It is not just the number, but also the complexity and regional variations of new banking regulations that are posing a challenge to international banks.
A sea change has occurred in the global banking industry and a wave of regulation is now a priority for senior bankers around the world. Ask any banking executive what the major trend is that affects their role both now and in the future, and the answer will undoubtedly be 'regulation'. For those running banks, regulation has been a key concern since the onset of the global financial crisis.
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What is often viewed as a regulatory onslaught or clampdown is not only a response by the authorities to make the financial system safer, but also part of longer term changes that have seen the global banking industry become more interconnected and more technologically advanced.
The regulatory burden poses unique challenges to banks operating across borders and for wholesale banks that are operating in numerous jurisdictions. The regulations are now beginning to take shape and are being implemented in various countries, but the variations between the jurisdictions in how the rules are put into practice are complex.
Cross-border banks have to navigate the various local differences in the countries where they operate. Added to this challenge is some inconsistency between the rules and uncertainty about how they will be implemented. Regulation has affected the cost of doing business and is also impacting the strategic planning and structural organisation of cross-border banks.
New regime
If regulation is the major theme for senior bankers, then it is Basel III specifically that is set to have the most impact on cross-border wholesale banks. The third round of the Basel Accord sets stronger rules for capital levels and introduces liquidity and leverage ratios. Set at a global level, the regulations have already started to be implemented with a final deadline of 2018.
Douglas Landy, partner at law firm Allen & Overy and an expert in US financial regulation, says that out of all the regulations affecting the global banking industry, Basel III is the most significant. He explains that one consequence of the increased capital requirements is that capital and cash are trapped within a bank, which impedes its return on equity, which, in turn, impacts the bank’s ability to raise capital.
While the banks may struggle to keep on top of all the changes, the challenges are not insurmountable, according to Mr Landy. “The banks that are well capitalised and have managed themselves well and come through the crisis with relatively clean balance sheets will have an advantage,” he says.
As banks begin to adjust to this new regime, other knock-on effects have already begun to take shape. Patricia Jackson, head of financial regulatory advice for Europe, Middle East, India and Africa at Ernst & Young, also highlights Basel III as the most significant regulation to affect cross-border wholesale banks. One of the effects of Basel III, she says, is that there has been a retreat of banks going back into their core markets. And in terms of cross-border banking products, it is trade finance that has been the most affected, she says.
Banks have restructured and retreated as a way to boost their capital levels, and the new regulations have given trade finance a risk weighting that makes it more attractive for banks to pursue other, more profitable product lines.
Regional variations
Basel III is designed to create a global standard for the global banking industry. But for international banks there have been differences in the time frame in which the rules will be applied and also divergences in how the rules will be implemented at a local level.
In Europe, for example, local regulators have been debating the final shape of the Capital Requirements Directive IV – the EU’s framework that reflects Basel III – and implementation is taking longer than first anticipated. As with any European regulation, there is the potential for differences in how the rules are transposed in each of the EU countries. While there has been concern that there may be divergences in how Basel III is applied in Europe, Ms Jackson says that European regulators are seeking to harmonise the rules to cause less confusion.
In the US, the implementation of the Basel III international framework – in the form of the Dodd-Frank Act – is also taking longer than was first anticipated. Added to this has been the addition of a further, US-specific regulation in the form of the Collins Amendment, which imposes a capital floor and affects how capital is defined. Banks’ overall capital levels cannot fall below the minimum requirements established by the federal banking agency – the Federal Deposit Insurance Corporation – for depository institutions. This means that banks cannot use more sophisticated and aggressive risk-weighting methodologies for their capital optimisation.
Swiss finish
Another country that has come up with stricter rules for its banks is Switzerland – the so-called 'Swiss finish'. A spokesperson at the Swiss Bankers Association (SBA) says that the regulatory framework was set up mainly by the Swiss Federal Council and the Swiss Financial Market Supervisory Authority, and was based on the international capital adequacy rules.
On top of this, the Swiss National Bank, which is responsible for macro-prudential supervision, has also identified systemically relevant institutions and has set higher standards for international banks UBS and Credit Suisse. Banks in Switzerland have agreed to the capital adequacy ratios defined under the ‘too big to fail’ package – Swiss legislation for systemically important institutions – and Basel III requirements for all institutions.
“Switzerland is a pioneer in implementing capital requirements and has implemented Basel III consistently with the recommendations by the Basel Committee, starting at the beginning of 2013,” the spokesperson for the SBA says.
Level playing field
There have been concerns among bankers that an earlier introduction of the rules puts banks at a disadvantage because it impacts their return on equity in the near term and also because it puts them at a disadvantage compared to their rivals in neighbouring countries. There is the argument that there is the potential for regulatory arbitrage between the countries that have been stricter with the implementation and those jurisdictions where the rules have yet to be implemented.
For example, the CEO of Credit Suisse, a bank that has undergone a major restructuring and is now Basel III-ready, has been reported as saying that the regulatory environment has created an “unfair playing field”.
The systemically important Credit Suisse and UBS require capital adequacy ratios of up to 19% compared with the 9.5% required by Basel III. However, Ms Jackson at Ernst & Young says that the capital in the ‘Swiss finish’ requirements is not all equity capital and the regulator is accepting different bail in arrangements, and so it is not easy to compare this regime with that in other countries.
“The SBA sees a comfortable capitalisation as an advantage in the international context,” the SBA spokesperson says. “The SBA warns, however, that Switzerland should closely follow international developments to maintain competitiveness for its banks. The discrepancy in regulatory requirements must not become inadequately large. Future regulation must keep a proper balance between promoting systemic stability on the one hand and limiting competitional disadvantages on the other.”
There are also concerns that the cumulative effects of the various regulations, along with their associated cost burden, may be transferred to the real sector and affect banks' ability to lend and will have implications for the wider economy.
“Basel III rules are thought to be implemented all over the world, so negative effects on competitiveness should not be a problem if all financial centres are adopting these rules. Swiss banks are committed to comply with Basel III rules, and some banks will even have to follow stricter capital rules. We are currently observing that neither the US nor the EU have implemented Basel III so far. The comparison with other financial centres could give rise to serious issues of a missing level playing field,” says the spokesperson for the SBA.
Cross-border complications
For banks that are operating in numerous countries, the differences in the Basel III implementation are just one of the challenges they have to contend with. Added to this are market-specific regulations that seek to restrict and ring-fence various banking activities. These include Volcker in the US, Vickers in the UK and Liikanen in Europe. Operating in various jurisdictions with such complexities “can make it difficult to run a global business”, says Mr Landy.
At the moment, it is still unclear exactly how these new regulations will take shape and impact the business models and structure of cross-border wholesale banks. “The issue that banks face is the uncertainty,” says Ms Jackson.
Added to this, and making life even more complex for cross-border banks in the US, is another facet of the Dodd-Frank Act that seeks to bring the regulation of foreign banks in line with that of domestic institutions in the US.
Under proposals that were published in December 2012 and are currently under consultation, banks with total global assets of more than $50bn will be subject to additional requirements in the US. Any large foreign bank that has assets of more than $10bn in the US must bring all of its subsidiary companies under a single holding company. And any large international bank that has assets of more than $50bn in the US will be subject to more stringent Basel III rules
Beefing up defences
Another issue with US regulation for cross-border banks is that the rules can be far-reaching and can apply even when the institution does not operate on US soil. This is this the case with the Foreign Account Tax Compliance Act, which requires foreign institutions to report the data held on US customers as well as bank customers who own US assets.
Such tax regulations are distinct from the other regulations that banks face in the current environment in the sense that they are not a response to the financial crisis with the intention of making the financial system safer. Nancy Atkinson, senior analyst and an expert in wholesale banking at Aite Group, says that wholesale banks are currently facing many types of regulations and it is not just because of the banking crisis.
“Overall, banks are certainly experiencing greater regulations and a strong regulatory environment as a result of the terrorist acts in 2001,” she says.
Since then, the US authorities beefed up anti-money laundering regulations to clamp down on the financing of terrorism. In this time, many large international banks have fallen foul of the US regulatory authorities and have been fined for weaknesses in their systems. Ms Atkinson says that it is not just money laundering that is a concern but also fraud. Such prevention methods need to keep apace of technological developments and a longer-term trend that is seeing money becoming increasingly digital and cross-border payments systems more efficient.
A complex maze
Efforts to increase competition in the e-money space in Europe have come as part of the introduction of the Single Euro Payments Area (SEPA), another regulatory deadline – set for 2014 – that is fast approaching. Although SEPA is mostly focused on lower-value payments, there is still much work to be done by corporates to adapt their systems so that they are SEPA compliant.
And there are other consumer payment regulations that affect the wholesale banks, such as Section 1073 of the Dodd-Frank Act. This regulation refers to consumer-initiated cross-border payments, but Ms Atkinson argues that it is not retail banks but the wholesale banks that provide the systems behind such payments and that will have to make the changes.
Some of the changes, for example, will include providing a breakdown of the detailed charges for making cross-border remittances, and meeting the requirement to hold the payment for 30 minutes so that the consumer has a window during which time they can change their mind. “It is the wholesale bank that has to deal with the systemic changes and procedures,” says Ms Atkinson.
Ms Atkinson explains that there has been a delay in implementing Section 1073 because the banking industry has made a concerted effort to explain to the regulators of the unintended consequences of the rules, which could result in smaller banks not offering the remittance service altogether because the regulations are too onerous to comply with.
And for large cross-border institutions, the regulations in the various jurisdictions are a complex maze for banks to navigate. Ms Atkinson says that because the large banks have a presence in most countries, to do business “they need to have people in the different countries who are paying attention to the regulatory environment in every country they do business in”.
