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The problem is cross-border banking.

FT.com | Willem Buiter's Maverecon | Ruminations on banking

(3) The repatriation of cross-border banking


This means that conventional border-crossing banks and other systemically important financial institutions will become a thing of the past.  We will not see the kind of cross-border branch banks that we have seen during the past decades for very much longer.  These foreign branches are not independently capitalised, have no independent, ring-fenced sources of liquidity, are often effectively managed from the home country (the country of the parent bank), are regulated and supervised by the home country regulator and supervisor, with lender-of-last-resort support (if any) from the home country central bank and fiscal support (if any) from the home country Treasury.


There will no doubt continue to be cross-border banking subsidiaries.  These will, however, be independently capitalised.  Their liquidity will not be pooled between parent and subsidiaries, but will have to be ring-fenced for each subsidiary.  They will be regulated and supervised by the host country (as they often are today).  Lender-of-last-resort support, if any, will be provided by the host country central bank (as it often is today) and fiscal support when insolvency threatens will be provided by the host country fiscal authority.

The reason for host country supervision and regulation is simple: the pain is local, so the control will have to be local.  The reason for host-country bail-outs is even simpler: tax payers are national.  They will not accept the use of their taxes in bail-outs of foreign shareholders, unsecured creditors and counterparties.  The US authorities have been able to channel somewhere between $40 bn and $50 bn of US tax payers' money to foreign counterparties of AIG, but that is unlikely to be the new status quo.  They got away with it, thus far, because the foreign bail-outs by the US tax payer was hidden in obscure, indeed barely comprehensible financial transactions.

See also here and also FT.com | Willem Buiter's Maverecon | The Banca d'Italia and the re-nationalisation of cross-border banking

As a result of the current crisis,  I expect that cross-border bank branches will become a thing of the past, and that the only cross-border subsidiaries we will continue to see will be independently and fully capitalised entities, regulated and supervised by the host country regulator and with recourse to the resources of the host country central bank and fiscal authority on the same terms as `domestic' banks in the host country, that is, host-country banks that are not wholly owned by some foreign bank.

The Eurozone is in a bit of a pickle here, because although it has a central bank with supposed uniform access to its resources for all Eurozone banks, regulation and supervision remain national and  fiscal bail-outs (recapitalisation by the state, guarantees, insurance, loans or whatever provided by the sovereign) definitely remain national.  When the central bank acts as market maker of last resort, as the Banca d'Italia is  now doing in the Italian interbank market, it takes on significant credit risk which requires a fiscal back-up - the Italian Treasury.  But that undermines the principle of equal treatment of banking institutions across the Eurozone, and makes a mockery of the claim that general eligibility criteria for counterparties to national central banks "are uniform throughout the euro area".

So there we are.  If we are to avoid the balkanisation of the Eurosystem, and its degeneration into 16 national sub-systems, with different conditions of access to central bank resources, we will need some form of common European fiscal authority.

But the underlying assumption is that it makes sense for the UK government and no other to be the one guaranteeing deposits by UK savers with UK institutions (and icesave must have been "authorised and regulated by the FSA").

En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma
by Migeru (migeru at eurotrib dot com) on Mon Aug 17th, 2009 at 06:56:12 AM EST
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