015/ ring-fencing branches – not publicly, by regulation, but measuring-the-macroeconomic-costs-and-benefits-of-higher-uk- policies that enable bank-capital-requirements secretly, through the examination process. This includes risk 7 https://www.imf.org/external/pubs/ft/sdn/2016/sdn1604.pdf leading banks to safely management requirements utterly at odds with the notion of 8 https://minneapolisfed.org/~/media/files/publications/studies/ consolidated risk management. Think of it as requiring the endingtbtf/the-minneapolis-plan/the-minneapolis-plan-to-end-too- big-to-fail-final.pdf?la=en serve their customers branch manager for the bank around the corner from you 9 https://bpi.com/hoenig-and-bair-two-false-premises-and-an-ad- to have her own risk policies, independent of the main bank hominem-argument/ and fulfi ll their vital 10 D. Wilson Ervin, “The Risky Business of Ring-Fencing,” and its other branches. Some of this effort may be attributable December 12, 2017. Available at SSRN:https://ssrn.com/ LEARN MORE AT WWW.BPI.COM abstract=3085649 or http://dx.doi.org/10.2139/ssrn.3085649 economic role. to the same underlying motivations for ring-fencing LINKEDIN.COM/COMPANY/BANKPOLICYINSTITUTE BANKPOLICY 12 BANKING PERSPECTIVES QUARTER 3 2018

bpi-house-ad.v5.indd 108 8/24/18 3:25 PM Bank Policy Institute is a new nonpartisan public policy, research and advocacy group, representing the nation’s leading banks.

Our economists, attorneys, and policy experts aim to shape policies that enable leading banks to safely serve their customers and fulfi ll their vital LEARN MORE AT WWW.BPI.COM economic role. LINKEDIN.COM/COMPANY/BANKPOLICYINSTITUTE BANKPOLICY BANKING PERSPECTIVES QUARTER 3 2018 13

bpi-house-ad.v5.indd 108 8/24/18 3:25 PM OUR PERSPECTIVE Achieving a Ubiquitous Faster Payments Capability in the U.S. BY STEPHANIE HELLER AND ROB HUNTER, TCH, AND RICHARD TAFFET, MORGAN LEWIS

he race is on to achieve a ubiquitous standard, ISO 20022. As such, the RTP system not only faster payments capability in the U.S. that is a new entrant competing with existing payment rails promotes efficient commerce, facilitates – i.e., wire, Automated Clearing House, and checks – it innovation, reduces fraud, and improves has already created and facilitated new competitive public confidence. When the Federal opportunities throughout the payments ecosystem. TReserve first began focusing in 2015 on the need to improve the U.S. payments system to achieve this goal, it decried More specifically, also like existing systems, a faster the fact that there was then “no ubiquitous, convenient payments system must support “front-end” applications and cost-effective way for U.S. consumers and businesses and networks that customers can use, and which then to make (near) real-time payments from any bank account clear and/or settle over the payment rail. The RTP system to any other bank account.”1 Much has been achieved in is specifically designed technologically and by its rules the intervening three years at many levels of the payments to support interconnectivity and innovation. Direct ecosystem, with new entrants offering faster payments participation is offered to financial institutions of all capabilities, which when taken together provide a strong sizes on the same commercial terms. Participants can foundation for realizing the Federal Reserve’s objectives. connect directly or through their core processor, and can work with a banker’s bank or corporate credit union to help manage their funding, liquidity, and other issues. Achieving ubiquity is not just an Other payment services, such as Zelle (which does not academic aspiration. Although currently offer real-time settlement) can ride the RTP rail and achieve that goal. Payments service providers all of the Federal Reserve’s goals for engaged in the business of handling money transmission faster payments are important, transactions are also permitted to leverage the capabilities of the RTP system.2 All of these entities have the incentive ubiquity clearly stands out. to create, and are in fact creating, new faster/real-time payment products and services that will be or are capable of interconnecting with the RTP system and, regardless of use case (e.g., business to business, consumer to business, However, if the U.S. is to realize a successful faster business to business, person to person) or medium (e.g., payments environment by the Federal Reserve’s target mobile device, PC, tablet, etc.), contribute to an end-to- date of 2020, all with an interest in achieving this goal end real-time payments environment. must recognize certain basic truths. The U.S. payments system is complex, involving myriad participants with Anyone assessing the capabilities of a real-time many different, often interrelated and interconnected system anchored by the RTP platform must understand market segments. At its core, however, a payment “rail” these complexities if a faster payments system is to over which interbank transactions are cleared and settled succeed within the Federal Reserve’s time frame. must support a faster payments system. In November Indeed, understanding these complexities is particularly 2017, The Clearing House launched its RTP system, important if the cornerstone of a successful faster the first payments rail introduced in the United States payments system is to be achieved – that is, ubiquity, in over 40 years. It offers 24/7 real-time clearing and by which we mean the ability of the greatest number settlement capabilities, coupled with enhanced messaging of users to interact over a faster payments system in functionality compliant with the leading international connection with the greatest number of use cases.3 Put

14 BANKING PERSPECTIVES QUARTER 3 2018 UPFRONT Achieving a Ubiquitous Faster Payments Capability in the U.S.

differently, if a faster payments system is going to succeed, a host of other solutions offered by FinTech companies, positive network effects must be achieved, which occur including Square, PayPal, and Venmo. All of these when an ever-increasing number of users are attracted provider solutions (and others not yet developed or to the system.4 This, in turn, provides incentives for the offered) in one form or another play a role in meeting the development of new and innovative products and services Federal Reserve’s goal for convenient and cost-effective to meet the demands of consumers, businesses, and other ways for U.S. consumers and businesses to make “near” potential users of the system. real-time payments, and all provide innovative ways to meet the payment needs of consumers and businesses. Achieving ubiquity is not just an academic aspiration. Although all of the Federal Reserve’s goals for faster None of these solutions, however, provide the core payments are important, ubiquity clearly stands out as infrastructure for the settlement of real-time interbank an objectively established desired outcome for faster transactions, which is supported, for example, by the RTP payments. For example, one Federal Reserve study system. RTP, however, is what facilitates the competition revealed that 61% of consumers and 67% of business among the “front-end” service providers; it is intentionally agreed that they “won’t use a payment method unless it is designed to allow these solutions to ride on top of and used and accepted by most people and businesses.”5 interconnect through the RTP platform. This allows the products and services offered by the “front-end” providers However, to achieve ubiquity and the positive network to “expand” their reach – because of the network effects effects that come with it requires recognition that merely that are created – which will drive the ubiquity of faster supporting a multitude of options at all levels of the payments. In turn, users – both payers and payees – will payments ecosystem may retard the progress already benefit from continuing innovation and the introduction being made in the marketplace and thereby deter the of new faster payments products and services by the overall competitive benefits that a ubiquitous faster solution providers as more users rely on the platform and payments system will provide. drive demand for new innovation.

For example, competition among providers of “front- To achieve ubiquity, and as a result greater competition end” faster payment products and services is consistent within a faster payments environment, the role played by with the goal of ubiquity. This would include competition a core infrastructure faster payments platform such as involving products and services being developed RTP must be analyzed differently. The RTP system plays and offered by many of the private sector companies two important roles in driving competition. First, it is an STEPHANIE (including Dwolla, Mobile Money, and WingCash) that alternative to the existing wire, check, and ACH payment HELLER, submitted 16 proposals to the Federal Reserve’s Faster rails. Second, it creates the platform through which ROB HUNTER AND Payments Task Force, which was created to evaluate payment solution providers can interconnect, which RICHARD TAFFET how best to achieve an improved U.S. payments system. allows otherwise disparate payers and payees throughout Stephanie Heller is Executive Vice President It would also include the products and services being the ecosystem to make payments that would not be and General Counsel introduced by private sector companies that did not possible absent the centralized platform. This is critical at The Clearing House, submit their solutions for evaluation or did not consent for achieving ubiquitous faster payments. Unlike front- Rob Hunter is Executive Managing Director and to their submissions being made public, including Zelle, end products and services, because of the coordination Deputy General Counsel at which is offered by Early Warning Services; Popmoney, role played by platforms such as RTP, a multiplicity The Clearing House, and a payment service offered through CheckFreePay of core infrastructure real-time payment platforms Richard Taffet is a Partner at Morgan Lewis. Corporation; Visa and MasterCard’s OCT system; and that perform settlement could cause fragmentation,

BANKING PERSPECTIVES QUARTER 3 2018 15 ArticleOur Perspective Title Goes Here

forcing payment solution providers to choose between ENDNOTES different platforms or increase costs for such providers 1 United States Federal Reserve System, “Strategies for Improving the U.S. Payment System,” at 8-9, January 26, 2015. https:// because of the need for redundant interconnectivity, fedpaymentsimprovement.org/wp-content/uploads/strategies- thus depriving users – for all use cases – the ability to improving-us-payment-system.pdf make payments to counterparties that would no longer 2 “Real-Time Payments Operating Rules,” § 2(H), The Clearing House, October 30, 2017. https://www.theclearinghouse. be on the same payments platform. Interoperability org/payment-systems/real-time-payments/-/ among faster payment core infrastructure platforms as a media/6de51d50713841539e7b38b91fe262d1.ashx means of avoiding fragmentation is unrealistic given the 3 This is in accord with the Federal Reserve’s definition. See Federal Reserve System, supra note 1, at 9, 28-29. “Ubiquitous characteristics of faster payments and the technical and participation refers to payment products that are broadly practical hurdles that would have to be surmounted.6 The accessible by everyone and available to be used in a variety of different circumstances.” Id. at 9, n. 9. inevitable result of fragmentation is the diminished ability 4 Network effects occur when ever-increasing numbers of users of payment solution providers to broadly interconnect rely upon a system; as use increases, overall costs of the with each other, reduced opportunities for disparate system decrease and implementation efficiencies increase. See John Weinberg, “Network Externalities and Public Goods payers and payees to make payments, and increased costs. in Payment Systems,” November 1997, at 2 (“The value of a Ubiquitous fast or real-time payments will at least be payment instrument depends on the extent of the network with which it connects”). https://www.minneapolisfed.org/research/ slowed, if not undermined entirely. conferences/research-events---conferences-and-programs/~/ media/files/research/events/1996_12-03/Weinberg_ PaymentSystems.pdf The U.S. is blessed with 5 Federal Reserve System, supra n. 1, at 29. Our Perspective. 6 Reliance on analogies to the ACH system to support calls for many innovative payments interoperability are misplaced. The ACH system developed out of paper check processing and the goal of moving to electronic solutions that could support the clearing and settlement at a time when there were no significant retail electronic systems, no established legal framework, and Federal Reserve’s goal of faster interstate banking as we know it did not exist, all resulting in Your Vision. a payments system that was more geographically regional in and real-time payment ubiquity. nature. The relatively clean slate that existed at the time allowed for comparatively speedy development of a common rule set, message standards, and use of the Federal Reserve to provide a Promontory, an IBM Company, provides unique insight and advisory shared settlement infrastructure across regional boundaries. In contrast to the ACH, more than just geographical boundaries must The U.S. is blessed with many innovative payments be overcome. Systems have already well-established formats, services that help industry leaders confidently navigate complexity at unique payment and messaging characteristics, established legal solutions that could support the Federal Reserve’s goal structures (that can vary significantly between systems), and the the intersection of strategy, risk management, and regulation. of faster and real-time payment ubiquity. Reaching this real-time nature of the payment introduces enormous operational and other complexity that would be difficult to overcome. goal is not a certainty. Getting there will take time, and Interoperability in the present context would be more akin to existing efforts already underway, like RTP, must be given being able to send a Fedwire payment over CHIPS, where the two systems have radically different characteristics in terms of how About Promontory the opportunity to take root and achieve positive network they clear and settle payments that would be virtually impossible effects. This will permit competitive opportunities to reconcile. We excel at helping clients resolve critical issues, particularly those with a regulatory dimension. throughout the payments ecosystem to expand, driven by Our deep domain expertise, combined with IBM’s world-class technology, allows us to address market forces, and the demands of consumers, businesses, challenging national and cross-border issues in banking, securities, commodities, financial instruments, and all payments system users will be met. n markets, and insurance.

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16 BANKING PERSPECTIVES QUARTER 3 2018 Our Perspective. Your Vision.

Promontory, an IBM Company, provides unique insight and advisory services that help industry leaders confidently navigate complexity at the intersection of strategy, risk management, and regulation.

About Promontory We excel at helping clients resolve critical issues, particularly those with a regulatory dimension. Our deep domain expertise, combined with IBM’s world-class technology, allows us to address challenging national and cross-border issues in banking, securities, commodities, financial instruments, markets, and insurance.

More at promontory.com State of Banking

All the change that we thought was going to happen 30 years ago is happening now, and at the core of what is changing most rapidly is money movement and payments.

STATE OF 18 BANKING PERSPECTIVES QUARTER 3 2018 UPFRONT

Andy Cecere, chairman, president and CEO of U.S. Bancorp, discusses changes in the banking industry, the effects of the financial crisis, real-time payments, and fostering innovation with Greg Baer, CEO of the Bank Policy Institute.

GREG BAER, BANK POLICY INSTITUTE: You’ve had and payments. Lending and deposit-taking are mostly the a long career at U.S. Bancorp – 33 years and counting. same, but the way we move money and the information that Obviously, you’ve seen a lot of industry changes over that goes along with the payment is the core change. time. What are some of the big shifts you have experienced? BAER: This leads to a related question. By the latest count, ANDY CECERE, U.S. BANCORP: When I started in if I recall, you still have over 3,000 branches? the banking industry in 1985, the common belief at that time was that branches, checks, and cash were going to CECERE: Yes, we do. go away. The fact is, for 30 years, that was not true. But it has been happening during the last couple of years, so BAER: How do you think about the bank branch as you when I speak with our employees I say that I’ve seen more plan for the future? Is it a customer convenience, or do you change in the last three years than the 30 years before. think it is becoming obsolete? What’s driving that change is a confluence of things: the technological and innovation changes that are occurring CECERE: Branches will always be here, but their function rapidly; the customer’s expectations driven by other has changed and will continue to change. So, while 65% industries – Amazon, Apple, and such; and the fact that to 70% of service transactions happen on a digital device, we have the ability to use data to know and serve our 80% of sales still happen in person. customers better. I believe over time that sales will increase on mobile All these things are happening at once. As a result, 65% devices, but there will always be a face-to-face discussion to 70% of customer transactions with our company are for the most complex financial needs. When people want happening on digital devices, including smartphones that to talk about their retirement or investment needs or weren’t here 10 years ago. All the change that we thought was what type of mortgage would most benefit them, they still going to happen 30 years ago is happening now, and at the want to talk person-to-person. We will continue to see core of what is changing most rapidly is money movement the combination of the digital channel together with the BANKING BANKING PERSPECTIVES QUARTER 3 2018 19 State of Banking

Size is less important than the CECERE: We were always rather conservative; that has platform you have, the services been our reputation. It has served us well, and it served us particularly well during that difficult time. We would you provide, and how you treat the get together and we’d say, Company ABC has an issue or customers. That’s where we’re focused. Bank XYZ has a liquidity issue – what are the connections and what could happen, and what are the downstream impacts? We wouldn’t look just for the first level but also the second- and third-level impacts. physical branch in the future. The physical branch will continue to focus more on consultation, advice, and person- BAER: That’s a great point. Currently, U.S. Bank is one to-person interaction, as opposed to transaction activity. of the largest in the country, and I think you once called the bank “The best bank no one has ever heard of.” You’ve BAER: Do you think the trend is going to change the type obviously made a major marketing push, between the of person who’s working at the branch? Super Bowl and other efforts, to increase the profile of the company. [Editor’s note: U.S. Bancorp bought the naming CECERE: We already have people in the branches who are rights to the Minneapolis stadium where the 2018 Super focused on consultation and giving advice; that’s what they Bowl was played.] What’s the goal in terms of expanding do, and that will continue to be a focus. We’re trying to get your brand? our employees to be more digitally active themselves so they can offer advice around the digital components. CECERE: In the early 2000s, we were very well known by investors, analysts, and rating agencies, but not as well BAER: Turning back to your experience at U.S. Bancorp. known by customers and potential customers. We had You were CFO from 2007 to 2015 – throughout the the best returns, the highest debt ratings – and we still do financial crisis. How did that experience shape how you’re – but we just didn’t tell our story very well. We knew we approaching the job as CEO now? needed to change that.

CECERE: First, it was an interesting and rewarding time Our best move was retelling our story internally. We to be a CFO. That period included the first stress test, and created a purpose statement and defined our core values. TARP [the Troubled Asset Relief Program], the issuance of We wanted to make sure our employees understood what equity to pay off TARP, the debt issuance that went along was unique about our role in the industry, and what was with that, a lot of M&A activity, and the FDIC transactions special about how we played that role. We also wanted we went through. It was an incredible learning experience. them to believe the words were true and that they could live up to them authentically, because the crux of our story What I recall most from that time was senior – at the center of every relationship we build – is trust. management getting together at 6:30 almost every We believe our purpose is to invest our hearts and minds morning to talk about what happened the night before. It to power human potential – and that is grounded in the showed why you need to have a great team. We had great notion of being a trusted partner to all our stakeholders. communication and great discipline. After employees were on board, we started to widen U.S. Bank came through the crisis very well. the story to the customer base. Our work around the “Big Game” was just one example. Telling our story is a continual BAER: Do you think generally, for you or other CEOs, it’s journey, and it’s a combination of every interaction, every made you more conservative from a risk perspective or communication, and every experience a customer or a more thoughtful and wanting more data? potential customer has with us. When everything is said

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and done, we have a great bank that’s performing very heightened liquidity regulation for large banks, may well for the benefit of customers and communities, and not have anticipated that the liquidity regulation would the principal reason an individual, a small business, or a increase the large banks’ appetite for deposits, which corporation chooses a bank is not location, product, or previously had gone to community banks. Is U.S. Bank’s pricing – it’s trust. That’s really the goal of our brand work: desire for deposit share driven by regulation as well as just to bring our unique story and the reasons to believe in us as a good business practice? a trusted partner to a broader audience. CECERE: It’s almost entirely good business. When you BAER: Do you worry about being known as a big bank, step back, the greatest advantage a bank has is deposit- whether that’s in the eyes of consumers or regulators? taking. It is the best source of liquidity, low-cost money, and it is the magic around what a bank does. It is the CECERE: For us, it’s about being a great bank that serves driver of loan activities, the driver of relationships. customers well. We’re actually at a very good size. We Deposit activity and gathering deposits is about gathering are the largest non-G-SIB [global systemically important customers, and it’s about gathering low-cost funds. It’s not bank], which gives us some advantages from a capital about regulation at all; it’s about a good business model. standpoint. But at the same time, we have the scale and the ability to invest a billion dollars for the benefit of our BAER: Let’s switch topics. U.S. Bank sponsored seven teams customers and employees every year in technology and in the recent Technovation competition, which offers middle innovation. Size is less important than the platform you school and high school girls the opportunity to learn the have, the services you provide, and how you treat the skills they need to emerge as tech entrepreneurs and leaders. customers. That’s where we’re focused. The girls even had a chance to pitch you and other senior leaders at the bank about their creations. Why do you focus BAER: Interesting. Do you think the move to mobile on events like that, which are geared toward very young and online, from the perspective of community banks, is folks, and do they serve as a long-term recruitment strategy? that making size, scale, and scope more important or less important? CECERE: First, let me tell you, it was the most impressive set of individuals I’ve seen, ever. They developed these CECERE: The more interesting question in my opinion apps after school and on weekends, and they came to our is what will happen to the industry overall as consumer boardroom to present to senior leaders at U.S. Bank. They behavior continues to shift and as we are compared to were very eloquent and articulate, they were enthusiastic, more companies outside financial services. No one has and they were smart. It was a great experience. a perfect crystal ball to anticipate what is coming, but I suspect you will see new partnerships emerge, new roles We have a strong focus on education and building established for banks of all sizes, and new customer value skills for tomorrow, innovation and women in leadership. propositions created that promote greater differentiation Technovation fits all those priorities. between banks. Consolidation is likely to continue – we’re already down from 14,000 banks 30 years ago to 5,000 BAER: More broadly, how do you think about the now – but there will always be a place for niche markets, competition for talent when you look at FinTechs, which for unique offerings, and for innovative approaches to can offer equity and Ping-Pong tables and free coffee? the customer relationship. Size, scale, and scope will be What’s your offer to people who have the talents that make important – just in different ways. them attractive to both U.S. Bank as well as FinTechs?

BAER: On the deposit point, I often think that small CECERE: I’m on the board of the University of St. Thomas, banks, whose trade groups have advocated strongly for where I graduated, and the Carlson School at the University

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of Minnesota, where I earned my MBA. When I talk about BAER: I recently heard another bank executive say that U.S. Bank, one of the great attributes of our company is that she used to refer to her company as a FinTech company but if you want to work in technology or marketing or finance doesn’t do that anymore because FinTech companies are or accounting, you can do all those jobs at the bank. And allowed to fail and FinTech companies can roll out products if you want to work days or nights, you can do that. If you very quickly, and the regulatory environment simply doesn’t want to work with people or by yourself, you can do that. allow that for a bank. Do you agree? There is great variety and a ton of opportunity. I always tell people that one of the things you should think about is CECERE: No. One of the unusual things about banks is that working for a great company that’s growing and doing well, we’ve been conditioned to act when we’re incredibly certain. because opportunities will present themselves. I think all We are right 99% of the time when it comes to things like those attributes are advantages to working at U.S. Bank, so credit losses, for instance. So, when we went through the we’ve been able to attract great talent. development process historically, the way it was structured was to be right 99% of the time. You try to get all the perfect Speaking specifically to FinTechs, I think we have an answers, you try to understand the ramifications, you went opportunity to partner and learn. The optimal structure through testing, and more testing, and the objective was to between FinTechs and banks is a partnership, combining our be almost entirely correct when all is said and done. expertise with theirs to create a better customer experience. When you look at it that way, it’s better for all of us. In this environment, you have to be willing to be a little wrong. What we’re trying to drive toward is an acceptance BAER: Relatedly, within a larger, broader-based organization, of the fact that we won’t have perfect information, that we’ll how do you foster innovation? Do you need laboratories or continue to evolve and develop. That’s the way we need to do sandboxes, or do you think of innovation as everyone’s job? it. Regulation doesn’t necessarily hinder that, and I believe you can make mistakes in technology, adjust, and then react. CECERE: It’s a little of both. We are thinking about things in a different way than we did in the past. The typical bank I’ve been sending the message to our team that we have process has been to create a set of requirements, go through to accept the fact that we’re going to make a number of a series of tests, develop and test, develop and test some bets, and sometimes they won’t pay off – but many will. more, and in over a year you have what you were trying to develop. In today’s environment, by the time you have gone BAER: While we’re discussing innovation, let’s talk about through the typical bank development cycle, you’re already real-time payments, which you mentioned earlier. As out of date. That has happened to us and other banks. We you know, The Clearing House and its owner banks are need to shift toward rapid, agile development. quickly moving ahead with its Real-Time Payments (RTP) system, and in November 2017 the first new payment on More than that, we have to approach innovation from the real-time system was initiated between U.S. Bank and the customer’s perspective. We have to have customers as BNY. What benefits do you think RTP will provide your part of that creation process. In other words, what is the customers in the future? problem you’re trying to solve or what’s the need you’re trying to fulfill from their lens? CECERE: This is a game changer. One of the keys to the future is money movement and payments, and among the Today, customers are part of the process, we’re much things supporting that shift are these new real-time rails more rapid in the way we innovate, and we are testing that are being built by The Clearing House and Zelle. and learning, releasing and releasing, as opposed to these annual processes that historically have been the way It’s a huge difference. It’s going to be more secure, banks develop. more convenient, and it’s going to provide additional

24 BANKING PERSPECTIVES QUARTER 3 2018 UPFRONT

data. It is going to change the way payments have Talking specifically to the recent tax reform, we occurred for 150 years. Things such as checks and decided at the outset to invest the value we received Automated Clearing House and wires are going to be, from tax reform back into our business across all our over time, replaced by this new real-time rail, which stakeholders. We invested in our employees with a will provide greater convenience, greater information, one-time bonus for most of our staff, increased our and greater communication between businesses. It is minimum wage, and invested more heavily in our fundamentally the most important change I’ve seen in health-care benefits. We invested in our communities banking. with a contribution to our foundation. We invested in customers with additional technology spending and an BAER: What do you think the remaining obstacles are to investment to provide better products and services, and achieving ubiquity for RTP? I think that is an important ultimately all of that has benefited shareholders. component of it; everyone needs to be on the same rails. Tax reform has done two things – it’s created more CECERE: One of the challenges with the U.S. is we have certainty and more confidence. Companies – small to 5,000 banks, and we have 25 big banks. Getting us all to large corporates – were waiting to see what would happen, think the same way can sometimes be a challenge. The and we are seeing increased activity. process that we’ve gone through with Zelle, and having seven owner banks, is actually quite good. We were One of the leading indicators we have is a large all focused on the end objective, which was ubiquity, corporate payments business, and we are able to monitor common standards, and common processes. In the how corporations spend money. If I go back a year or end, we have to have that because if we’re going to build two ago, spending in areas like T&E and payables was rails that everyone can use, we have to have a common in the low single digits. More recently, that has been methodology and a common way of thinking. in the high single to low double digits. So, activity in businesses is increasing. Part of the driver of that is tax It is a challenge, but it’s a challenge we will overcome. reform because it’s created certainty, confidence, and ultimately the ability to invest more. BAER: We’ve just seen rather significant tax reform, which most people believe is having a greater economic impact BAER: In addition to the data, you probably have a lot of than any bank regulation. How do you think that’s affected anecdotal experience talking to business leaders around U.S. Bank? the country. Is that the impression you get from them?

CECERE: If you step back from the financial crisis, I CECERE: We do a small-business survey every year, and think the financial services industry is much safer today we’ve been doing it for a decade. For the first time this than it was in the early 2000s. We have more capital, year, regulatory and tax reform are not even in the top more liquidity, better processes, and better technology; five concerns, which is good. This is an indication that that can’t be disputed. It is always a balance, and the goal those concerns are behind them. And actually, their No. today is to be more balanced in a positive way. While a 1 worry was finding the talent to do the business they lot of the legislative changes and regulatory changes that need to do. have occurred are not going to impact us directly, the way the current law is interpreted and regulated, so to speak, BAER: That’s a nice outcome for the country. We talked will be impactful, and we’re already seeing that in the way about this a little bit earlier, so in terms of U.S. Bancorp’s we’re doing things today. There are positives not only for reaction to tax reform, there’s been recently some sort of the banking industry but for the customers we serve and political criticism of banks doing share repurchases. for the economy.

BANKING PERSPECTIVES QUARTER 3 2018 25 State of Banking

You’re authorized to do share repurchases now – I BAER: U.S. Bancorp has a good view of the economy from think $3 billion over the next four quarters. How do they a unique and very valuable perch. Do you see sectors that add value for shareholders, and how do you believe this are lagging or sectors that are overheated? is consistent with doing the best for your employees and your customers? CECERE: First, I’ll say that things are generally pretty good. Credit quality is stable, and activity is Tax reform has done two things good. There is more spending occurring in business, consumer confidence is up, and employment numbers – it’s created more certainty and are strong. Inflation is starting to occur, and rates are more confidence. Companies – small to starting to go up. So, it’s sort of a pretty good scenario large corporates – were waiting to see if you’re a bank, right? Now, one of the challenges is the flat yield curve, and what that indicates and what that what would happen, and we are is signaling. seeing increased activity. There are a couple areas in the industry that are a little heated. One is commercial real estate. Our commercial real estate growth has been a little lower than some of the CECERE: We generate a lot of capital at U.S. Bank, and other large banks and small banks because we’re seeing we have a tangible return on equity in excess of 19%. We some structures that are a little bit more aggressive than generate, frankly, more capital than we can use in this we are comfortable with. slower-growth environment. Appropriate financial theory would say if you’re not able to achieve the cost of capital BAER: At Bank Policy Institute, I think one of our real on the capital you’re generating, you should return it to priorities is going to be to study why so many low- and shareholders. And that’s exactly what we’re doing. And middle-income borrowers and depositors are operating we’re returning it to shareholders in a combination of outside the regulated banking system, and then advocate dividends and buybacks. It’s about 50/50, with a little for policies that would bring them back in. As you stated, higher on buybacks and a little lower on dividends. a deposit is a very good product, and bank loans are a low-cost alternative to credit. BAER: I’m just curious. The mix between dividends and repurchases, is that affected at all by CCAR? On the deposit side, we still see millions of unbanked Americans. We see people using check cashers. What do you CECERE: Yes. I think it is influenced by both CCAR see as the obstacles to banking those folks? and the environment. You have to have more certainty with a dividend because it’s difficult to change that. With CECERE: I agree with you 100%. As a bank, and as the buybacks, you have more flexibility because of their industry, we need to think about products for those approval threshold. just entering the banking systems, to allow them to graduate to other products, and the banking system is During the last few years, when there was uncertainty where we ought to have those products. Small-dollar about rate increases and the environment and growth loan products, which would be an alternative to payday overall, we wanted to be careful about the dividend side lenders, are a good thing. We’re working on alternatives of the equation because of that uncertainty. In addition, to that. By getting unbanked individuals into the the language in CCAR that said anything in excess of banking system, it allows a better product from the 30% will receive additional scrutiny caused us to be customer perspective and a much-safer process from a more careful too. regulatory perspective. n

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28 BANKING PERSPECTIVES QUARTER 3 2018 MAKE GOOD NEIGHBORS?

A DECADE HAS PASSED SINCE THE FINANCIAL CRISIS, AND IT’S AN APPROPRIATE TIME TO DETERMINE IF RING-FENCING MAKES SENSE.

BY H. RODGIN COHEN, SULLIVAN & CROMWELL

BANKING PERSPECTIVES QUARTER 3 2018 29 Do Good Ring Fences Make Good Neighbors?

THE TENTH ANNIVERSARY of the 2008 financial crisis marks an appropriate time to review the cumulative impact of the legislative and regulatory responses. Do these responses continue to strike the appropriate balance among the multiple constituencies that depend upon both the safety and the effectiveness of the banking system? Since 2008, there have been major enhancements In the immediate aftermath of 2008 and the losses to the basic building blocks of bank safety, soundness, resulting from failures of major banks, the push for and resilience: capital, liquidity, stress-testing, risk jurisdictional ring-fencing by host-country regulators was management, and resolution planning. The success of understandable. They had been left to fend for themselves, these core enhancements suggests, however, the need and the result in several notable cases was severe losses for a re-examination of the more peripheral regulatory and the deployment of unprecedented host-country tools that have also been adopted. Are those other financial support to the local operations of foreign banks. regulatory responses reducing risk, and are they taking an undue toll on the capacity of financial institutions to The issue, however, is whether the jurisdictional Tserve the economy? ring-fencing response that was understandable then remains the right course today in view of subsequent developments. These developments include Some trace the current debate on implementation of international standards for external jurisdictional ring-fencing to the total loss-absorbing capacity (TLAC), the availability of recapitalization and liquidity support through single- Federal Reserve’s decision to impose an point-of-entry (SPOE) resolution plans, adoption of intermediate holding company requirement automatic stays on early terminations in financial contracts from the International Swaps and Derivatives on foreign banks with $50 billion or Association, and international cooperation protocols. more in U.S. subsidiary assets. Some trace the current debate on jurisdictional ring- fencing to the Federal Reserve’s 2012 decision to impose an intermediate holding company (IHC) requirement on Ring-fencing is one of the most consequential foreign banks with $50 billion or more in U.S. subsidiary peripheral regulatory responses. Although ring-fencing assets. To be fair, the Federal Reserve was responding to is a somewhat protean term, it can be defined as the legitimate stimuli: statements by certain European regulators government-required isolation of operations, assets, or that they would not support the large U.S. broker-dealer activities. There are two basic types of ring-fencing that affiliates of their major banks, the curtailment of the Federal are applied to financial services companies: jurisdictional Reserve’s own emergency lending powers by Dodd-Frank, and activities.1 and the role thrust upon the Federal Reserve throughout the crisis as the global provider of U.S. dollar liquidity. Moreover, Jurisdictional ring-fencing involves a legislative or the Federal Reserve stopped well short of total jurisdictional regulatory determination that the assets, capital, liquidity, ring-fencing, as the IHC requirement does not apply to the and/or governance of a banking operation should be U.S. branch operations of foreign banks. captured by the rules and regulations of the jurisdiction in which the operations are located. It represents an attempt With respect, however, to the entities covered by the IHC to superimpose a nationally based regulatory structure on requirement, the jurisdictional ring-fencing that is imposed a global banking system. is comprehensive. The IHC rules apply capital, stress testing,

30 BANKING PERSPECTIVES QUARTER 3 2018 liquidity, and governance requirements – almost the entire Internal TLAC can serve a useful panoply of the enhanced prudential supervisory regime. Furthermore, the IHC requirement encompasses all U.S. purpose in fostering international subsidiaries of the foreign bank – even those companies cooperation if calibrated appropriately, that are not controlled in fact by the foreign bank, but are deemed subsidiaries under the Federal Reserve’s expansive but there can almost always be too definition of control. much of a good thing.

The European Commission appears to be following the U.S.’s lead with its own IHC-type proposal for large non–European Union institutions. Other jurisdictions implemented as a total prohibition on certain activities could follow. Moreover, the European Central Bank is for both banks and their affiliates or require that the advocating for total jurisdictional ring-fencing through relevant activities be conducted in separate affiliates. a subsidiarization requirement that would eliminate Activities ring-fencing takes multiple forms. For example, the ability of non-European Union banks to establish or until the end of the last century, banking in the United maintain branches in European Union countries. States was ring-fenced not only from commerce but, as reinforced by the Glass-Steagall Act, from investment NATIONAL ACTIONS HAVE INTERNATIONAL banking and most other financial activities. The 1999 IMPLICATIONS Gramm-Leach-Bliley Act enabled bank affiliates, but not National actions that affect the global economy are banks themselves, to engage in most financial activities, likely to have global consequences. One of the lessons of while leaving the demarcation between banking and the Smoot-Hawley Tariff Act of 1930 is the miscalculation commerce substantially in place. As a prominent part by its supporters, who maintained that other nations of the Dodd-Frank Act, the Volcker Rule reintroduced a would be “passive” to its enactment. Just as with tariffs, limited form of activities ring-fencing, and Sen. Elizabeth jurisdictional ring-fencing is unlikely to go unnoticed Warren and others have been advocating for a wholesale and unmatched. If just one jurisdiction engaged in reintroduction of Glass-Steagall. A more comprehensive ring-fencing, it could be the net winner. But if other activities ring-fencing approach is soon scheduled to come jurisdictions ring-fence in response, which is the more into effect in the United Kingdom, where the demarcation likely result, it is likely that everyone loses. would be between wholesale and retail banking.

A second form of post-crisis jurisdictional ring-fencing HOW EFFECTIVE IS RING-FENCING? with a substantial impact is an internal TLAC requirement Two issues determine the desirability and efficacy imposed by host countries on global systemically important of ring-fencing in our post-crisis environment. First, banks (G-SIBs). Under the Financial Stability Board’s does ring-fencing actually enhance bank safety and TLAC framework, a material host-country subsidiary of a soundness, in particular because of the direct tension G-SIB is required to maintain a substantial debt obligation with such regulatory prudential objectives as enterprise to the home-country parent, and the value of this debt risk management, reliance on the parent company as a obligation is ring-fenced because the host-country regulator source of strength, and risk diversification? Second, do the can require it to be converted into equity. Internal TLAC objectives achieved by ring-fencing outweigh the burdens can serve a useful purpose in fostering international imposed? As a general premise, limitations on the ability cooperation if calibrated appropriately, but there can almost of financial institutions to serve their customers impose a always be too much of a good thing. cost on both those customers and financial institutions.

Activities ring-fencing involves the separation of These are not questions that can be answered once deposit-taking from certain other activities – banking, and forever. As conditions change, so too should the nonbanking, or both. The mandated separation can be evaluation. The near catastrophe that occurred in 2008

BANKING PERSPECTIVES QUARTER 3 2018 31 Do Good Ring Fences Make Good Neighbors?

may be viewed as justifying regulatory actions that, to prevent them. Consequently, if there is one lesson that in the context of the times, were deemed necessary to should have been learned from the 2008 financial crisis, ensure against a reoccurrence. But the efficacy of the it is that flexibility is paramount. Because participants in major actions taken by the regulators and the financial both the public and private sectors must act immediately institutions themselves since 2008, which have created and decisively in response to unforeseeable and constantly far greater stability and resilience as well as greater changing circumstances, artificial constraints are very perspective, should call for a new assessment. much in the way. If capital or liquidity is trapped in one part of a global institution, irrespective of the actual need for With respect to activities ring-fencing, the empirical it, the flexibility to deal with a crisis in any other affiliated record does not provide credible evidence that a entity is curtailed. Human nature being what it is, in a time combination of financial activities within a single of great uncertainty, a regulator or government is unlikely banking organization either created or intensified the to be sufficiently confident of the financial soundness of an 2008 financial crisis. Specifically, the assertion that the entity in its jurisdiction that it will make the hard decision Gramm-Leach-Bliley Act’s partial repeal of Glass-Steagall that there is excess capital or liquidity that can safely be was responsible for the financial crisis is as demonstrably transferred to another jurisdiction. invalid as the claim by Glass-Steagall proponents that securities activities of banks and their affiliates were Jurisdictional ring-fencing is designed to ensure that the responsible for the wave of bank failures in 1929–1933. operations of a financial organization in that jurisdiction have sufficient resources to avoid a financial meltdown – The debate over activities ring-fencing, however, should or, at worst, if a meltdown occurs, that a local wind-down not be limited to whether it is unnecessary but whether can occur with only limited damage to that jurisdiction’s it is counter-productive and detracts from safety and other financial institutions and overall economy. The soundness. One of the basic elements of risk minimization unpredictability of a severe financial problem means, is risk diversification. It is undeniable that some diversified however, that, if one occurs at an individual host-country financial institutions encountered severe, on occasion fatal, subsidiary, the resources that are locally available to it may financial distress during the financial crisis, but there is well be insufficient to restore the subsidiary’s financial seemingly no basis for concluding that the distress was health or enable an orderly wind-down. In a ring-fenced a consequence of diversification. To the contrary, there world, the local institution cannot anticipate any support appears to have been a correlation between the monolinear from its affiliates because of their own ring-fenced regimes. nature of an institution, in particular certain forms of investment banking and real estate lending, and the If major financial institutions live globally and die institution’s susceptibility to financial distress. nationally, the death is likely to be more violent and the ramifications more widespread. If the funding and other Likewise, jurisdictional ring-fencing cannot be justified if markets conclude that ring-fencing prevents, or at least it makes banks or the banking system riskier or banks more discourages, a global bank from assisting a troubled difficult to resolve. A principal concern with jurisdictional affiliate in a foreign jurisdiction, not only will the affiliate IHCs, and, even more so, if accompanied by high internal be more likely to collapse when confronting financial TLAC requirements, is that they may actually increase difficulty, but there is an increased danger of contagion rather than reduce systemic and individual bank risk. The affecting both the bank’s other affiliates, wherever located, inevitable consequence of these constraints is reduced and unaffiliated financial institutions in that foreign flexibility – not only in a bank’s ability to provide customer- jurisdiction. Moreover, ring-fencing is likely to weaken the needed products and services in a “business as usual” potential for international cooperation in the resolution of mode, but when an institution most needs it. an international bank.

Crises are by their very nature unpredictable because, Admittedly, the pure “trust me” approach is if it were otherwise, actions could almost always be taken insufficient for resolution of a global institution across

32 BANKING PERSPECTIVES QUARTER 3 2018 Turn compliance into opportunity

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480299-2019-The Clearing House Annual Conference Quarterly Journal Ad.indd 1 8/9/2018 4:58:42 PM Do Good Ring Fences Make Good Neighbors?

multiple jurisdictions. No matter how well-intentioned Application of this principle suggests reconsideration of the government officials might be and how much pre- the seemingly settled debate about the 75% to 90% range planning and collaboration takes place, self-interest for internal TLAC. Would not a 50% to 75% range be more will often be a more powerful motivator. The answer, consistent with all the relevant objectives, particularly however, should not be the total absence of trust as in view of the high external TLAC requirements that is seemingly reflected, for example, in the highest have been imposed? At the very least, a serial push to the possible internal TLAC percentage. Rather, it should upper end of the current range would seem to subvert the be to harness properly motivated national self-interest Goldilocks Principle. in the construction of a stable cross-border framework that fosters resiliency and serves critical intermediation An intriguing alternative approach has recently been needs of the global economy. adopted by the Bank of England. This approach is based on reciprocity. Under this model, a host jurisdiction could assert that it was prepared to adopt a 75% internal TLAC We need to strive for a requirement, the low end of the current range, for a material balance that is ‘just right’ subgroup of a G-SIB if that G-SIB’s home country applies a to both promote confidence and similar requirement for the host country’s institutions. maintain sufficient flexibility. With respect to intermediate holding companies, abolishment of the Federal Reserve’s basic requirement may be unrealistic. But in that event, there should be a meaningful attempt to reduce the burden that the IHC imposes. In establishing the terms of the debate over the Possible steps include: more flexibility for foreign banking appropriate amount of internal TLAC, hopefully there organizations to hold subsidiaries, particularly minority- is an evolving consensus that more is not inevitably owned ones, outside the IHC structure; a governance better. If all external TLAC is replicated downstream by structure that recognizes that the IHC is part of a global mandatory, pre-positioned internal TLAC, then there enterprise; adoption of a tailored approach to such matters are no reserves of loss-absorbing capacity that can be as the Comprehensive Capital Analysis and Review; and called upon if the capacity at a subsidiary is exhausted. appropriate accommodation as either a tax or regulatory Likewise, as a matter of logic, capital or liquidity is more matter to alleviate the unfair tax burden that the IHC likely to be exhausted at a single legal entity than at the structure can now create. A more accommodative approach combined organization. Indeed, the highest levels of by the U.S. may encourage the EU and other jurisdictions internal TLAC seem inconsistent with the very concept to refrain from imposing their own IHC structural of SPOE, which has become the foundation of much requirements, or, at least, to accommodate the business and resolution planning. regulatory imperatives of banks from other jurisdictions.

JUST RIGHT A final recommendation is not for any specific change. We need to apply a Goldilocks Principle. Too much Rather, it is that our regulators and policymakers internal TLAC, and there are insufficient central reserves recognize and evaluate – in the context of the current of capital and liquidity to call upon in response to stress relevant circumstances – the critical role that an at a subsidiary. Too little internal TLAC, and there is appropriately balanced policy toward ring-fencing could no trust, which can lead to precipitous action to protect play in optimizing both the stability and economic what is there. We need to strive for a balance that is “just effectiveness of our financial system. n right” to both promote confidence and maintain sufficient flexibility. And we need to evaluate what is “just right” ENDNOTES based on conditions as they are today – following and 1 The ring-fencing regimes described in this article are ex ante, in that they are implemented before an actual problem exists. incorporating a decade of post-crisis reform.

34 BANKING PERSPECTIVES QUARTER 3 2018

ENCING’S GLOBAL IM RING-F PAC T

A BASEL COMMITTEE PERSPECTIVE ON THE IMPLICATIONS FOR POLICYMAKING AND INTERNATIONAL COOPERATION.

BY WILLIAM COEN, BASEL COMMITTEE ON BANKING SUPERVISION

36 BANKING PERSPECTIVES QUARTER 3 2018 ENCING’S GLOBAL IM RING-F PAC T

BANKING PERSPECTIVES QUARTER 3 2018 37 Ring-Fencing’s Global Impact

WHEN THE BASEL III FRAMEWORK was finalized in December 2017, it represented an important milestone for the post-crisis movement to reform and strengthen financial regulation. Yet, in parallel with these global efforts steered by the Basel Committee,1 many jurisdictions have introduced additional measures, including more-conservative prudential requirements and bank structural reforms, such as ring-fencing. What impact do these measures have on the global regulatory framework for banks, and what are the implications for international cooperation? Do they complement the Basel III framework, with both sets of measures mutually reinforcing bank prudential safeguards? Or are there areas of tension that could weaken the Committee’s mandate of enhancing global financial stability? In this article, I look at the role of prudential minimum standards for global banks in providing the basis for national laws, rules, and regulations.

FROM GLOBAL TO LOCAL national regulations that are less stringent than the Basel Broadly speaking, the post-crisis bank reform agenda standards, these could prove unsafe and unsound in the Whas focused on three main dimensions: long term, undermining the resilience of banks and the financial system. In contrast, many jurisdictions can – i. Strengthening the regulation and supervisory and often do – apply more-conservative requirements oversight of banks than those set out in the Basel framework.

ii. Developing a toolkit to resolve failed banks in Certain other international initiatives relate to the a timely and orderly manner resolution of troubled banks. For example, the Financial Stability Board has adopted guidance on effective iii. Insulating certain banking activities through resolution regimes for financial institutions, and it has structural ring-fencing set total loss-absorbing capacity standards. These global agreements apply mostly to global systemically important These measures were generally developed in parallel banks. But they are complemented by a wide range of with Basel III but vary in terms of their scope of domestic and regional measures. application. For example, in the case of the regulatory framework, the Basel III framework is a global minimum Finally, a number of structural reforms aim at what is standard for internationally active banks. It seeks to sometimes referred to as ring-fencing. These constitute a ensure a level playing field across all jurisdictions for fairly broad set of measures, including both geographic global banks. If individual jurisdictions were to adopt ring-fencing (requiring capital or liquidity resources of a global bank to be held at a jurisdictional or regional level) and functional ring-fencing (requiring that certain types Any discussion about the impact of of activity are segregated or prohibited within a banking regulation must be prefaced by a group). Unlike the global frameworks, these initiatives look at the costs and benefits. The evidence have been adopted at the jurisdictional or regional level. shows that Basel III regulatory costs Why have these measures been put in place at different are easily outweighed by the benefits. levels? What impact, if any, does this have on international cooperation and global financial stability? And what does it mean for the work of the Basel Committee?

38 BANKING PERSPECTIVES QUARTER 3 2018 When assessing the role of global standards in forming But such gold plating has set off a lively debate, the basis for national or regional laws, directives, rules, particularly about its supposedly damaging effects. For and regulations, one must remain mindful of the context.2 instance, some allege that national ring-fencing results in “trapped” capital or liquidity at the local level. But this Any discussion about the impact of regulation must ignores the obligation of national supervisors to apply start with a look at the costs and benefits. The evidence national regulations to firms doing business in their to date shows that any Basel III regulatory costs are jurisdiction and their supervisory duty to maintain the easily outweighed by the benefits. For example, a Basel safety and soundness of their banks and banking system. Committee 2010 study, “An Assessment of the Long- It also overlooks the mechanisms for cooperation built Term Economic Impact of Stronger Capital and Liquidity into the international regulatory architecture, such as Requirements,”3 found that clear long-term economic supervisory colleges and crisis management groups. benefits will accrue from increasing minimum capital and liquidity requirements. These benefits consist of making In the run-up to the completion of the Basel framework financial crises less likely and reducing the associated in December 2017, a common refrain was the need output losses. Experience since 2010 suggests that the to maintain risk sensitivity. There was a concern – actual net benefits have been even larger than expected. misguided, in my view – that the imposition of an output floor and the other measures might impair the Another important contextual factor is the distinction framework’s risk sensitivity. The Committee supports a between global minimum standards and a jurisdiction’s risk-weighted capital regime, which should remain at the regulations. The Basel Committee sets global standards core of the framework for banks, as complemented by the for bank regulation and supervision. It also issues leverage ratio and liquidity metrics. At the same time, the guidelines and promotes sound practices. It has no pursuit of increased risk sensitivity considerably increases formal supranational authority, however. Its decisions the complexity of the capital adequacy framework in have no legal force. Rather, the Committee’s members are some areas – particularly the calculation methodology for responsible for transposing the agreed-upon standards risk-weighted assets.4 Simply put: One cannot and should into binding laws and regulations. not relentlessly pursue risk sensitivity as a goal in itself; it must be balanced with simplicity and comparability. “GOLD PLATING” – COMPLIMENT OR Similarly, one cannot expect national supervisors and PEJORATIVE? regulators to abandon established national regulations The Basel standards represent global minimum standards. in pursuit of a common global framework that does not allow for the exercise of discretion in response to national National arrangements – such as ring-fencing circumstances – as long as those national measures meet schemes, stress-testing frameworks, deposit insurance or exceed the globally agreed-upon minimum standards. guarantees, and resolution regimes – supplement or complement the global standards. The implementation of The desirability of having a single set of harmonized such measures is consistent with the Basel Committee’s global standards is understandable, especially for philosophy that national circumstances may speak for large, internationally active banks conducting business the adoption of additional national regulations, or ones worldwide. Although the prospects of adopting a that exceed the global minimum standards. From the uniform global legal framework and harmonized global perspective, such “gold plating” is warranted – even supervisory powers and practices are highly improbable, welcome and expected – in light of the wide variety of the revised Basel framework provides a common national supervisory powers and practices among Basel foundation. Combined with a vastly improved Committee members, to say nothing of their differing set of Pillar 3 disclosure requirements, investors, legal environments; resolution and insolvency regimes; counterparties, and other market participants can make financial and business cycles; fiscal policies; and degree of like-for-like comparisons of banks, thereby helping to economic development. instill market discipline.

BANKING PERSPECTIVES QUARTER 3 2018 39 Ring-Fencing’s Global Impact

BETTER SUPERVISORY AND REGULATORY • Monitoring the implementation of the Basel COOPERATION standards in member countries and beyond to encourage their timely, consistent, and effective The revised Basel minimum standards have addressed implementation flaws that were exposed by the global financial crisis. When implemented at the national level, they will also • Consulting with nonmember central banks help reduce variability in the reported results produced and bank supervisory authorities to benefit by banks’ internal models. Disclosure requirements from their input into the Committee’s policy will also improve the global framework for large formulation process and to promote the internationally active banks. Last but not least, better implementation of its standards, guidelines, and supervisory and regulatory cooperation will also sound practices beyond its member countries contribute to leveling the playing field. • Coordinating and cooperating with other For many, the promotion of global standards for financial sector standard setters and the regulation and supervision of banks is the Basel international bodies, particularly those involved Committee’s defining role. Such standards include in promoting financial stability the Basel capital and liquidity frameworks, the “Core Principles for Effective Banking Supervision,”5 and the Communication, coordination, cooperation, and large exposures regime. Yet an equally important part of consultation: Collectively, these have been the Basel our work focuses on promoting communication between Committee’s raison d’être since 1974, the year it was supervisors by doing the following: founded. For example, one of the Committee’s earliest guidelines, known as the “Concordat,”6 was published After a decade of developing new in 1975 and sets out principles for sharing supervisory responsibility for home and host supervisors on banks’ policies and revising existing ones, the cross-border establishments. The Committee continues Basel III framework published in 2017 provides to focus on these activities today. The importance of these four “Cs” was never more apparent or necessary certainty and stability. The Committee will than during the global financial crisis, when potentially nevertheless carefully assess, evaluate, and disastrous episodes unfolded one after another – at times, almost minute by minute. The ability for the authorities monitor the new standards to ensure they to interact, share information, and keep abreast of are producing the anticipated impact. developments was crucial then and remains so today.

As the global financial system is intricately interconnected, so, by necessity, are its regulation, • Exchanging information on the banking sector supervision, and oversight. International and financial markets to help identify current or communication, coordination, cooperation, and emerging risks to the global financial system consultation among authorities have improved dramatically since the crisis. Some of the measures • Sharing experience on supervisory issues, include the Committee’s expanded membership and the approaches, and techniques to promote a creation of its Basel Consultative Group; the adoption common understanding and improve cross- and promotion of “supervisory colleges”; and the regular border cooperation International Conference of Banking Supervisors (ICBS). Beyond the banking sector, the cross-sectoral • Addressing regulatory and supervisory gaps interaction among standard-setting bodies, regulators that endanger financial stability and supervisors has been extensive and unprecedented.

40 BANKING PERSPECTIVES QUARTER 3 2018 BASEL COMMITTEE MEMBERSHIP AND THE BASEL The Basel standards represent CONSULTATIVE GROUP Pre-crisis, the Basel Committee had 13 member global minimum standards. jurisdictions. Today, the membership spans 28 jurisdictions National arrangements – such as ring- and includes 45 central banks and supervisory authorities along with nine observers who participate in Basel fencing schemes, stress-testing frameworks, Committee meetings and those of its various working groups. deposit insurance guarantees, and resolution regimes – supplement or complement Expansion of the Committee’s membership was one of several measures taken to improve global interaction the global standards. among authorities. In 2009, the Committee established its Basel Consultative Group (BCG), which provides a forum for deepening the Committee’s engagement communicating key supervisory messages among college with supervisors around the world. The BCG facilitates members. Supervisory colleges help their members dialogue with nonmember supervisors on new Committee form a deeper understanding of a bank’s risk profile initiatives. Its membership is made up of central banks and provide a framework for addressing topics relevant and supervisory authorities from an additional 14 to the supervision of a banking group. Home and host countries, as well as supervisory groups, international supervisors are responsible for making risk assessments in agencies, and other bodies. their respective jurisdictions while information exchange organized at the supervisory college level plays an INTERNATIONAL CONFERENCE OF BANKING important role in contributing to these assessments. SUPERVISORS Another important plank in the Committee’s efforts to CROSS-SECTORAL ENGAGEMENT forge international supervisory cooperation is the ICBS, The financial system is complex, global, and highly which has been held every two years since 1979. The interconnected. This is true of all its sectors, such as conference brings together senior bank supervisors and banking, insurance, securities markets, and key market central bankers from more than 100 countries as well as infrastructures, such as payment and settlement systems. representatives of international agencies. The conference The level of coordination among those responsible for each promotes discussion of key supervisory issues and fosters of these sectors has increased dramatically compared with continuing cooperation in the oversight of internationally the pre-crisis period. For example, as the standard setter for active banks. With its wide membership of senior supervisors the banking sector, the Basel Committee keeps in regular and policymakers, the ICBS fosters broad-based discussions contact with the International Association of Insurance on issues that are timely and relevant to supervisors in Supervisors, the International Organization of Securities advanced and emerging market economy jurisdictions alike. Commissions (IOSCO), and the Committee on Payments and Market Infrastructures (CPMI). These organizations SUPERVISORY COLLEGES often collaborate to set standards for overlapping financial The Committee first published its “Principles for sectors. For example, in 2013, the Basel Committee and Effective Supervisory Colleges” in 2010 and a revised IOSCO worked closely together in developing the global version in 2014.7 Authorities have established supervisory standard on margin requirements for non-centrally cleared colleges to more effectively supervise global systemically derivatives. Also, in 2014, the Committee completed its important banks and other internationally active work on the regulatory capital treatment of bank exposures banking groups. This has been achieved by improved to central counterparties, following a collaborative effort information-sharing among supervisors, building a between the Committee, CPMI, and IOSCO. common understanding of risks and vulnerabilities in banking groups, promoting a shared agenda I believe this cross-border and cross-sectoral for addressing such risks and vulnerabilities, and engagement has taught some important lessons to all

BANKING PERSPECTIVES QUARTER 3 2018 41 Ring-Fencing’s Global Impact

involved. It has underscored the need to respect other and timely communication, coordination, cooperation, jurisdictions’ supervisory and regulatory decisions in the and consultation. The Committee’s response has light of national circumstances (while still meeting the substantially improved the global minimum standards, minimum global standards). It has also highlighted the which form the basis for national laws, directives, need to understand and respect each standards-setting rules, and regulations that implement the standards in body’s mandates and objectives. Committee member jurisdictions. The implementation of additional measures, such as ring-fencing schemes, LOOKING AHEAD stress-testing frameworks, deposit insurance guarantees, As the global regulatory framework has been radically and resolution regimes – which go beyond the transformed over the past decade and jurisdictions minimum standards – are actions taken by national continue the process of implementing the national or jurisdictional authorities that reflect and respect regulations, the Committee has shifted its focus from national circumstances. policy development to assessing, evaluating, and monitoring the new or revised standards. Much of the The Committee has become a truly global organization regulatory framework is new, such as the leverage ratio, and has played a key role in promoting and facilitating the liquidity coverage ratio, the net stable funding ratio, the four “C’s”: communication, coordination, cooperation, and the use of regulatory capital buffers. The standards and consultation. In addition, the level of engagement were agreed upon based on thorough quantitative impact among those responsible for global standard setting, testing and careful public consultation. However, because regulation, supervision, and oversight has improved implementation has started only recently, we now need to dramatically. In addition, after a decade of developing assess the real-world impact of the standards. new policies and revising existing ones, the Basel III framework published in 2017 provides certainty and Assessment, evaluation, monitoring – these activities stability. The Committee will nevertheless carefully assess, now constitute a large part of the Committee’s work evaluate, and monitor the new standards to ensure they program. This is a challenging but necessary task. are producing the anticipated impact. n Necessary, given the importance of global minimum standards and the need to help ensure the resilience of ENDNOTES banks and banking systems, but challenging because, in 1 The Basel Committee comprises 45 members from 28 jurisdictions, consisting of central banks and authorities with many ways, we are trying to hit a moving target. Studies formal responsibility for the supervision of banking business. to gauge the quantitative impact of the reforms have Additionally, the Committee has nine observers, including central limitations – that is, they assume bank balance sheets will banks, regional supervisory groups, international organizations, and other bodies. The Committee expanded its membership in remain static when in fact banks will optimize the rules 2009 and again in 2014. Additional information is available here: even before they officially come into effect. Also, and as https://www.bis.org/bcbs/membership.htm I have noted elsewhere, the quality of data submitted by 2 Laws, directives, rules, and regulations refer to the legally binding requirements adopted by a country or jurisdiction and are distinct banks for such studies is never perfect.8 Nevertheless, from the nonbinding nature of “standards.” For the sake of brevity, on the basis of evidence and analysis, the Committee “regulations” is used here but should be understood to refer to a jurisdiction’s laws, directives, regulations, etc. will assess whether its new or revised standards are 3 Available at https://www.bis.org/publ/bcbs173.htm. The Basel meeting their original objectives, what the impact might Committee is in the process of updating the earlier study. be, and whether the impact is as expected or if there are 4 Basel Committee on Banking Supervision, “The Regulatory unintended consequences. Only on the basis of empirical, Framework: Balancing Risk Sensitivity, Simplicity and Comparability,” July 2013. https://www.bis.org/publ/bcbs258.htm data-driven analysis will the Committee consider whether 5 Available at https://www.bis.org/publ/bcbs230.pdf adjustments are warranted. 6 Available at https://www.bis.org/publ/bcbs00a.htm 7 Available at https://www.bis.org/publ/bcbs287.htm CONCLUSION 8 William Coen, “The Market Risk Framework: 25 Years in the Making,” As I have outlined above, the official sector has keynote speech at the ISDA Annual General Meeting, Miami, April responded energetically to the imperative for effective 25, 2018. https://www.bis.org/speeches/sp180425.htm

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RING-FENCING: ESCAPE FROM THE PRISONER’S DILEMMA

WIDESPREAD RING-FENCING COULD MAKE BANKS MUCH RISKIER – BUT SMART ACTION COULD FIX THIS

BY WILSON ERVIN, CREDIT SUISSE

IN THE 10 YEARS since the financial crisis hit, extensive reforms have rebuilt the foundations of banking. The effort has been centered on the Financial Stability Board’s (FSB) four major reform pillars, including stronger capital and ending the concept of “too big to fail.” But could a little-known “fifth column” – the rise of widespread ring-fencing – threaten to undermine these achievements?

Ring-fencing is shorthand for local control around certain assets or activities, typically requiring dedicated pools of local capital and liquidity.1 The rise of widespread ring-fencing is perhaps a natural reaction to the recent crisis, but it can lead to unexpected and adverse Ioutcomes. It harms competition, economic resilience, and growth.2 In particular, it can actually damage bank safety, confounding the original intent of the exercise.

BANKING PERSPECTIVES QUARTER 3 2018 45 Ring-Fencing: Escape from the Prisoner’s Dilemma

In a recent working paper, we developed an analytic flexibility for the home jurisdiction (parent). A rough framework to assess the effects of ring-fencing for a outline of the framework includes: simple model bank.3 The results showed that widespread ring-fencing can increase the risk of bank failure, in 1. MODERATE CAPITAL PREPOSITIONING to some cases dramatically. While precise quantification protect hosts. The parent should have sufficient naturally depends on specific assumptions, the analysis net investment in key subsidiaries to enforce suggests that the rise of ring-fencing is a major issue and cooperation and deter “walkaway risk.” Such could be at the center of the next crisis. “skin in the game” is also important to avoid “no creditor worse off than in liquidation” (NCWOL) In this article, we summarize that analysis and outline challenges in the event of resolution. a potential solution: a plan for transparent “mutual disarmament” to restore bank resilience while addressing 2. TOP-UP RULES to maintain host safety (perhaps legitimate host concerns. The development of post-crisis via binding contracts to support needy entities, like resolution architecture forces a new look at home-host the support agreements used in U.S. living wills.) relations given the stark differences for subsidiary support between the multiple-points-of-entry (MPOE) and 3. Prepositioning should mostly be in single-point-of-entry (SPOE) frameworks (see Box 1). SUBORDINATED, GONE-CONCERN TLAC, plus It also forces us to consider how best to satisfy the twin a minimum equity requirement (but no local objectives of resilient recovery and credible resolution. equity buffers). However, the new resolution framework also gives us a large pool of subordinated total loss-absorbing capacity 4. The remaining group capital (equity buffers) (TLAC4) – resources that could be harnessed to solve the should be kept in a CENTRAL/MOBILE problems raised by ring-fencing. RESERVE, in order to ensure resilience. (Equity buffers make up perhaps two-thirds of the total Our framework tries to balance the need for certainty equity layer today.) for host jurisdictions (subsidiaries) with the need for BACKGROUND FIGURE 1: A COMPARISON OF INTEGRATED VS. RING-FENCED STRUCTURES Before the crisis, regulators were fairly comfortable

External Capital hosting international banks, at least from well-run INTEGRATED BANK jurisdictions. Competent home-country regulators aciiies are ar HOLDING COMPANY would supervise the group and address any problems arce o he hoe gro CAPITAL = $60 (100% MOBILE) that emerged. Those assumptions held up well for many aia hed a gro cener Resorces can shi o years and supported international growth, diversification, sor an branch D sian and competition. But this implicit home-host trust was as needed ranch ranch ranch ranch shattered by the crash-landing failures of major banks such as Lehman Brothers and Fortis in 2008, which imposed External Capital surprise losses on host countries. Banks were now said to be 5 RING-FENCED BANK “international in life, but national in death.” ciiies asses HOLDING COMPANY searaed ino geograhic CAPITAL = $60 (0% MOBILE) In response, many jurisdictions moved to protect sbsidiaries aia is diided and national interests and adopt stringent controls around ed don sor D sian local subsidiaries, including capital restrictions, liquidity b b b b sandaone restrictions, and operational support requirements. They No obie resere reains decided to ring-fence early, far in advance of potential Source: Wilson Ervin, Credit Suisse stress conditions.6 Some moves were public, such as the U.S. intermediate holding company rule and the European

46 BANKING PERSPECTIVES QUARTER 3 2018 FIGURE 2: HOW DIFFERENT FORMS OF RING-FENCING CAN MAKE BANKS RISKIER STRUCTURE OF GROUP CAPITAL ANNUAL RISK OF FAILURE (as a multiple of Integrated Bank Case) 1. Integrated Bank (full capital mobility) 1.0 (baseline case) 2. Integrated Bank & 1 “hard” ring-fenced sub a. Risk of failure: ring-fenced sub <0.1 (initial capital plus top-up) b. Risk of failure: other subs 5.5 (supported by remaining capital) 3. Fully ring-fenced group – all capital in 4 subs 4.8 (all capital downstreamed) 4. fully ring-fenced group with affiliate contagion 15.1 (one sub failure àall subsidiaries fail) Source: Wilson Ervin, Credit Suisse

Union’s response (the proposed intermediate parent cannot get those resources to the right subsidiary in time undertaking), but others happened under the radar. to avoid a local failure.11 (See Figure 3.) The risk increase Indeed, ex ante ring-fencing has become widespread even is only 4.8x (case 3 in Figure 2) if the subsidiaries can fail within the EU banking union,7 and Brexit will likely create without harming their affiliates but grows to 15.1x (case further barriers. These proposals have emerged as national 4) if the failure of one subsidiary ultimately leads to a initiatives, without a substantial international debate or cascade of failure throughout the group (interaffiliate a global framework. As these policies proliferate, they contagion). Misallocation with contagion is a nightmare threaten to undermine bank resilience (see Figure 1 for a scenario, but it’s unfortunately plausible unless we take schematic view of this shift). action to understand and address it.

Our analysis from here will focus specifically on geographic ring-fencing and the effect of capital Balkanization.8 The purpose of locking in local resources Many jurisdictions have moved is to create extra safety for your part of the bank. But does to protect national interests and ring-fencing actually make banks safer? adopt stringent controls around local

A sole ring-fencer can gain an advantage. There is a subsidiaries, including capital restrictions, large risk reduction for a first mover if other jurisdictions liquidity restrictions, and operational do not match that decision. The first ring-fencer benefits from both a) local capital and b) the ability to tap a large support requirements. central reserve (see case #2a, Figure 2). However, trapping capital for one entity reduces resources for others, and their risks begin to increase. In the real world, other jurisdictions will respond – typically with countervailing A HOME-HOST PRISONER’S DILEMMA ring-fencing policies to improve their own position. This If retaliation is pervasive, the outcome for everybody shrinks the pooled central reserve further, harming the – even the first ring-fencing country – is worse off resilience of the group. Eventually, the central reserve can than when this process started. Local entities become dry up and all jurisdictions become worse off.9 The risk of more likely to fail, potentially dramatically so. This is a failure can increase by 5x or even 15x compared with an “prisoner’s dilemma” – an economic paradox in which “integrated bank,” where internal resources are mobile.10 each participant seeks to achieve a local benefit but ends up worse off when others also pursue their own This threat to solvency is caused by “misallocation incentives.12 If local incentives are sufficiently strong, a risk” – the risk that a bank has enough capital overall but “tragedy of the commons” can seem inevitable.

BANKING PERSPECTIVES QUARTER 3 2018 47 Ring-Fencing: Escape from the Prisoner’s Dilemma

BOX 1: THE BIG IMPLICATIONS OF SPOE AND MPOE RESOLUTION STRUCTURES The development of resolution frameworks has revolutionized (or 2. SINGLE-POINT-OF-ENTRY BANKS (SPOE): The other should revolutionize) many aspects of bank regulation. If the core purpose major category is SPOE groups, which treat subsidiaries of regulation is to protect the financial system, then understanding the as part of a naturally interconnected enterprise – a single likelihood and impact of failure is central to the exercise. Resolution organization that acts as a “source of strength” for its frameworks divide into two basic approaches to bank structure; this choice entities around the world. For these groups, resolution will have important implications for host regulation. happens at the top entity only, and resources are pushed downstream from parent to subsidiary as needed to support 1. MULTIPLE-POINTS-OF-ENTRY BANKS (MPOE): One critical activities throughout the world. This is the dominant approach to managing a group is to think of subsidiaries structure for big banks today, applying to perhaps 90% of as independent “portfolio companies” with a common the world’s 30 most systemically important banks. shareholder. MPOE groups define certain subsidiaries as resolution units and reserve the right to walk away The choice of MPOE structure simplifies the regulatory analysis for the from them in crisis, to protect the rest of the group. Each host. The group has emphasized that the subsidiary is on its own, so these resolution unit is designed as a self-contained, individually subsidiaries should naturally be regulated as stand-alone banks. They should resolvable entity, in line with local requirements. In a be subject to capital and regulatory requirements in line with stand-alone sense, these groups have accepted misallocation risk in local banks of similar scale and activity. In this way, hosts achieve “certainty” exchange for the right to walk away from a local entity. – at least to the same extent they achieve it for similarly situated domestic This can be a practical solution for certain types of banks banks. In contrast, SPOE groups are built on the premise of group support – especially those that are built as a federation of locally and source of strength. That can provide different and important advantages oriented retail banks. to a host regulator; we discuss how to ensure this support in Box 2.

The rules of the actual prisoner’s dilemma also stipulate jurisdiction (i.e., a home regulator) will focus that the participants cannot communicate to achieve a primarily on the health of the consolidated group. better outcome. However, bank regulators can cooperate First of all, the group is a direct responsibility. and build ex ante structures and communication In addition, the other problems of local collapse mechanisms to share in the global gains from a more or home-host conflict simply fall away if the enlightened framework. What should they do? consolidated group is healthy. The home regulator will naturally focus on group solvency and work to DIFFERENT OBJECTIVES avoid misallocation risk and resource trapping.14 In a recent speech, Federal Reserve Governor In Quarles’ language, group flexibility will be the Randal Quarles took a broad view of the ring- prime objective for the home. fencing discussion, and discussed liquidity and capital ring-fencing, late versus early ring-fencing, • THE HOST-COUNTRY VIEW: Host regulators are and the importance of transparency in the pursuit charged with protecting local financial stability of a balanced and stable outcome.13 In particular, and national interests. A strategy of naïve trust he highlighted the need to understand the different is not credible in the wake of 2008. As Quarles objectives of home and host regulators. To plot our put it: hosts need certainty. They want enough escape from the prisoner’s dilemma, let’s first examine control and resources to ensure that activities these perspectives: undertaken in their jurisdiction meet local standards of safety and that they will be treated • THE HOME-COUNTRY VIEW: A regulator that fairly. The resulting policy implications are pretty supervises a bank with headquarters in its simple under MPOE but become more interesting

48 BANKING PERSPECTIVES QUARTER 3 2018 under a SPOE, “source of strength” regime (see Widespread local capital trapping Box 2 for a deeper dive into host concerns). will make banks riskier. The Ring-fencing lies at the heart of home-host benefit of extra local protection backfires relationships. Subsidiarization – with full local capital and liquidity – can provide hosts with a high degree when other hosts retaliate and results in of certainty. But the analysis above shows that such a Balkanized bank and a deeply widespread local capital trapping will make banks riskier. counterproductive outcome. It backfires as other hosts retaliate and leads to a deeply counterproductive result.

How can we address these legitimate host concerns without the drawbacks of ring-fencing? Can we, in the words We believe that the best balance of resilience and of Quarles, find a good “balance of flexibility for the parent certainty can be achieved through a mix of funded bank and certainty for local stakeholders” (emphasis added)? and unfunded capital commitments, together with a transparent approach to the timing and allocation of BRANCHES: One solution is branching, an ancient surplus resources. Some elements of this proposal are strategy that ties local and foreign interests into a single consistent with current regulatory thinking, but others legal entity. This avoids the problem of local-only failure depart significantly from the status quo. Our proposal altogether.15 A fully branched structure can solve the host rests on a mix of the following: problems mentioned above and support a more efficient and resilient business model. One positive element of both • MODERATE PREPOSITIONING USING GONE- the recent U.S. and EU proposals has been the decision to CONCERN LOSS ABSORBING CAPITAL (GLAC): exclude branches from their ring-fencing initiatives. A modest amount of ring-fencing provides the first element. The purpose, however, is not to While branching is a simple and time-tested solution, replicate a miniature stand-alone bank (per there are limitations. For example, many countries traditional thinking under the Basel Concordat) require a subsidiary structure for certain activities (e.g., but rather to deter walkaway risk and create a insured retail deposits that are backed by the national defensible endgame capital solution for a host. government).16 Branching is an effective and constructive solution where it is allowed, but it is unlikely to be the a. COMPOSITION: Capital and resolution entire solution in the near term. We therefore have to arrangements are most critical as the group grapple with the issue of subsidiaries. comes under serious stress. Our approach is to focus on what’s needed near the SUBSIDIARIES: We used our model to explore point of failure and work back from the various capital structures for banking groups. For a endgame. We want a consistent strategy given amount of total capital, our goal was to minimize that avoids restructuring the group under risk at both the group and the subsidiary level. We stress, so we propose to adopt a sufficient tested various approaches, including ones similar to endgame capital position ex ante. In the the current FSB approach.17 These structures generally endgame, hosts should not care if the local scored poorly on flexibility and resilience. We did resources are equity or GLAC as long as the not achieve satisfying results until we expanded our total is big enough; both are subordinated approach to consider going and gone concern capital to support critical local functions, and resources separately and took a broader view of the GLAC can be turned into equity under different needs of recovery and resolution (see Box 3 for local control if necessary. We choose GLAC a high-level discussion of these components). as the primary prepositioning resource

BANKING PERSPECTIVES QUARTER 3 2018 49 Ring-Fencing: Escape from the Prisoner’s Dilemma

because it is designed specifically to support frees up going-concern equity for the mobile recapitalization in resolution. Hosts will “group reserve,” which strengthens recovery demand such protection near the point of capacity and resilience. failure, which means GLAC is inherently less mobile and should be the natural b. SIZING: Recent FSB rules proposed that major prepositioning tool. Importantly, that choice subsidiaries carry internal TLAC equal to 75%

BOX 2: ACHIEVING “CERTAINTY” FOR HOSTS UNDER SPOE

As we saw in Box 1, the distinction between MPOE and SPOE if they do not respond to capital trapping by others. They structures has major implications. Regulation for an MPOE subsidiary rely on the availability of the central reserve, which could be can be built on a simple stand-alone entity framework. However, SPOE impaired by the actions of more aggressive hosts. Indeed, groups are built on the premise of group support and source of strength. perhaps the worst position is to be a lone “no-fencer” in a But how can hosts be sufficiently certainthat support will be available, ring-fencing world.19 Transparent and fair allocation is critical sufficient, and genuine? A few elements are critical: to support cooperation. This is similar to the “negative pledge” covenants that bond investors use to protect a. RESOLUTION CREDIBILITY: If the group does not have themselves: make sure that lenders rank equally and that a credible, well-resourced resolution plan, then hosts are the company doesn’t pledge assets to secure other loans exposed to the same pitfalls they faced in 2008. Without ahead of the existing loan group. such a plan, each country will have to sort out its own problems via local bankruptcy or local resolution. Even if d. ENDGAME CONSIDERATIONS: The stress on hosts will the bank group is bailed out, national authorities are likely be highest when the group is nearing failure. At this point, to fight over who should foot the bill, as in the acrimonious further support from the top will be unreliable at best, so case of Fortis in the Benelux region. A strong resolution plan, hosts are likely to want sufficient tangible prepositioned well-funded with external TLAC, is essential. resources most at this point. These resources will be important to a host for two reasons: for assurance against b. WALKAWAY RISK: Even if there is a strong resolution plan walkaway in resolution; and for locally resourced protection at the top that can recapitalize all operating subsidiaries, against poor resolution execution by the home. hosts are exposed to the risk that the group chooses not to support a weak subsidiary. A value maximizing group could Credible host arrangements will need to address all four elements to improve its economic position by discarding a subsidiary achieve a sufficient degree of certainty. It will be impossible to achieve with very negative equity. Walkaway risk is unlikely for absolute certainty – we are not attempting the impossible task of a going-concern group because of important franchise, reducing bank risk to zero. But the overall package should achieve at market, and reputational pressures, and has been very least the same level of safety as a local stand-alone bank of similar size rare in the modern era. However, host regulators worry that under domestic capital rules. group support could falter under the legal conditions of bank resolution, which may require resolution authorities to Our model bank analysis shows that strictly local (i.e., ring-fenced) consider walkaway options if the group fails.18 This risk can support is highly inefficient for SPOE groups. Hosts can achieve be addressed in two ways: via prepositioning of some capital significantly better risk outcomes with lower amounts of local capital to tilt the NCWOL calculations in favor of group support or by if the regime is built with strong, resilient group support distributed legal tools, such as guarantees or support agreements. under transparent rules. As we consider the prudential implications of the new resolution architecture for SPOE, arrangements like our c. TRANSPARENCY ON CENTRAL RESERVE: Our model “straw man” proposal can produce significantly better outcomes for shows that “friendly” hosts can be put into a risky position both groups and hosts.

50 BANKING PERSPECTIVES QUARTER 3 2018 to 90% of the external TLAC requirements for FIGURE 3: AN EXAMPLE OF MISALLOCATION RISK a stand-alone bank, but we are unaware of any quantitative work behind this proposed External Capital range. In our analysis of host needs (see Box 2), HOLDING COMPANY we need sufficient resources to address both $60 / 15% “walkaway risk” and “endgame considerations.” aring D sian Because we also propose a top-up rule (see aia b b b b below), walkaway risk is short-term in nature (to

the next top-up date), and can be deterred by a CRISIS LOSSES -15 -5 -2 +2 avg. loss (-) x - total loss relatively modest amount of capital.20 Endgame considerations are the dominant constraint. In A. US A. US A. US DA. sian US A. US HOLDING COMPANY nding Sub (0) Sub (0) Sub (0) bSub (0) Sub (0) a resolution (or near-resolution) situation, hosts aia b b $40 / 10% will likely want to hold at least a minimum

“normal” going-concern capital structure Sub (15) Sub (15) Sub (15) Sub (15) Ringencing coe b ais negraed coe No Faires when they exit resolution, to support critical aia isached s osses aia and osses are baanced functions after GLAC has been bailed in.21 deae gro caia ae ringenced bank sees some subsidiaries fail, even though the group is solvent This could be set at 8% of RWA (per standard ased b isaocaion risk ha caia is in he rong ace and can ge o b Basel calculations) or perhaps slightly higher to branched bank or a gro ih high caia obii od srie aong ih a sbs provide a margin of safety.

We propose host capital prepositioning at 10.5%, partly for conservatism and also to utilize some also provides an early and frequent check of Basel benchmarks. The 10.5% is comprised of the parent’s commitment to central SPOE-style 4.5% in equity (the Basel minimum) together with support.23 It tests this commitment under real- 6% in GLAC (modeled on the FSB benchmark of world conditions, without having to wait until 33% of 18% TLAC). This gives us a substantial conditions become dire. quantum of prepositioned subordinated resources to protect hosts, and also shifts the NCWOL By utilizing the resources of the calculation to force parent support (i.e., home cooperation) in resolution. Our bank solvency new bank capital and resolution analysis already considered those capital frameworks, we can develop a much components to be naturally immobile and unusable for recovery, so they had no effect on more resilient structure to support failure risk in our model.22 This frees up all equity cross-border cooperation. buffer capital for a central reserve to be allocated to relieve stress wherever it arises. In this way, equity buffers can fulfill their core resilience function with maximum efficiency. The large U.S. banks have adopted a contractual approach to subsidiary support as part of their • TOP-UP REQUIREMENTS: What happens if the Title I resolution planning requirements. These value of prepositioned resources drops as a crisis “secured support agreements” (SSAs)24 are intensifies? We propose a capital maintenance designed to ensure that the group supports key rule whereby the group tops up the subsidiary operating subsidiaries with sufficient capital and for significant losses, to restore the economic liquidity to remain viable throughout resolution position of the subsidiary and maintain a positive and beyond. SSAs must be legally robust under net investment position for the parent. This the conditions of resolution. The SSA approach

BANKING PERSPECTIVES QUARTER 3 2018 51 Ring-Fencing: Escape from the Prisoner’s Dilemma

has a number of useful elements already, provides a strong in extremis capital cushion, one and perhaps could be extended to clarify the that is consistent with a solid capital ratio today. overall plan for intragroup support and underpin However, the decision to not preposition any going- international cooperation. concern equity beyond the required minimum is also important. The bank therefore retains flexibility to A STRAW-MAN PROPOSAL: In summary, we look to use these resources wherever the need arises, which integrate these prepositioning and top-up mechanisms eliminates the addressable misallocation risk.26 This as follows: structure allows us to achieve a low failure risk, identical to the “integrated bank” because we use the • Minimum going-concern equity of 4.5% plus other components of TLAC to satisfy host-specific gone-concern GLAC of 6% of risk-weighted safety concerns. We believe it provides a strong answer assets in prepositioned resources; plus to Quarles’ dilemma of how best to maximize flexibility for the home and certainty for the host. • Regular top-ups in the case of any deficit. These top-ups are drawn from buffer CET1 capital, which CONCLUSION would be kept at the home, in a central reserve. We believe our straw-man proposal provides a credible path out of the prisoner’s dilemma of endemic This package provides a total of 10.5% of RWAs ring-fencing. It provides a better, more transparent in prepositioned, subordinated resources (plus outcome for both homes and hosts, using both ex ante replenishment rights). This provides a robust response structure and transparency to control the pressures of to walkaway risk.25 If converted in resolution, it ring-fencing.

BOX 3: MAJOR CAPITAL CATEGORIES AND THEIR ALLOCATION

1. CAPITAL MINIMUM: Basel standards require a minimum resources would be converted – or “bailed-in” – to equity of 4.5% of risk-weighted assets. We accept this as a create fresh equity and support critical operations and minimum for both the group and for each major subsidiary, key subsidiaries. The outcome is similar to Chapter 11 and assume that any breach would trigger a failure event. reorganization, but with more preplanning (and much faster). In the U.S., GLAC debt resources have been scaled 2. GOING-CONCERN BUFFERS: Most common equity at to roughly $1 trillion (on top of more equity). This is ample large banking groups is now driven by the numerous buffer to restore group capital, even under tough assumptions and requirements (capital conservation buffer, G-SIB buffer, etc.) 2008-scale conditions. Several other key jurisdictions have and other rules (e.g., CCAR stress tests). These increase achieved similar levels of resourcing. the effective requirements for capital far beyond the official Basel minimum. The average G-SIB Tier 1 capital These resource pools for buffers and GLAC are massive. But there ratio is now over 14%, suggesting that regulatory and has been little discussion on how best to deploy them across bank management buffers are close to 10%. This provides a group to address the twin challenges of resilience in going a resource that can be drawn down to absorb losses in concern and credibility in resolution. We propose to utilize capital the case of a future downturn and is the primary capital buffers – resources designed for drawdown in adverse conditions resource we modeled in our analysis, up to the capital – as the natural tool for resilience and recovery. For SPOE firms, minimum threshold. these buffers should be housed in a central reserve to avoid misallocation risk and avoid unnecessary failures. In contrast, 3. RESOLUTION FUNDING (GLAC27): Large amounts capital minimums and GLAC are designed to ensure acceptable of subordinated debt have been issued to provide a endgame results. They are naturally less mobile and therefore prepositioned resource for bank resolution. These GLAC prime candidates for prepositioning.

52 BANKING PERSPECTIVES QUARTER 3 2018 The current regulatory approach has mostly transposed man may not be the final or perfect answer, we believe it rules for external capital without considering the broader offers substantial improvements over the status quo. We implications of how to handle equity buffers and GLAC hope it helps start a debate on how to build a durable “high allocation.28 By utilizing the resources of the new bank road,” and re-establish cross-border trust on a firm base of capital framework and resolution, we can develop a much enlightened, clear, and well-funded self-interest. more resilient structure, one that takes advantage of the “high road” suggested last year by Bank of England The full methodology paper can be seen here: https:// Governor Mark Carney: papers.ssrn.com/sol3/papers.cfm?abstract_id=3085649

A decade of hard-fought financial reform creates The views expressed are the author’s own. n enormous opportunities. It’s all too easy to give into protectionism, but the road less taken is ENDNOTES often the most rewarding. All the conditions are 1 Ring-fencing typically involves both a structural requirement and resourcing rules that trap capital or liquidity (often via separate in place for following the “high road” of mutual rules). Ring-fencing can also emerge from local preference recognition and cooperation both with Europe requirements, such as U.S. rules that require assets booked in local branches to first satisfy local liabilities before they can be and across the G20.29 used elsewhere. Ring-fencing can also occur on a product basis, such as U.K. ring-fencing for retail activities. 2 See Mario Draghi, European Central Bank president, for an Both home and host regulators benefit from a high- extensive discussion on how ring-fencing has impaired monetary road approach, built around a well-designed, verifiable transmission across the EU and reduced the ability of EU banks to cushion economic shocks – in contrast to the U.S., which program of “mutual disarmament.” Our straw-man has benefited from “banking union” (i.e. widespread interstate approach looks to improve group resilience by replacing banking) since the 1980s and 1990s). https://www.ecb.europa. eu/press/key/date/2018/html/ecb.sp180511.en.html hard ring-fencing with a broader framework, while also 3 See D. Wilson Ervin Working Paper: “The Risky Business of Ring- addressing the legitimate concerns of host countries. Fencing.” The approach uses a Monte Carlo process to produce numerous economic scenarios for a model banking group with Similar issues arise in the liquidity arena, which some four equally sized subsidiaries. Failure is deemed to occur when believe are even more serious than capital ring fencing; we capital buffers are exhausted and the subsidiary has reached a believe they should likewise be addressed with a similar minimum level of capital. The author would like to thank Bogdan Ianev for extensive quantitative support and insight on this mix of moderate prepositioning and contractual top-up. project. https://papers.ssrn.com/sol3/papers.cfm?abstract_ id=3085649 4 TLAC is a liability side resource (like equity). Some people think of This would provide a robust solution for cross-border allocating this resource to support loss-absorbing capacity across global banks, even under 2008 levels of stress. It also key subsidiaries. Others prefer to think of the benefit of TLAC in terms of the corresponding surplus assets it adds to the parent provides critical transparency on how the process should entity of the group, which can be invested in its subsidiaries. Both work, from a starting point of full capital down through to frameworks are useful to explain certain elements of the system; they deliver similar results because double-entry accounting the endgame position. This transparency is important to set matches assets and liabilities. out ex ante, to meet Quarles’ maxim: “Trust everybody – See also Davis Polk FinReg Blog (posted August 15, 2018) for an but brand your cattle.” interactive spreadsheet tool that highlights these relationships. https://www.davispolk.com/files/internal_ringfencing_ interactive_illustration_-_locked.xlsx It’s crucial to update the rules for cross-border financial 5 Variously attributed to Mervyn King, Charles Goodhart, and engagement to account for the new architecture of Thomas Huertas. resolution for the pressures of today. It will become even 6 Some people highlight the risk of late ring-fencing (under stress conditions), and argue that ex ante ring-fencing is better. We more important as the world economy diversifies away agree that it’s important to avoid surprises, and that a clear- from the North Atlantic. In the next 20 years, the seven headed analysis of endgame pressures is essential. However, the primary effect of early ring-fencing is simply to bring the problem biggest emerging countries – the “E7” – will grow to double forward and leads to the counterproductive outcomes we highlight the GDP size of the major industrialized nations that in Figure 2. In this article, all references to ring-fencing refer to the early or ex ante type, unless otherwise specified. 30 comprise the G7 today. This is a dramatic change from 7 See comments by Andrea Enria (chair of European Banking the old world, where G7 economies held a consistently Authority) in EUROFI magazine (April 2018), and Danièle Nouy (chair of the SSM) at the EU Parliament Economic and Monetary dominant economic and financial position. While our straw

BANKING PERSPECTIVES QUARTER 3 2018 53 Ring-Fencing: Escape from the Prisoner’s Dilemma

Affairs Committee (testimony of June 19, 2018). 17 The current FSB framework generally requires subsidiaries to carry 8 Capital ring-fencing is an active topic in the current FSB debates going-concern capital amounts at full Basel levels (100%) and because of its implication for internal TLAC allocation. However, internal TLAC requirements at 75% to 90% of G-SIB stand-alone some would argue that liquidity ring-fencing is actually an even external TLAC requirements. more pressing concern. 18 Most resolution regimes incorporate a “no creditor worse off than 9 The exhaustion of the central reserve can be accelerated by liquidation” (NCWOL) test. This requires resolution authorities to local gold plating – several countries have adopted local internal provide creditors with at least the liquidation value in resolution, TLAC policies that are effectively higher than similarly situated and provides an important creditor protection. local banks or international standards. Another pressure point 19 If aggressive jurisdictions trap most of the group’s capital, then it is the “sum-of-the-parts” issue: Most subsidiaries also have can become difficult to re-allocate resources for others. This puts some intragroup exposures, which means the sum of the assets the “friendly host” into the unenviable position of a weak-capital (or RWA) across all subsidiaries will be larger than the net entity inside a weakened group. consolidated balance sheet. If internal capital or TLAC is based off 20 Our model assumes valuations are done quarterly and estimates the local balance sheets, then capital trapping will have an even walkaway risk using simple option probabilities (i.e., it ignores more powerful effect when compared with consolidated figures. other franchise elements that could also induce support). It uses 10 See our Working Paper, op. cit., for methodology details. Our the same underlying assumptions as our core model, using an paper is a first attempt to assess the impact of ring-fencing on equity-only framework to avoid negative solvency; the results bank safety and propose a policy response; refinements to either suggest risk is minimized at around 4% to 6% of RWA. would be welcome. Many assumptions are still crude (e.g., no fat 21 This is primarily to support going concern operations at the tails, a highly simplified bank structure, etc.). However, the policy subsidiary in a whole-bank SPOE resolution, but this also provides imperative does not depend on exact math. If refined models emergency resources in the unforeseen event that the host is reduced the impact from 5x to 3x, the outcome would still deserve forced to resolve the subsidiary on its own. a major policy response. 22 Because GLAC can only be used in resolution, and minimum 11 We assume an SPOE strategy, which applies to the vast majority equity was the trigger for failure, we did not allow them to be used of G-SIBs (see Box 1 for details). up or reallocated as a firm suffered losses. They were effectively 12 See Davis Polk FinReg blog: “FSB Finalizes Guiding Principles on excluded from our drawdown process, so using them to provide Internal TLAC” posted 10 July, 2017, for an early discussion of this certainty for the host was effectively “free” and did not have any issue in the context of internal TLAC. https://www.finregreform. adverse effect on modeled failure rates. com/single-post/2017/07/10/fsb-finalizes-guiding-principles- 23 Hosts can enforce compliance via legal tools if the top-up is on-internal-tlac/ contractual, or via other regulatory sanctions, such as: dividend 13 See Randal Quarles, “Trust Everyone – But Brand Your Cattle” or activity restrictions, public shaming, or (in extremis) local (https://www.federalreserve.gov/newsevents/speech/ resolution. quarles20180516a.htm). Implicit in his speech (and our 24 See (e.g.) JPMorgan, 2017 Public Resolution Plan, pp. 35-44. analysis) is that the main goal of a national regulator is to 25 This provides roughly 50% of the FSB external TLAC standard; if reduce the risk and cost failure on his or her watch (i.e., for the the official FSB calibration range for internal TLAC remains at 75% specific entities they are charged with supervising). For a more to 90%; the top-up obligation could perhaps be counted to satisfy mercantilist assumption (minimization of national outflows), see the remaining increment above prepositioning. Bolton and Oehmke, “Bank Resolution and the Structure of Global 26 In Basel terminology: minimum CET1 equity and GLAC are Banks,” forthcoming at the Review of Financial Studies. prepositioned at the subsidiary; all of the remaining elements 14 Even home countries face group vs. local conflicts. Several (mostly buffers that are designed for drawdown in crisis) are held jurisdictions impose forms of ring-fencing for local entities, such centrally at the group level. as U.S. national depositor preference, or U.K. retail ring-fencing. 27 GLAC (gone-concern loss absorption capacity) is subordinated These rules increase group risk somewhat in pursuit of other capital (typically long-term debt) that can be converted to equity policy objectives. To simplify our task, however, we assume that in resolution to recapitalize the bank and operating subsidiaries. home regulators focus only on the consolidated entity. GLAC is a subset of TLAC (total loss-absorbing capacity), which 15 We base our discussion on an idealized branch that participates consists of both going-concern capital (e.g., equity) and GLAC. fully and equally in the enterprise of the bank. In practice, many See FSB: http://www.fsb.org/wp-content/uploads/r_141015.pdf jurisdictions deviate from the ideal, in some cases materially. 28 For example, the U.S. IHC imposes capital rules that are broadly Jurisdictions that impose subsidiary-type rules on branches (e.g., similar to U.S. BHC requirements, such as RWA, leverage, and TLAC dotation capital) are likely to achieve little except additional ratios and CCAR stress tests. Net IHC constraints typically lie in a group risk. range that is similar to (or higher) than BHC capital. Exceptions 16 See Bank of England, SS10/14, September 2014, for a have begun to emerge in areas that are most obviously linked to policy discussion of branches vs. subsidiaries. They support resolution considerations, like internal TLAC. subsidiarization for critical domestic sectors (e.g., retail deposits 29 Mark Carney, Governor, “The High Road to a Responsible, Open – especially where insured by a national government agency – or Financial System,” Bank of England, April 7, 2017. https:// large domestic lenders). Otherwise, branches are seen as superior, www.bankofengland.co.uk/speech/2017/the-high-road-to-a- as long as the bank is from a well-regulated jurisdiction and responsible-open-financial-system carries strong capital and has a credible resolution strategy. 30 PricewaterhouseCoopers, “The World in 2050,” February 2017.

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www.debevoise.com 56 BANKING PERSPECTIVES QUARTER 3 2018 RING-FENCING FOR BANK RESOLUTION AND CRISIS RESPONSE

PRESENT PRACTICES ARE PREVENTING THE EMERGENCE OF CROSS-BORDER BANKING GROUPS.

BY EDOUARD FERNANDEZ-BOLLO, AUTORITÉ DE CONTRÔLE PRUDENTIEL ET DE RÉSOLUTION

UNCERTAINTIES THAT EXIST regarding the level of capital and liquidity available at the local level when a crisis happens that involves a cross-border banking group (Figure 1) tend to lead the supervisors of the foreign branches and subsidiaries of an international bank (“host supervisors”) to adopt various forms of ring-fencing measures: increased capital buffers or Pillar 2 requirements for subsidiaries, and application at the local level of specific capital or liquidity requirements. In my view, these ring-fencing practices represent an obstacle to the emergence of truly cross-border banking groups even within the EU banking union, where all banks are subject to the single supervision of the European central bank, because they hinder the effectiveness of the allocation of capital and liquidity within banking groups and therefore reduce economies of scale. They also constitute an obstacle to financial stability because Ubanking groups are less able to diversify their risks. BANKING PERSPECTIVES QUARTER 3 2018 57 Ring-Fencing for Bank Resolution and Crisis Response

1. The role and responsibilities of national FIGURE 1 supervisors in the event of a crisis involving a cross-border banking group is a strong explanatory factor.

U.S. PARENT BANK

HOME Ring-fencing practices by national supervisors generally have the same root causes in different jurisdictions and economic areas. A host supervisor anticipates that the parent company of a banking group headquartered in a third country might decide to repatriate liquidity and capital located in the host jurisdiction if the group faces some difficulty. If the host supervisor is not confident enough that the local subsidiary will not suffer a liquidity shortage and retains U.K. U.K. PARIS PARIS enough loss-absorbing capacities, it will set ex ante BRANCH SUBSIDIARY BRANCH SUBSIDIARY HOSTS requirements to ensure that a minimum level of capital and liquidity is readily available at the national level if a crisis occurs.

Similar decisions are also taken by host resolution supervisors when there is a doubt over the effective But at the same time, because these practices mostly implementation of a single-point-of-entry (SPOE) strategy reflect legitimate concerns from host supervisors, the for a banking group – for instance, due to the lack of only way to remove the former is to address the latter. explicit liquidity support for subsidiaries. For banking In this regard, practical solutions have to be worked groups implementing an SPOE strategy, subsidiaries stay out and implemented to increase the confidence of out of resolution, and their losses need to be moved up to supervisors in the ability of cross-border banking groups the resolution entity (i.e., the parent company). This could to withstand a possible crisis without involving public cause concern for the host resolution authority over the finances at the national level. allocation of loss-absorbing and recapitalization capacities within the banking group. At least within the European Union, credible cross- border guarantees provided by EU parent banks to These ex ante ring-fencing practices can be easily their subsidiaries, based on EU law and enforced by EU explained. National supervisors can still be responsible supervisors, are in my view the most credible option for addressing a cross-border banking crisis – even when to increase trust between supervisors in the short term considering the recent progress toward implementation of while we continue working on the completion of the the new international standards, which have not yet been banking union. Outside the banking union, continuous tested in a severe international case. dialogue aimed at reciprocal recognition of recovery and resolution measures should help to limit ex ante 2. Various kinds of ring-fencing practices hinder ring-fencing. the ability of banking groups to freely move capital and liquidity across borders. 1. FACED WITH UNCERTAINTIES REGARDING THE LEVEL OF CAPITAL AND LIQUIDITY There are various ways to maintain the desired AT THE LOCAL LEVEL IF A CRISIS HITS, level of capital or of liquidity at the local level. Some SUPERVISORS TEND TO IMPLEMENT approaches, such as those in the EU, involve activating DIFFERENT RING-FENCING MEASURES. macroprudential tools, including the systemic risk buffer

58 BANKING PERSPECTIVES QUARTER 3 2018 and other systemically important institution (O-SII) subsidiary, which decreases the flexibility of allocation of buffers, in order to address potential microprudential capital within the banking group. risks. Higher buffer requirements lead to an increase in the total amount of capital held at the level of the All in all, ring-fencing is not a uniform measure but subsidiary. A similar outcome in the European Union covers a wide array of approaches, depending on the could be achieved through the minimum requirement for situation of each banking group and on the perception own funds and eligible liabilities top-up. that host supervisors may have of the risks. Beyond this diversity, one must look at the effect these measures A national resolution supervisor can increase the have on the proper allocation of capital where banks, amount of eligible liabilities required from a subsidiary through their role of intermediates, have a critical role of third-country banks in addition to the decisions of the to play for the economy. It is therefore important to home supervisor regarding the international total loss- work out ways to address the root causes of the issue absorbing capacity (TLAC )standard. under consideration here, with the aim of removing the unjustified constraints that may weigh on banks while In regard to banking groups operating cross-border, fully reassuring host supervisors. some national supervisors may tend to impose the creation of a subsidiary instead of a branch due to the 2. BECAUSE THESE RING-FENCING PRACTICES greater control they have over this type of legal entity. This LEAD TO SUBOPTIMAL ALLOCATION OF leads to additional constraints for banking groups. CAPITAL AND LIQUIDITY FOR CROSS-BORDER BANKING GROUPS, PRACTICAL SOLUTIONS International banking groups operating with a MUST BE WORKED OUT. significant footprint in different economic areas may also be affected when it comes to TLAC. Decisions on the 1. A suboptimal situation for cross-border level of internal TLAC are one example: There has been banking groups hinders economic efficiency an international tendency to progressively set a higher and financial stability. level of required internal TLAC (from 75% to 90% of an otherwise applicable external TLAC requirement, for instance), which leads to increased ring-fencing of capital Some national supervisors and recapitalization resources. may tend to impose the Decisions to increase the level of required internal creation of a subsidiary instead of a TLAC can be explained by the fact that some host supervisors believe that loss-absorbing capital and branch due to the greater control they recapitalization resources could be easily repatriated by have over this type of legal entity. This the parent company in the event of a crisis or, worse, not leads to additional constraints deployed from the parent to the local operations in the host jurisdiction where they may be needed. for banking groups.

The level of Pillar 2 requirements for subsidiaries represents a key “lever” for host supervisors: These requirements can be especially high for subsidiaries The post-crisis era increased fragmentation of the when taking into account their risk profile. In some banking markets; this may be seen as inefficient from extreme cases, Pillar 2 requirements for subsidiaries an economic perspective but is also suboptimal in can even be higher than for the parent company. The terms of bank resolution and crisis response. Because relative flexibility to set Pillar 2 requirements allows host of ring-fencing, resources available in resolution are supervisors to maintain more capital at the level of the fragmented and less fungible; contrary to the purpose

BANKING PERSPECTIVES QUARTER 3 2018 59 Ring-Fencing for Bank Resolution and Crisis Response

of the SPOE model, a banking group cannot rely on Improving the ability of banking groups to do business the possibility of easily moving capital and liquidity across borders would allow for a more efficient allocation resources across borders. of savings and investment.

From a multiple-points-of-entry (MPOE) perspective, 2. Possible solutions to limit ring-fencing the ex ante freezing of assets diminishes the capacity practices in the banking union include the to generate diversification and group support. use of credible guarantees between parent Furthermore, groups are less resilient to idiosyncratic banks and their subsidiaries. shocks if they are exposed to only a few domestic markets, and one should note that private risk-sharing Reducing ring-fencing practices in the banking system remains low in the EU compared with the United States. represents an achievable goal over the medium term, but it requires significant effort on different fronts. At the international level, progress may be slower than inside All in all, ring-fencing is the European Union, but we should be able at least to not a uniform measure but preserve the advantages of a common international framework and encourage reciprocal recognition to covers a wide array of approaches, counter further fragmentation. depending on the situation of each At the EU level, some progress is already underway banking group and on the perception stemming from the ongoing discussions on the banking that host supervisors may package at the European Council and the European Parliament. We like the idea that the European Union have of the risks. should be seen as a single jurisdiction in calculating an alternative global systemically important bank score. This will tend to reduce the cost of doing business across borders inside of the EU. Limiting Pillar 2 to A more integrated global banking sector would allow microprudential risks is also a positive result even if, in for more efficient financing of all the economies through our view, the macroprudential powers given to national better matching between savings and investment needs supervisors can still lead to ring-fencing because of the across different markets as well as economies of scale in flexibility given to host supervisors on the levels of Single the collection and allocation of savings. Resolution Board (SRB) and O-SII buffers for subsidiaries.

Ring-fencing practices constitute an obstacle to Other progress includes the introduction of cross- economic efficiency and financial stability because border capital waivers by the European Parliament. This they do not allow banking groups to progress toward idea goes in the right direction but should take into resource- and risk-sharing: Capital and liquidity remain account the legitimate concerns of host supervisors. trapped at the national level. Banking groups therefore On the risk-reducing front, the recent initiative of the do not have the flexibility that is required to operate European Commission to tackle the nonperforming across borders. They are also less keen to set up and loans issue also constitutes a step in the right direction develop new subsidiaries because they know that this because it might be seen as a prerequisite for more risk- could significantly increase their cost of doing business. sharing in the banking union. Ring-fencing practices also do not allow banking groups to build up an efficient internal capital market through However, much remains to be done. We believe that which the business units in different countries compete the key issue is to develop credible guarantees provided to access the limited resources of the group (capital, by EU parent banks to their subsidiaries, based on EU liquidity, leverage). law, and enforced by EU supervisors. This will allow

60 BANKING PERSPECTIVES QUARTER 3 2018 increasing the level of confidence of host supervision and Ring-fencing practices resolution supervisors. These guarantees should include ex ante arrangements to upstream losses. They have to be constitute an obstacle to robust and enforceable by EU supervisors. Resolution and economic efficiency and financial supervisory supervisors in the different countries should work in cooperation to design the adequate guarantee stability because they do not allow mechanisms for each specific banking group. These banking groups to progress toward guarantees should address the question of group support resource- and risk-sharing: for subsidiaries during going-concern and not only during resolution. They could be adjusted regularly depending on capital and liquidity remain the evolution of the risk profile of the banking group. trapped at the national level.

These credible EU guarantees would allow lower prudential constraints aimed at subsidiaries. At the banking union level, the creation of the SRB allowed framework because one can start from the assumption former host countries that are now members of the that if the regulations are broadly equivalent, efficient Union to believe that we should focus on effective coordination for its implementation could allow each guarantee mechanisms for cross-border banking jurisdiction to avoid a “race to fragmentation” if it is groups as a first step, and then build on the trust. confident that ultimately its own measures could be effectively recognized. At the global level, other critical steps could be taken in order to improve the situation for cross-border banking CONCLUSION groups. A more significant involvement of the host Ring-fencing appears to be the symptom of a deep countries in the ex ante management of cross-border problem, which results from several causes. Those who banking groups’ recovery and resolution plans would recognize the value of an international framework allow for an increased level of trust between supervisors. know they need to work out solutions to deal with these This dialogue should happen before the next banking issues. The solutions mentioned in this article suggest or financial crisis arrives, in particular covering early in broad terms possible ways forward. Further work will intervention phases and recovery planning in order to build be needed to make solutions implementable. To go live, up confidence between jurisdictions before a crisis erupts. strong political support will be essential. The benefits that can be expected from a better allocation of capital and In this context, we should encourage reciprocity among liquidity across countries leads to the hope that this effort all those jurisdictions that share the global international eventually will prevail. n

BANKING PERSPECTIVES QUARTER 3 2018 61 On the Resiliency of U.S. Operations of Foreign Banks

U.S.-BASED OPERATIONS OF FOREIGN BANKS, WHICH ARE RESILIENT AND WELL POSITIONED TO WEATHER THE NEXT SIGNIFICANT ECONOMIC DOWNTURN, ALSO PLAY A KEY ROLE IN THE ECONOMY BY PROVIDING AN IMPORTANT SOURCE OF FUNDING FOR U.S. BUSINESSES.

BY FRANCISCO COVAS, MYYA MCGREGORY, AND ROBERT LINDGREN, BANK POLICY INSTITUTE

62 BANKING PERSPECTIVES QUARTER 3 2018 BANKING PERSPECTIVES QUARTER 3 2018 63 On the Resiliency of U.S. Operations of Foreign Banks

THE U.S. OPERATIONS of foreign banks have become both more resilient and more integral to U.S. economic activity during the past decade. In this article, we report the current size of capital buffers of foreign banks operating in the U.S., their holdings of high-quality liquid assets, trends in the degree of resilience of U.S. broker-dealer subsidiaries of foreign banks, and the amount of net borrowing of branches and agencies of foreign banks from their parent companies. Our results indicate that U.S. operations of foreign banks are extremely resilient, have sizable capital buffers, and provide a key source of funding for U.S. economic growth.1

Figure 1 below shows that foreign banks operating in to risk-weighted assets. The amount of excess capital is the U.S. are extremely well capitalized. The two bars in the defined as the maximum amount of capital those banks chart depict the amount of excess capital of foreign-owned could pay out without breaching any of the existing capital subsidiary banks in the U.S. and domestic banks relative requirements.2 It is equivalent to banks’ own capital buffers above regulatory requirements. The bar on the left shows T the capital buffer of foreign banks under the current set FIGURE 1: EXCESS CAPITAL: CCAR BANKS of capital requirements, and the bar on the right shows the capital buffer of domestic banks. The capital buffer of 3.0 foreign-owned subsidiary banks operating in the U.S. and subject to the U.S. stress tests is equal to 2.8% of risk- 2.5 weighted assets, while the capital buffer of domestic-owned U.S. banks is 0.6% of risk-weighted assets. 2.0 On the liquidity front, the U.S. operations of foreign 1.5 banks also hold a sizable stock of high-quality liquid assets (HQLA). As a result of Basel III liquidity 1.0 requirements, banks are required to hold liquid assets

% RISK-WEIGHTED ASSETS that can be easily liquidated if a financial crisis were 0.5 to occur. These large stockpiles of highly liquid assets make fire sales of illiquid assets much less likely to 0.0 FOREIGN BANKS DOMESTIC BANKS occur, thereby decreasing the potential magnitude of bank losses during a crisis. Although data on holdings Note: Excess capital is calculated as a percentage of risk-weighted assets under the standardized approach. Excess capital is defined as the maximum amount of capital banks could return to of HQLA are not directly available on regulatory shareholders without breaching any of the current capital requirements. These include 8 non-stressed capital requirements and 10 stressed capital requirements. disclosures (except for the largest U.S. banks), we Source: DFAST 2018, CCAR 2018 and FR-Y9C as of 2018:Q1 constructed a proxy for HQLA using data from the regulatory FR Y-9C forms.3 The HQLA proxy is defined

64 BANKING PERSPECTIVES QUARTER 3 2018 as the sum of level 1 and level 2A assets. Level 1 assets include reserve balances, Treasury securities, mortgage- FIGURE 2: RATIO OF HQLA TO TOTAL ASSETS: IHCS backed securities (MBS) guaranteed by Ginnie Mae, 16.5% and agency debt that is explicitly guaranteed by the full faith and credit of the U.S. government. Level 2A assets comprise government-sponsored enterprise (GSE) debt, 16.0% GSE MBS, and GSE commercial MBS. Level 2A assets are subject to a haircut. As shown in Figure 2, the ratio 15.5% of HQLA to total assets is about 16% for foreign-owned subsidiary banks operating in the U.S. 15.0%

The operations of 14.5% foreign banks in the U.S. play an important role 14.0% in the economy because they hold approximately 20% of 13.5% all domestic commercial 13.0% and industrial loans. 2016Q3 2016Q4 2017Q1 2017Q2 2017Q3 2017Q4 2018Q1 Source: FR -C and B calculations

It is difficult to assess how current capital and liquidity levels compare with the period before the 2007–2009 FIGURE 3: CHANGES IN LIQUIDITY AND CAPITALIZATION financial crisis. The concept of U.S. intermediate holding companies (IHCs) is relatively new, so it is a cumbersome 8% task to estimate a consistent time series for capital and HQLA levels of IHCs prior to 2016. However, there is 7% some historical data that is readily accessible on the levels of capital and liquidity of U.S. broker-dealer 6% subsidiaries of foreign banks.4 As shown in Figure 3, U.S. 5% broker-dealers of foreign banks increased their resilience significantly during the past 11 years. Specifically, the 4% broker-dealers have roughly tripled their capital relative to total assets and approximately doubled their cash 3% holdings as a proportion of total assets. 2% Finally, the operations of foreign banks in the U.S. 1% also include the branches and agencies of foreign 5 banks. These entities play an important role in the U.S. 0% economy because they hold approximately 20% of all EQUITY-TO-ASSETS CASH-TO-ASSETS domestic commercial and industrial loans. In the post- ource C For -- and B calculations crisis period, the assets and liabilities of the branches

BANKING PERSPECTIVES QUARTER 3 2018 65 On the Resiliency of U.S. Operations of Foreign Banks

FIGURE 4: NET DUE TO...

30%

20%

10%

0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

-10%

-20%

-30%

-40%

-50%

Source: Federal Resere and B calculations

and agencies have also experienced profound changes. ENDNOTES As shown in Figure 4, branches and agencies were 1 Generally speaking, our analysis focuses on the U.S. operations of the 12 foreign banks that are required by Federal Reserve borrowing funds in the U.S. and using those funds to regulation to maintain a U.S. intermediate holding company. lend to their foreign parents until early 2011. Beginning These foreign bank-owned IHCs are: Barclays US LLC; BBVA in early 2011, this pattern reversed, and branches and Compass Bancshares, Inc.; BMO Financial Corp.; BNP Paribas USA, Inc.; Credit Suisse Holdings (USA), Inc; DB USA Corporation; agencies now raise funds abroad to fund loans and other HSBC North America Holdings Inc.; MUFG Americas Holdings investments in the United States. Corporation; RBC USA Holdco Corporation; Santander Holdings USA, Inc.; TD Group US Holdings LLC; UBS Americas Holding LLC. 2 https://bpi.com/the-fed-increases-large-banks-capital-requirements/ In summary, our analysis shows that the U.S. operations 3 https://bpi.com/wp-content/uploads/2018/07/ of foreign banks are resilient and well positioned to weather e3426a1e96114e018f5aa06783ec8856.pdf the next significant economic downturn. At the same 4 We included the following 11 broker-dealers in our sample: time, the branches and agencies of foreign banks play an Barclays Capital, Inc.; BMO Capital Markets Corporation; BNP Paribas Securities Corporation; Credit Suisse Securities (USA), important role in funding U.S. businesses. LLC; Deutsche Bank Securities, Inc.; HSBC Securities (USA), Inc.; MUFG Securities Americas, Inc.; RBC Capital Markets, LLC; RBS Securities, Inc.; UBS Securities, LLC. Disclaimer: The views expressed in this article are those 5 The sample includes all branches and agencies of foreign banks of the authors and do not necessarily reflect the position that are included in the H.8, “Assets and Liabilities of Commercial of the Bank Policy Institute or its membership, and are Banks in the United States.” not intended to be, and should not be construed as, legal advice of any kind. n

66 BANKING PERSPECTIVES QUARTER 3 2018 PRECISION GUIDANCE We help our clients navigate today’s markets with an eye for what lies ahead. Morgan Lewis is always on—marshaling our global resources and precise insight to build your future. We have industry-leading teams working in offices across North America, Europe, Asia, and the Middle East.

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©2018 Morgan, Lewis & Bockius LLP SURVEY SHOWS CONSUMERS WANT TO CONTROL THIRD-PARTY DATA ACCESS, READY TO FOLLOW U.S. BANKS’ LEAD.

BY DAVE FORTNEY, TCH, AND RAJESH JOHN, A.T. KEARNEY

68 BANKING PERSPECTIVES QUARTER 3 2018 PERSONAL FINANCIAL DATA: CONSUMER VIEWS ON DATA AGGREGATION

NEARLY A THIRD of U.S.-banked consumers responding to a 2018 TCH/A.T. Kearney study used at least one FinTech application in the prior 12 months to facilitate complex data sharing, ranging from personal financial management services and budgeting/saving schemes (for example, Mint, Acorns, and Wally), investment services and robo-advisors (such as Betterment and Robinhood), and lending services applications (including LendingClub and SoFi).

But how much do consumers know about the about the privacy of the information that is shared ways FinTechs access, collect, use, store, and share when they use online or mobile FinTech applications, their personal and financial information? Research including 33% who were “very concerned” and 34% suggests they know shockingly little, although many who felt “extremely concerned” (Figure 1). In this harbor serious apprehensions. same study, roughly half of FinTech application users reported being “uncomfortable” about the sharing of In our survey of approximately 1,500 self-described most payment information, financial information, and NFinTech users, 99% report feeling some level of concern financial history (Figure 2).

BANKING PERSPECTIVES QUARTER 3 2018 69 Personal Financial Data: Consumer Views on Data Aggregation

FIGURE 1: CUSTOMERS CARE ABOUT PRIVACY FinTech users care about privacy two-thirds of users are very or extremely concerned about privacy when using these apps LEVEL OF CONCERN AND DISCOMFORT REGARDING DATA PRIVACY AND DATA SHARING

LEVEL OF CONCERN REGARDING DATA PRIVACY LEVEL OF COMFORT REGARDING THIRD-PARTY USING FINTECH APPS DATA SHARING BY SERVICE PROVIDERS1 who selected each level of concern among a who selected each option among banked consumers targeted population of FinTech users Not at all concerned None of the above 1% Very 10% comfortable 8% Somewhat concerned 8% 37% 34% Very 12% Extremely uncomfortable concerned Somewhat 22% comfortable Concerned

I am indifferent to how the service 11% providers I use share my personal 33% and nancial data 33% Very Somewhat concerned uncomfortable

1. Service providers include retailers, online merchants, mobile wallets, or P2P payment services. Questions: In general, how concerned are you about the privacy of the information that is shared when you use non-bank nancial applications either online or on a mobile device? Are you comfortable with the service providers you use sharing your personal and nancial data with third parties? Source: Q1 2018 TCH/A.T. Kearney FinTech Consumer Research (US banked customers N=2,030; Targeted FinTech users N=1,504)

FIGURE 2: MANY CUSTOMERS FEEL UNCOMFORTABLE ABOUT SHARING INFORMATION Roughly half of FinTech users are “uncomfortable” sharing most payment information and nancial information and history LEVEL OF COMFORT SHARING DATA WITH FINTECH APPS % who selected each data type among a targeted population of FinTech users

PAYMENT INFORMATION FINANCIAL INFORMATION AND HISTORY

10% 1% 10% 1% 11% 1% 9% 1% 9% 1% 11% 1% 11% 1% 11% 1% 15% 20% 20% 19% 23% 22% 23% 25% 12% 14% 15% 13% 18% 22% 22% 25% 20% 29% 29% 27% 27% 26% 27% 26% 38% 26% 27% 29% 18% 21% 16% 16%

Credit card Debit card Prepaid card Bank account Bank account Bank account Loan Investment number number number number username and balances and information information password transaction history and history and history

Very uncomfortable Uncomfortable Indifferent Comfortable Very comfortable Unsure

Question: How comfortable would you be with sharing the following personally identi able information with non-bank nancial applications you have used in the past year? To what extent are you comfortable with non-bank nancial applications you have used in the past year accessing these things? Source: Q1 2018 TCH/A.T. Kearney FinTech Consumer Research (Targeted FinTech users N=1,504)

70 BANKING PERSPECTIVES QUARTER 3 2018 ACCESS TO SENSITIVE DATA a future in which EU consumers are provided explicit, transparent disclosures of third-party access, collection, Consumers seem mostly unaware of how readily their and use of their data. most sensitive data can be accessed. Within the same population of FinTech users, less than half believe the apps they use can access their personally identifiable How much do consumers information, which includes Social Security number, date of birth, phone number, email address, and home know about the ways FinTechs address. Thirteen percent admit they don’t know which access, collect, use, store, and data types the FinTech apps they use can access. Only 20% of FinTech users claim to be certain about which share their personal and financial third parties receive their data from the FinTech apps information? Research suggests they use. they know shockingly little. The reality, of course, is that credential storage effectively allows third parties to access any or all of a consumer’s bank account data (even consumer-provided bank usernames and passwords), far beyond the data U.S. financial regulators, in contrast, have taken a actually required to power the application’s stated more market-oriented regulatory stance, reflecting a services. FinTech and data aggregators freely use “screen different regulatory framework. In 2017, the Consumer scraping” to access user account information from Financial Protection Bureau issued a principles-based HTML forms to periodically refresh the data within approach to consumer data privacy and security, their applications – and for other purposes of their own which addressed the topics of data access, payment choosing. While screen scraping allows third parties to authorization, data security, and consent (among other quickly source personal and financial data they need things). This has encouraged an environment in which to meet consumer demand for FinTech services, the banks are rapidly pursuing bilateral partnerships with practice also exposes banks to significant operational, data aggregators and FinTechs directly (for example, cybersecurity, and data privacy risks. the data-sharing partnerships JPMorgan Chase and Wells Fargo formed with Intuit in 2017). These partners REGULATORY REACTION recognize not only the mutual benefit of scale but also In the European Union, the Revised Payment Service Directive (PSD2), enacted in November 2015 and rolling out in stages, will ban screen scraping in 2019 while requiring banks to grant third parties access to customer data via dedicated interfaces. PSD2 further stipulates While screen scraping that these interfaces may only be used in relation to the allows third parties to specific service the third party provides to the consumer. quickly source data they need to PSD2 is an effort to boost marketplace competition through Open Banking, a system that provides users meet consumer demand, it also with data from multiple financial institutions through exposes banks to significant application programming interfaces (APIs), while curtailing the consumer data protection risks posed by operational, cybersecurity, unconstrained data aggregation. These regulations, in and data privacy risks. addition to the recent implementation of the General Data Protection Regulation on May 25, 2018, mandate

BANKING PERSPECTIVES QUARTER 3 2018 71 Personal Financial Data: Consumer Views on Data Aggregation

FIGURE 3: BANKS MOST LIKELY SEEN AS ADVOCATES

Banks are viewed as consumers best advocate and data steward CONSUMER PERCEPTIONS AND BEHAVIOR ON PROVIDERS, DATA SECURITY, AND CONSUMER EDUCATION CONSUMER PERCEPTIONS AND BEHAVIOR: PROVIDERS’ ABILITY TO SAFEGUARD THE SECURI- DATA PRIVACY AND EDUCATION TY OF CUSTOMERS’ PERSONAL INFORMATION who selected each provider among banked …of FinTech users look to banks to protect US consumers their data privacy and security interests, relative to regulatory agencies (47%), 51% Primary bank 62% retailers (35%), FinTechs (34%), Visa 49% government/Congress (33%), and social Amazon 47% media services providers (23%) PayPal 45% MasterCard 42% …of FinTech users are at least “somewhat” American Express 38% interested in learning more regarding how 80% Mobile carrier 37% these apps access, store, use, and share Apple 36% their data Discover 34% Google 33% A large/ …of FinTech users think banks should national retailer 28% provide consumer education and promote Financial information 21% 59% aggregator Examples include Mint awareness on how FinTech apps may access 20% and Personal Capital Facebook and use their personal and nancial data

1. Percentage who said each provider safeguards the security of its customers’ personal information extremely or very well among banked consumers. Question: Please rate the following rrms on how well they safeguard the security of their customers' personal information. Source: A.T. Kearney Q4 2017 Banking and Payments Study (US banked customers N=7,084), Q1 2018 TCH/A.T. Kearney Payments and FinTech Survey (Targeted FinTech users N=1,504)

the data privacy and security benefits gained through FinTech and data aggregation ecosystem represents partner APIs. thousands of FinTech applications, many offering wondrous financial solutions but also the potential for BANKS’ OBLIGATION AND OPPORTUNITY the next massive data breach. As the source system(s) Nevertheless, in light of banks’ intrinsic obligation for consumer financial data, banks can (and should) to safeguard the data consumers entrust to them, it is capitalize on their “trusted” custodian status to provide not enough for banks to seek one-off partnerships. The consumers with the financial education and tools they need to protect their own data.1

The incremental added friction Thankfully, consumers have straightforward data from transparent consumer privacy and control expectations. Our study found that FinTech users desire a permissions dashboard within disclosures and opt-in permissions their primary bank (that is, the one where they conduct can empower bank customers to make transactions most frequently). Additionally, FinTech users want the permissions mechanisms banks provide to allow better and more-informed consent by account and data type. In an environment decisions about their data. where banks and FinTechs continue to improve and enhance the consumer experience, providing explicit opt-in and transparent disclosures can empower bank

72 BANKING PERSPECTIVES QUARTER 3 2018 customers to make better and more-informed decisions The time for U.S. banks to act is now; U.S. financial about their data while also helping banks reduce the risk regulatory agency actions support it, consumers demand of the next major data breach. it, and market evolution requires it.

If banks do not capitalize on this opportunity, their The 2018 TCH/A.T. Kearney Payments and FinTech margin of trust relative to their FinTech counterparts Survey was conducted to address digital behaviors across may risk further erosion. As of early 2018, 59% of banked customers, including both payments services user and FinTech application user awareness of how third FinTech users say banks should serve as a consumer parties (i.e., non-banks) access, collect, use, store, and share educator regarding FinTech data access and usage (see their financial and nonfinancial data. n Figure 3). Nevertheless, banks only topped FinTechs as the preferred provider of such education and awareness ENDNOTE by 12%, followed by regulators and industry/consumer 1 Bob Hedges, “Data Privacy: A Strategic Opportunity for Bank,” The Clearing House. https://www.theclearinghouse.org/ advocacy groups. Only 2% of FinTech users believed that banking-perspectives/2016/2016-q4-banking-perspectives/ consumer education was not required. departments/my-banking-pers=pective-data-privacy

DATA PRIVACY IS AN IMPORTANT CONSUMER NEED AS CONSUMERS CONTINUE TO EXPOSE SENSITIVE FINANCIAL DATA TO THIRD PARTIES FinTech usage (non-bank nancial application)

% who use FinTech applications among U.S.-banked customers, by FinTech app type

Personal nancial managers, 19% Budgeting/saving schemes E.G., 69% 31% Investment services NON-FINTECH FINTECH 11% USERS USERS and robo-advisors E.G.,

Lending services 10% E.G.,

Level of concern and discomfort regarding data privacy and data sharing1

…of U.S.-banked customers …of FinTech users …to 63% of FinTech users over the age of 18 are speci cally are at least speci cally are “uncomfortable” 70% “uncomfortable” with 67% “very concerned” about 44% or “very uncomfortable” sharing services providers2 sharing their data privacy when most payment information and their data third parties using FinTech apps nancial information/history3

1. Sample size across insights varies by population discussed. (US banked consumers N=2,030, Targeted FinTech users N=1,504) 2. Service providers include retailers, online merchants, mobile wallets, or P2P payment services. Level of discomfort increases 3. Financial information and history include credit card number, bank account number, loan information and history. as data sensitivity increases Question: Which of the following non-bank nancial applications have you used in the past year? Select all that apply. (e.g., email vs. biometric data) Source: Q1 2018 TCH / A.T. Kearney Payments and FinTech Survey (US banked consumers N=2,030, Targeted FinTech users N=1,504)

BANKING PERSPECTIVES QUARTER 3 2018 73 Bank Conditions Index

The Bank Conditions Index (BCI), which provides an regulations continue to be holding back economic analytical and concise measurement of the condition of growth somewhat. the U.S. banking system, was roughly unchanged in the first quarter of 2018 and continues to show an extremely Exhibit 2 depicts the heat map of the BCI for each resilient banking system, reflecting in large part the of the six categories that make up the aggregate index. very strong capital and liquidity positions of U.S. banks Values near 100 (higher resiliency) are shown in blue; (Exhibit 1). In the fourth quarter of 2017, the index values near 0 (higher vulnerability) are shown in red. registered a decline in profitability and capital driven by Overall, the changes in each of the six subcomponents changes to the U.S. tax code – specifically, the reduction of the index – capital, liquidity, risk aversion, asset of the value of deferred tax assets and the repatriation quality, interconnectedness, and profitability – were of overseas earnings. In the first quarter of this year, mixed in the first quarter of 2018. In particular, the risk profitability recovered because of the lower corporate aversion, liquidity, and profitability categories showed tax rate, and the liquidity and risk-aversion categories improvements in their degree of resiliency. In contrast, also increased their degree of resiliency. Overall, the interconnectedness declined in the degree of resiliency. BCI remains well above the level that maximizes the Lastly, the capital and asset-quality categories of the index contribution of the index in tracking future GDP growth, were about unchanged relative to the previous quarter. suggesting that risk aversion by banks or banking The increase in resiliency observed in the liquidity category was driven by a decline in the gap between the maturity of assets and liabilities held by banks. The EXHIBIT 1: AGGREGATE INDEX OF RESILIENCE maturity gap had been rising since the end of 2014, and OF THE U.S. BANKING SYSTEM a recent BPI blog post1 discussed the possibility that the 100 Fed’s stress tests were incentivizing banks to hold longer- term assets, such as longer-term fixed-rate government securities, to improve their performance in the stress tests. The share of assets financed with short-term wholesale 75 liabilities also declined slightly this quarter. In summary, U.S. banks continued to have highly liquid balance sheets BC MORE RESILIENT and sizable liquidity buffers, and banks’ share of high- 50

→ quality liquid assets remained very elevated. Meanwhile, bank profitability recovered due to the reduction in the corporate tax rate and an increase in non-interest income 25 and net interest margins, but it remained still somewhat subdued relative to historical standards.2 LESS RESILIENT

0 The increase in risk aversion was mainly driven by a 1995Q1 2000Q1 2005Q1 2010Q1 2015Q1 decline in the loan-to-GDP ratio gap. Currently, the gap QUARTER is well below its long-run trend and declined further in the first quarter of 2018, signaling a lackluster growth rate Note: BCI* denotes the estimate of the optimal level of the BCI, that is the value of the index that maximizes the contribution of the BCI in tracking future GDP growth. of loans relative to the size of the economy. Headwinds arising from tighter banking regulations3 have likely

74 BANKING PERSPECTIVES QUARTER 3 2018 EXHIBIT 2: HEAT MAP OF ALL CATEGORIES OF THE BANK CONDITIONS INDEX

AGGREGATE 100.0 MORE RESILIENT

CAPITAL

LIQUIDITY 50.0

RISK AVERSION LESS RESILIENT

ASSET QUALITY

INTERCONNECTEDNESS

PROFITABILITY 0.0

2016 2017 2018 YEAR

continued to put downward pressure on loan growth, markedly as a result of a reduction in the dynamic particularly on loans to borrowers with less-than-perfect correlation between each bank and the market index; or insufficient credit histories. That said, total loans grew however, it was offset by a decline in regulatory capital at an annual rate of 5.75% in the first quarter of 2018. ratios due to an increase in risk-weighted assets under the standardized approach. In addition, accumulated The decrease in resiliency of the interconnectedness other comprehensive income – which is part of common category was driven by an increase in exposures to financial equity Tier 1 capital for advanced-approaches banks – also entities, defined as the ratio of loans made to other declined due to a rise in longer-term interest rates. The depository institutions, repos, and federal funds sold to total asset-quality subcomponent was also little changed this assets. According to several industry reports and discussions quarter. Improvements in the nonperforming loans ratio, at a recent BPI symposium on money market conditions, the reserve to loans, and reserves to nonperforming loans ratio increase in interconnectedness is in most part driven by an were almost offset by an increase in net charge-offs.n increase in repo balances at primary dealers because they provide financing for an increased supply of Treasury bills. ENDNOTES 1 https://bpi.com/the-feds-stress-tests-may-have-left-banks-more- exposed-to-rising-interest-rates The capital category was about unchanged in the 2 https://bpi.com/the-record-profit-canard/ first quarter, on net. Market leverage under stress rose 3 https://bpi.com/bank-regulations-as-a-tax-on-lending

BANKING PERSPECTIVES QUARTER 3 2018 75 Regulatory Change and Monetary Policy BPI members make up nearly half of small business loans, totaling more than $225 billion BPI members are resilient, holding $1.1 trillion in common equity Tier 1 capital and BPI members $1.3 trillion make up Tier 1 capital, and have 72% risk-weighted assets of of the total assets of the banking Total loans by BPI $9.7 trillion sector members: $6.8 trillion BPI loans to businesses: BPI $2.5 BPI members loan trillion more than by the $3.1 trillion to households for things such Numbers as mortgages, auto loans, and credit cards

BPI’s members have nearly 2 million employees BPI members hold nearly The aggregate market cap $9 trillion of BPI members is in deposits $2 trillion

BPI members make 71% of banking sector loans Data is from Federal Reserve Y-9C and FFIEC 031 reports and BPI Research calculations.

76 BANKING PERSPECTIVES QUARTER 3 2018 A LEADING FIRM FOR FINANCIAL SERVICES

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BEIJING BERLIN BRUSSELS DENVER HONG KONG LONDON LOS ANGELES NEW YORK NORTHERN VIRGINIA PALO ALTO SAN DIEGO SAN FRANCISCO SHANGHAI SINGAPORE TOKYO WASHINGTON, D.C. Research from Around the Industry: ACADEMICS, THINK TANKS, AND REGULATORS Research Rundown provides an overview of the most groundbreaking and noteworthy research on critical banking and payments issues and seeks to capture insights from academics, think tanks, and regulators that may well influence the design and implementation of the industry’s regulatory architecture.

78 BANKING PERSPECTIVES QUARTERQUARTER 3 3 2018 2018

CAPITAL, LIQUIDITY AND LENDING FROM OUR SHOP Research Conducted LEVERAGE LIMITS AND BANK RISK: NEW EVIDENCE ON AN OLD QUESTION by Bank Policy Institute

(Choi, Holcomb & Morgan) During the second quarter, the research department has released 1 working paper, 2 research notes, and 16 blog posts. The full library The paper finds that the imposition of the supplementary of BPI research can be found at www.bpi.com/research leverage ratio requirement, which treats risky and riskless assets the same, led banks to shift their portfolios toward riskier assets. The paper also finds, however, that overall bank risk did not increase, likely because the higher capital required offset for the shift toward riskier assets. is still 1% to 2% higher relative to banks’ cost of capital in the period prior to the start of the deregulatory wave NBER WORKING PAPER: LIQUIDITY REGULATION, in the early 2000s. The paper concludes that the higher BAIL-INS, AND BAILOUTS (Dewatripont & Tirole) cost of capital in the post-crisis period is due to a lower loan share in banks’ asset mix. The authors develop a framework to study the interaction between liquidity regulation and solvency BANK RESPONSE TO HIGHER CAPITAL concerns. Their framework provides support for the REQUIREMENTS: EVIDENCE FROM A QUASI- existence of a liquidity requirement; however, the NATURAL EXPERIMENT (Mosk) requirement should depend on the availability of high- quality liquid assets in each jurisdiction. In addition, This article examines the potential impact of Basel III’s the liquidity requirement should account for interbank increased capital requirements. The analysis shows that exposures and eliminate the differential treatment banks subject to European Banking Authority capital between retail and wholesale deposits. exercises increased their capital ratios by decreasing their risk-weighted assets rather than raising equity. ECB WORKING PAPER: BENEFITS AND COSTS OF This resulted in reduced lending to corporate and LIQUIDITY REGULATION (Hoerova et al.) retail customers.

The authors assess the costs and benefits of liquidity THE COST OF BANK REGULATORY CAPITAL regulation and conclude that liquidity tools such as the (Plosser & Santos) liquidity coverage ratio, leverage ratio, and net stable funding ratio are not sufficient enough to supersede This paper estimates the cost of bank regulatory capital the need for a lender of last resort. Results show that if by measuring the change in fees charged by banks for European banks fully complied with Basel III liquidity the undrawn portion of short-term commitments. standards, they still would have needed central bank With the adoption of Basel II, loan commitments with assistance during the global financial crisis and the a maturity less than one year became subject to capital sovereign debt crisis. requirements (under Basel I, short-term commitments were not subject to capital requirements). As a result, REGULATORY CHANGES AND THE COST OF both undrawn fees and spreads went up for such CAPITAL FOR BANKS (Kovner & Van Tassel) commitments. The authors estimate that banks are willing to pay at least 5 cents to reduce regulatory This paper finds that post-crisis regulations have lowered capital by $1 (this is lower than previous estimates in the cost of capital of banks. However, the cost of capital the literature).

BANKING PERSPECTIVES QUARTER 3 2018 79 Research Rundown

BANK LIQUIDITY PROVISION AND BASEL suppressed by low interest rates depending on their LIQUIDITY REGULATION (Roberts, Sarkar & Shachar) business model, and 2) banks may shift toward more risk-taking and loans with longer tenors to offset the A core function of banks is to create liquidity by downward pressure on returns and profitability. funding long-term loans with short-term liabilities, but the activity also makes their funding fragile. The THE POLITICAL ORIGINS OF SECTION 13(3) OF authors find that banks subject to the liquidity coverage THE FEDERAL RESERVE ACT (Sastry) ratio requirement (LCR) engage in less liquidity transformation than banks that aren’t. Banks subject to This paper analyses the legislative events and political the LCR hold more government securities, make fewer environment that led to the addition of Section 13(3) loans, and fund themselves less with runnable liabilities at the height of the Great Depression. This addition than banks that aren’t. expanded the Fed’s emergency-lending authority beyond banks to any “individual, partnership, or MACROPRUDENTIAL POLICY corporation.” The Federal Reserve exercised this authority to support a variety of markets and market BIS WORKING PAPER: U.S. MONETARY POLICY participants at the height of the 2008 financial crisis. AND FLUCTUATIONS OF INTERNATIONAL BANK According the author, the passage of the Federal LENDING (Avdjiev & Hale) Reserve Act in 1932 was meant to give the Fed the ability to lend directly to the real economy as was done The authors explain how various international capital decades later. flow regimes determine the impact of the U.S. federal funds rate on cross-border lending. If cross-border BANK STRUCTURE AND SYSTEMIC RISK capital is flowing from banks in advanced economies to banks in emerging economies, search-for-yield BOE WORKING PAPER: THE IMPACT OF THE behavior induces a positive relationship between the LEVERAGE RATIO ON CLIENT CLEARING federal funds rate and cross-border lending. If bank (Acosta-Smith, Ferrara & Rodriguez-Tous) lending from advanced to emerging economies is stagnant, the relationship between the federal funds The authors demonstrate that because leverage ratio rate and bank lending is negative because a tightening requirements do not allow clearing member banks of monetary policy leads to a decline in bank lending to use the initial margin of interest-rate derivative to emerging markets and occasionally an increase in transactions to reduce their exposure to counterparty lending to advanced economies. credit risk, they are forced to incur increased capital cost. Analyzing the effect of the leverage ratio CGFS PAPERS: FINANCIAL STABILITY IMPLICATIONS requirements on U.K. trade depositories in 2016, the OF A PROLONGED PERIOD OF LOW INTEREST RATES authors confirm that this increased capital cost makes (Committee on the Global Financial System) client clearing unprofitable and many clearing member banks are reluctant to provide this service as a result. The working group presented findings on whether prolonged low interest rates induce fragility in the BIS WORKING PAPER: DO SMALL BANK DEPOSITS financial system. They concluded that there has been RUN MORE THAN LARGE ONES? THREE EVENT little correlation between interest rate movements and STUDIES OF CONTAGION AND FINANCIAL measures of bank stability and risk-taking activity, INCLUSION but they did identify a few risks to financial stability. (Canlas, Ravalo & Remolona) For example, 1) bank profits are more likely to be

80 BANKING PERSPECTIVES QUARTER 3 2018 The authors analyzed deposits of different account They also confirm that bank distress was a major cause sizes around three bank closure events in the of the overall contraction in employment. Philippines. They found no evidence that the closure of a large bank led to withdrawals by account holders ECB WORKING PAPER: ASSET PRICING AND THE of any size at other nearby banks. They did, however, PROPAGATION OF MACROECONOMIC SHOCKS find that if depositors suspect that their bank will fail, (Jaccard) they will begin withdrawals before the bank is closed. Though they observed a decrease in deposits at nearby The author analyzes the role of habit formation and branches after a bank closure, there is no evidence that financial frictions in propagating macroeconomic small depositors contribute any more to contagion than shocks. A model that matches asset pricing moments large depositors. showed that a short-lived shock that depletes a small fraction of an economy’s stock of pledgeable collateral RESOLVING “TOO BIG TO FAIL” can still generate a large and prolonged recession. (Cetorelli & Traina) The result links the asset pricing implications of macroeconomic models and their ability to amplify This paper assesses the extent to which Dodd-Frank macroeconomic shocks. resolution planning requirements – also known as “living wills” – have reduced the perceived TBTF subsidy BANK OF FINLAND RESEARCH DISCUSSION PAPERS: for large banks. The paper concludes that “living wills TESTING THE SYSTEMIC RISK DIFFERENCES IN reduce TBTF subsidies” and therefore “are an effective BANKS (Jokivuolle, Tunaru & Vioto) policy tool for banks.” In particular, the paper asserts that living will requirements have increased banks’ cost This paper develops a framework to test the reliability of capital by 22 basis points on average, which the paper of bank systemic risk measures. The paper finds that describes as “economically significant.” The paper also the measure of systemic risk obtained using the risk indicates its estimate is conservative, describing it as “a categories defined by the Financial Stability Board is lower bound of the overall impact on the TBTF subsidy.” different from those based on market-based measures of Moreover, the paper finds that the increased funding systemic risk (CoVaR, MES, and SRISK). In particular, cost is greatest for those banks that were deemed some banks not considered systemically important using to present the most systemic risk. Finally, the paper the FSB method are considered systemically important observes that, in the post-crisis environment, banks have according to market-based measures. The results suggest reduced their reliance on borrowed money for funding that regulators should use a combination of the FSB (despite the higher cost of equity capital) and simplified method and market-based risk measures to monitor and their organizational structures by decreasing the number regulate G-SIBs. of their subsidiaries. IMF WORKING PAPER: EVOLUTION OF GLOBAL NBER WORKING PAPER: WHAT HAPPENED: FINANCIAL NETWORK AND CONTAGION: A NEW FINANCIAL FACTORS IN THE GREAT RECESSION APPROACH (Korniyenko et al.) (Gertler & Gilchrist) The authors employ a multilayer network framework Exploiting panel data on state-level house prices, to assess the interconnectedness of the global financial mortgage debt, and employment along with measures system and the propagation of shocks. Analysis showed of banking distress, the authors present evidence that that despite structural changes in some regions, the declines in household balance sheets were central to global financial network remains susceptible to shocks regional variation in employment during the recession. originating in the U.S. and U.K. in particular. In addition,

BANKING PERSPECTIVES QUARTER 3 2018 81 Research Rundown

since 2009 the network has become more susceptible to The paper argues that the post-crisis bank regulations shocks from the entire euro area as well as China and have contributed to large, persistent deviations in the Hong Kong. prices of similar financial assets. The authors show that, for regulated institutions, the return on equity for taking BANK REGULATION, INNOVATION & OTHER positions that would tend to reduce such deviations are now lower, and that hedge funds, the natural alternative DEALER BALANCE SHEETS AND BOND LIQUIDITY arbitrageurs, are less able to take such positions because PROVISION (Adrian, Boyarchenko & Sachar) of reduced leverage from banks.

Using a unique data set of corporate bond transactions, CHANGING RISK-RETURN PROFILES the authors demonstrate that bonds traded by the (Crump, Giannone & Hundtofte) institutions subject to increased regulation after the crisis have become less liquid. They also find that the This paper finds that realized volatility of financial institutions have reduced their trading activity and are sector returns has a strong predictive content for the less able to intermediate customer trades. future distribution of market returns. In addition, the paper finds that post-crisis reforms are associated with BANK BAILOUTS, BAIL-INS, OR NO REGULATORY an improvement in the health of the banking sector (in INTERVENTION? A DYNAMIC MODEL AND terms of lower realized volatilities). EMPIRICAL TESTS OF OPTIMAL REGULATION (Berger et al.) BANK OF NETHERLANDS WORKING PAPER: COUNTERPARTY CREDIT RISK AND THE This paper presents a dynamic model of optimal EFFECTIVENESS OF BANKING REGULATION regulations to address large banking organization in (Kroon and van Lelyveld) distress. The first model resembles TARP; the second, a bail-in; and finally no intervention as proposed by In this working paper, the authors assess whether the CHOICE Act. The model reveals that no regulatory a seller’s creditworthiness is a relevant factor intervention is suboptimal, while the other two provide in determining CDS pricing. They find that the incentives for banks to preemptively rebuild capital. creditworthiness of the CDS seller and the price of the CDS contract are negatively correlated. The CREDIT MARKET CHOICE counterparty credit risk of the seller, however, is (Boyarchenko, Costello & Shachar) significant. Results show that a 100 basis point increase in the credit spread of the seller decreases the price of The authors examine individual corporate bond and the CDS contract by 7.2 basis points. credit default swap (CDS) transactions. They find that institutions rarely engage in transactions in both NBER WORKING PAPER: INTERNATIONAL markets against the same reference entity, suggesting CURRENCIES AND CAPITAL ALLOCATION aggregate statistics on the extent of speculative versus (Maggiori, Nieman & Schreger) hedging activity may be misleading, and that both speculative and hedging activity in CDS markets by The authors use a data set of $27 trillion in security-level large banks have declined in response to post-crisis investment positions to show that investors are biased regulations. toward their own currencies and that each country holds most of all foreign debt securities issued in their BANK-INTERMEDIATED ARBITRAGE own currency. While large firms issue bonds in foreign (Boyarchenko, Eisenbach, Gupta, Shachar & Van Tassel) currency and borrow from foreigners, most firms deal

82 BANKING PERSPECTIVES QUARTER 3 2018 only in local currency and do not access foreign capital. This paper tries to explain why banks emphasize ROE The paper also notes that global portfolios shifted as a performance metric while non-financial firms link toward the dollar and away from the euro after the 2008 performance targets to earnings per share (EPS). The financial crisis. paper builds a model that explains the focus on ROE due two important characteristics of banks: 1) Banks’ ability to pay NBER WORKING PAPER: JUDGING BANKS’ RISK a deposit rate below a competitive risk-free rate (“franchise” BY THE PROFITS THEY REPORT value); and 2) deposit insurance. Specifically, in response (Meiselman, Nagel & Purnanandam) to an increase in competition from the liberalization of intrastate and interstate branching restrictions, banks This working paper shows empirically that high reacted by reducing capital levels. The reduction in capital accounting profitability prior to a crisis helps explain worsened EPS growth further while raised ROEs. The paper the cross-sectional variation in banks’ stock returns claims that the increase in competition in banking was the during the crisis. The impact is stronger if pre-crisis main reason why banks have favored ROEs since the 1980s. profits are driven predominantly by non-interest income or such profits are paid out in the form of dividends or BOE WORKING PAPER: COMPETITION FOR RETAIL management compensation. DEPOSITS BETWEEN COMMERCIAL BANKS AND NON-BANK OPERATORS: A TWO-SIDED PLATFORM REGULATION AND RISK SHUFFLING IN BANK ANALYSIS (Siciliani) SECURITIES PORTFOLIOS (Fuster & Vickery) In this working paper, the author examines how commercial banks would respond if a non-bank The authors investigate the effects of a policy change competitor that had access to the central bank’s balance that ties regulatory capital to the market value of sheet were to challenge the commercial bank’s access the “available-for-sale” (AFS) investment securities to a stable supply of retail deposits. The author models portfolio (but not the “held-to-maturity,” or HTM, competition for retail deposits capturing the payment portfolio) for some banking organizations. The paper functionality between consumers and merchants. Results finds that removing the filter has led banks to shift indicate that commercial banks are vulnerable to deposit longer-duration securities from AFS to HTM status. outflows under multiple permutations of competitive The paper also reports that banks have not responded scenarios; however, coexistence is possible if customers to the change by reducing the duration of their are allowed to operate across both platforms. government securities. MODELING YOUR STRESS AWAY DOES CFPB OVERSIGHT CRIMP CREDIT? (Niepmann and Stebunovs) (Fuster, Plosser & Vickery) This paper analyzes changes in the sensitivity of The authors find little empirical evidence that the CFPB banks’ projected credit losses to macroeconomic has reduced mortgage lending at banks. However, shocks between the 2014 and 2016 European Banking the paper finds the CFPB has had an impact on the Authority’s stress tests. The authors argue that their composition of mortgage lending. In particular, CFPB results suggest that banks smoothed the impact of oversight has shifted mortgage originations away from changes in macroeconomic scenarios on projected credit riskier borrowers and into large “jumbo” loans. losses by changing their own internal models. The effect was more pronounced for banks using the internal WHY DO BANKS TARGET ROE? ratings-based approach and that experienced increases (Pennacchi & Santos) in losses due to an increased severity of the scenario. n

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Randy Benjenk, Covington & Burling; Kevin Bailey, Citigroup; and John Court, BPI Greg Baer, BPI (L), chats with Greg Wilson, Greg Wilson Consulting, during (L to R), pose for a photo during the BPI Launch Party. the Launch Party. NEW YORK BEIJING HONG KONG HOUSTON LONDON LOS ANGELES

84 BANKING PERSPECTIVES QUARTER 3 2018 PALO ALTO SÃO PAULO SEOUL TOKYO WASHINGTON, D.C. Clients appreciate our unique insight into issues relating to the financial services industry, gained through our extensive experience and deep knowledge of the complex and changing regulatory framework. Our Financial Institutions Practice Group integrates transactional work across a broad spectrum of mergers and acquisitions and capital markets and financing transactions with a depth of regulatory, compliance and litigation experience that we believe is unrivaled. Our broad experience gives us an invaluable perspective to address our clients’ needs with practical and creative solutions in light of prevailing commercial realities.

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BPI member banks hold $7.7 trillion in U.S. deposits and have loans of $2.5 trillion to businesses and $3.1 John Court and Dafina Stewart of BPI pose for a trillion to households (businesses, auto loans, and credit cards). photo shortly before the BPI Launch Party.

Anthony Cimino (L) of BPI and Sam Geduldig of CGCN Group share a laugh during Rob Blackwell (L) of American Banker, and Edward Yingling, Covington & Burling, the BPI Launch Party. chat during the BPI Launch Party.

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