Banks that operate across borders must tackle differences between jurisdictions in a context where most regulators are intensifying the scrutiny of both balance sheet and strategy.

By 2012, even those banks that came through the crisis intact were undertaking major strategic overhauls and scaling back risk-weighted assets. The painful economic environment, especially in the EU, is part of the reason, but the tide of new regulation is perhaps more significant, because it is expected to be more sustained.

But there is still widespread uncertainty on what the final map of global regulation will look like. In a survey of banking executives carried out by Ernst & Young during a series of round tables held in association with The Banker in the final quarter of 2012, 57% of respondents listed regulatory uncertainty as the number one obstacle to implementing new capital and liquidity requirements – well ahead of data, skills or operational limitations.

“When banks decide to sell portfolios of assets, or even whole businesses, they know it will be difficult to return. So it is not easy to take those decisions if you believe the regulatory environment is not a stable one because it is too harsh, and because there is no strong alignment between the various jurisdictions. There are differences between the Liikanen and Vickers reports in the EU and UK, and many more differences in the US under the Volcker Rule and Dodd-Frank Act,” says Michel Péretié, who was chief executive of Société Générale Corporate & Investment Banking until January 2012.

What is the top challenge in implementing the new capital and liquidity regulatory requirements

Maintaining standards

In a September 2012 speech, Thomas Hoenig, director of the US Federal Deposit Insurance Corporation (FDIC), went as far as suggesting a total overhaul of Basel III. At the other end of the spectrum, the Swiss National Bank has already introduced a higher set of standards for its two dominant institutions Credit Suisse and UBS, dubbed the 'Swiss finish' by the markets. These measures require capital adequacy ratios of up to 19%, compared with about 9.5% for Basel III. Meanwhile, the drafting of the EU interpretation of Basel III, the Capital Requirements Directive IV, is taking much longer than anticipated.

However, a deal in December 2012 between the Bank of England and FDIC on common principles for resolving cross-border banks shows that global regulatory coordination is far from dead. Stefan Walter, a principal in financial services advisory at Ernst & Young and former secretary-general of the Basel Committee on Banking Supervision, says the impetus to global standards will persist.

“Unlike the earlier Basel agreements, with Basel III there is the intention to work through the Financial Stability Board up to the G-20, to push for consistent implementation and peer review. But there are still areas of divergence that are significant,” says Mr Walter.

Regulatory divergence

One divergence that he flags up in particular is the effect of the Collins Amendment to the Dodd-Frank Act in the US, which will change the effects of Basel III for American banks. The Collins capital floor clause stipulates that advanced methodology banks cannot use risk weighting so aggressively that they cut their overall capital requirement below the population as a whole. This restricts the use of more sophisticated risk weighting methodologies for capital optimisation, which will be more prevalent in Europe.

At least one prominent European central banker believes that fears about regulatory divergence are overplayed. While the US authorities are concerned about the application of Basel III to community banks, he believes the American commitment to applying worldwide standards to its own global banks is not wavering.

“The country finishes do not alter the landscape fundamentally. We are already seeing signs in Europe that opinion is converging around measures to prevent the manipulation of risk weightings, which could be similar to the Collins Amendment in the end. The Swiss rules are not far away from the Basel rules on global systemically important banks, they have just front-run those rules. And the Vickers ring-fence in the UK applies to domestic retail operations, so it should have no impact on global capital flows,” says the central banker.

First-mover advantage

The Swiss finish is an interesting dichotomy. On the one hand, there is less detailed regulation of bank structures and the securities industry than under Vickers, Dodd-Frank or the EU’s European Market Infrastructure Regulation. On the other hand, Swiss capital requirements are not only higher, but come into force faster. The higher capital cushion is essential given the risks posed by two banks that are far larger than Swiss annual economic output, says Jean-Pierre Danthine, vice-chairman of the governing board of the Swiss National Bank.

“The approach taken by [Switzerland’s] too-big-to-fail expert group can be characterised as a relatively liberal approach. Let us create the correct incentives, and allow the banks to decide on their business models and organisational structures without prescription. Credit Suisse and UBS have taken different views on this, but they are both in their own way going in the right direction based on the incentives that we set them. We are glad that our framework makes it possible for the two banks to go down different routes, which should also be good from the point of view of diversification for the Swiss economy,” he says.

Mr Danthine believes that moving more quickly to Basel III compliance – and beyond to the Swiss finish – could give Swiss banks a competitive advantage, especially in their core wealth management activities that rely on a high level of client trust. But he acknowledges that, in certain business lines, slower implementation of Basel III in other jurisdictions could lead to a market share grab by banks from those jurisdictions.

“It is a risk that we have to accept, because our priority is to protect the Swiss economy, but we certainly believe everyone should move to Basel III as soon as possible,” says Mr Danthine.

The concept of global systemically important banks (G-SIBs) with differentiated capital requirements poses further strategic difficulties. In November 2012, the Financial Stability Board removed Dexia, Lloyds and Commerzbank from its list of G-SIBS requiring capital over and above the Basel III minimum, but added BBVA and Standard Chartered. In practice, however, uncertainty over specific regulatory capital requirements does not necessarily change the capital management priorities for individual banks, says Bridget Gandy, a co-head of Europe, Middle East and Africa financial institutions at Fitch Ratings.

“What regulators will want is unclear, but what investors will want is already clear, and it is all about relative safety. Since the largest banks are being asked to raise core capital to at least 10%, the question is whether any other bank can afford not to, or if they will otherwise be penalised on their cost of debt and equity,” she says.

Structural confusion

By contrast, structural measures such as the Volcker Rule, the Vickers ring-fence and the Liikanen proposals to separate trading operations are attracting a rather more mixed reception from the investors who are essential to funding the banking system. Georg Grodzki, head of credit research for Legal & General Investment Management, which manages about £380bn ($613bn), says the Vickers approach of separating commercial banking from investment banking may help to protect retail savers and taxpayers in extreme circumstances, such as another global financial crisis.

But he believes that the focus on structural change in the banking sector is a distraction, as monitoring and policing bank management remains far more important, especially with respect to credit and acquisition risks.

"The failure rate of commercial banks is not much lower than that of investment banks, if at all. History is littered with commercial banks destroying themselves through poor credit decisions, failed interest rate bets and strategic blunders. Lehman Brothers' default was not caused by its core investment banking activities but because it started warehousing large portfolios of asset-backed securities without a sufficient equity and funding base," says Mr Grodzki.

Assessing the impact

Despite such scepticism, Michel Barnier, European commissioner for the internal market and services, has apparently assigned 10 staff to carry out an impact study and follow-up on the Liikanen Report, and aims to implement its recommendations before the current European parliament leaves office in June 2014.

Former investment banker Marco Mazzucchelli, who was a member of the Liikanen Committee, says the concept of ring-fencing the trading operations is easier to implement than the Volcker rule, since it side-steps the problem of distinguishing proprietary from client-driven trading. And Mr Mazzucchelli, who was deputy head of global banking and markets at Royal Bank of Scotland from February 2009 to January 2012, says the structural separation would itself improve governance practices.

“This would remove the excuse for the retail and commercial banking operations of blaming the investment bank for any excessive risk-taking. Each business unit should produce separate profit and loss reporting, with a consistent approach to credit risk. The Liikanen report did not pass a value judgement on either part of the business, the point is simply that they are different, and should be kept separate even within the same universal banking group,” he says.

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