RESPONSIBILITY WITHOUT POWER NORDIC AND ANTIPODEAN SOLUTIONS TO THE PROBLEM OF FOREIGNOWNED SYSTEMIC

1
RESPONSIBILITY WITHOUT POWER NORDIC AND
ANTIPODEAN SOLUTIONS TO THE PROBLEM OF
FOREIGN-OWNED SYSTEMIC BANK BRANCHES

• The Architecture of Financial System Stability
• Form Market Micro Structure to Monetary Policy
• 24-5 May, 2006, Capri
• David G Mayes
• Bank of Finland

2
MOTIVATION

• Within two years the primary supervisory
  responsibility for half of Finlands banking
  system will lie outside the country
• Responsibility for financial stability remains
  with the Bank of Finland
• The impact of a systemic event does not move with
  supervisory responsibility
• We have to be convinced that the system will work
  well we dont have to run it

3
WHERE BANKS ARE CROSS BORDER

• Banks have an element of choice over structure
  and location want to maximise potential benefit
  from guarantees
• want to make themselves systemic
• potential guarantees are a guess - constructive
  ambiguity
• largely driven by benefits while in business not
  hypothetical failure
• Public cost of the safety net cost of avoiding
  failure vs. costs if it occurs implicit
  guarantees, including any support for private
  deposit insurance funds
• cost depends on certainty
• not the result of some grand study

4
A SPECIFIC CASE - NORDEA

• Leading example in EU/EEA Most cross-border of
  the major banks
• Proposes to take advantage of the European
  company statute and operate as a bank
  headquartered in Sweden with branches in Denmark,
  Estonia, Finland, Norway, Poland, (New York)
• Currently New York and Estonia are branches of
  Nordea Finland so issue already exists as from
  1 May 2004 (agency agreement)

5
NORDEA PROBLEMS POSED BY AN EEA BRANCH STRUCTURE

• Market Share 2004
• Banking Insurance
• Denmark 25 20
• Estonia 11 2
• Finland 40 35
• Norway 15 9
• Sweden 20 6

6
A SPECIFIC CASE - NORDEA

• Supervision a soluble problem
• US pointers of what to do (and not to do)
• Need local presence
• Improvement over current arrangements poor
  information
• Wrinkle over deposit insurance
• Matches supervisory responsibility in EU/EEA
  (top-up ability)
• Existing funds are not portable
• Lender of Last Resort sorted out already
• Problem is systemic responsibility and problem
  and failure provision EU agreement beforehand
  unlikely still a national problem when taxpayer
  money involved
• Have to be ready in advance not possible at the
  time
• Must be technical not political problem
• Will match legal structure more closely with
  actual
• Current reflects law illusion that can break
  off subsidiaries

7
AUTHORITIES FACE MISMATCH

• ability to decide on corporate structure, market
  structure, regulatory regime (arbitrage, EU/EEA
  structures)
• systemic responsibility
• within national jurisdiction (wider international
  responsibilities) different organisations CB
• power over resolution
• Home country control host cannot avoid systemic
  crisis
• distribution of benefit from intervention (losses
  from failure to intervene)
• owners, employees, depositors, insured
  depositors, creditors, borrowers, taxpayers,
  borrowers

8
PROBLEMS FOR JOINT ACTION

• Insolvency legislation different, differences in
  supervisory procedures, past preferences for
  intervention timing and methods different
• Common pool and equal treatment will help but
  not just a bank
• Need to intervene early, preferably before
  failure to minimise potential loss transparency
  of supervisory procedures not agreed -
  predictability
• Disclosure regime market discipline Not agreed
• Best if the market solves problems when bank
  merely a poor performer

9
A HOME AND A HOST PROBLEM

• Host country problem bank is systemic, when it
  is not so in the home country
• Interests not aligned the Finnish and New
  Zealand problem (Branches vs Subsidiaries)
• Home country problem bank is large relative to
  GDP
• Too big too save the Swiss problem
• Difficult to organise burden sharing
• Many countries
• Too difficult to organise the Swedish problem
• Case where branch is systemic to bank but not to
  host country

10
4 REGIMES

• Supervisors and market satisfied with performance
• Normal times no need for action
• Supervisorily compliant, poor market performance
• Market should be acting
• Supervisors concerned (poor market performance?)
• Supervisors and market should be acting
• Thought insolvent
• Authorities have to act
• For satisfactory resolution all regimes must work

11
A SECOND DIMENSIONINSTITUTIONS

• Supervisors, central banks, deposit insurers,
  governments, courts
• EU/EEA limitations on solutions
• A major contrast with the US, the role of the
  deposit insurer
• National/Supranational/Co-operative bodies

12
SUPERVISORS AND MARKET SATISFIED WITH PERFORMANCE

• How do we handle supervision Lender of last
  resort deposit insurance? main focus of
  discussion but not the most intractable problems

13
SUPERVISORS AND MARKET SATISFIED WITH PERFORMANCE

• How do we handle supervision Lender of last
  resort deposit insurance?
• Supervision main debate is over the difference
  between home country as lead/consolidating
  supervisor and college of supervisors Europe
  not yet ready for a federal level player
• Basel 2 forces a team approach for supervisors
  Pillar 2 committee
• Key issue is systemic branches host must be
  involved
• Need equal access to database on the group not
  exchange of information on home choice under an
  MoU
• Already in operation with Baltic States since May
  1 2004
• Strong degree of harmonisation of regulations and
  supervisory practice helped by CEBS
• Large element of mutual trust required

14
SUPERVISORS AND MARKET SATISFIED WITH PERFORMANCE

• How do we handle supervision Lender of last
  resort deposit insurance?
• Supervision
• Lender of last resort traditional definition
  (short-term, collateralised to believed solvent
  at above market rates)
• (collateralised market lending preferred to
  individual institution), central banks already
  working together even though only one in the
  Eurosystem. Different currency lending supplied
  by the relevant NCB, ex ante discretionary
  limits. MoU in June 2003.

15
SUPERVISORS AND MARKET SATISFIED WITH PERFORMANCE

• How do we handle supervision Lender of last
  resort deposit insurance?
• Supervision
• Lender of last resort
• Deposit insurance still a problem
• Not transferable
• More expensive in Sweden than Finland
  competitive disadvantage to operate as a branch
  from Sweden this and the common approach under
  Basel 2 may destroy European company idea
• Needs new EU directive to resolve it
  (grandfathering not possible) currently under
  discussion.
• Moral hazard from legacy and perceived
  willingness to bail out

16
SUPERVISORILY COMPLIANT, POOR MARKET PERFORMANCE

• Market discipline
• Basel 2 disclosure insufficient not even up to
  New Zealand 1996 levels of relevance, timeliness,
  frequency or auditing
• Need plausible route for action takeover but
  by whom when market share already high?
• Market signal from sub-debt? Must really be at
  risk. Action needs to follow commitment by
  supervisor?
• Not really under discussion pushes burden on
  supervisor market should solve most problems

17
SUPERVISORS CONCERNED

• Prompt corrective action
• Much better to avoid a serious problem by early
  action when no public money at risk
• Mayes, Halme and Liuksila (2001) compulsory
  resolution at zero net worth (or earlier)
• Is there a co-ordination problem?
• Is there an incentive problem?
• Incidence of losses not same as location of
  business
• Where are the shareholders? Where are the
  unsecured creditors? Where are the knock on risks
  (contagion)? Where is the insured deposit
  liability? Employees?

18
THOUGHT INSOLVENT

• Need universal solution, prior legal agreement to
  support it home supervisory country?
• Territoriality possible outside EU but
  subsidiaries have to be individually viable
• Territoriality essential if home has domestic
  depositor preference
• In many respects distinction between subsidiary
  and branch very limited functions, source of
  strength
• Legal basis for intervention varies considerably
  over the EU public vs. private law
• Can we distinguish systemically important from
  other operations (Hüpkes, 2004)?
• Specialised institutions
• Not all claims have to be dealt with immediately
  (NZ approach)
• Reputation (contagion within the organisation)
• Rating driven close-outs

19
THOUGHT INSOLVENT

• Need universal solution, prior legal agreement to
  support it home supervisory country?
• Do we need a resolution agency? Mayes and
  Liuksila (2003) Mayes (2004) Could exist for a
  group of countries, could exist for each systemic
  bank
• Avoid some conflicts of interest needs to act
  early to minimise losses, no loss of reputation
  from supervisory failure
• Could be a shell to be staffed on demand from the
  participant supervisors
• Judicial and executive functions

20
THOUGHT INSOLVENT

• Need universal solution, prior legal agreement to
  support it home supervisory country?
• Do we need a resolution agency? Mayes and
  Liuksila (2003) Mayes (2004) Could exist for a
  group of countries, could exist for each systemic
  bank
• There is no European equivalent to the FDIC
• Most deposit insurers are asset managers with
  very small staffs
• Not usually depositor preference
• No least cost resolution requirements
• Least cost for whom in systemic case wider than
  depositors taxpayers?
• EDIC route for non-systemic cases?

21
PROBLEMS FOR JOINT ACTION

• Need failure regime in parallel with supervisory
  regime
• Start when bank gets into difficulty. Major
  problem of valuation - capital adequacy wrong
  basis hypothetical liquidation value not mark
  to market
• Do we need a resolution agency?
• Just lead countries case by case, European?
• Adjudication and resolution departments.
• Deposit insurance agency not best choice in
  EU/EEA?
• CB has systemic responsibility.

22
WHEN SHOULD RESOLUTION AGENCY STEP IN?

• At PCA stage? As soon as a problem is identified
  preparations should start for the worst
• sharpens incentive to make voluntary solution
  work
• Need to value claims in a hurry
• NZ solution of compulsory bank systems to make
  this easier
• Is it possible to step in before shareholder
  value thought zero as with 2 rule in US?
• ECJ ruling suggests no, shares must be thought
  worthless
• Condition for a banking licence?
• Guarantee is key part of Mayes, Halme and
  Liuksila (2003) can this be offered by an
  agency on behalf of governments?

23
WILLINGNESS TO PRE-COMMIT RESOURCES UNDER
INSOLVENCY ENTAILS CONFIDENCE IN PRE-INSOLVENCY
PROCEDURES

• Whose fault was the insolvency? An event in
  another country? An action by another countrys
  authorities? Need joint prior responsibility
• Not possible to argue about who should pay at the
  time? Could CEBS act as an immediate adjudicator?
• Need to be convinced that all possible was done
  in regimes 1,2 and 3 to commit to regime 4. This
  is not currently the case

24
DESIRABLE PRINCIPLES

• Banks have strong self-interest in prudence
• Market offers effective correction mechanisms for
  weak performance
• Plausible solution method without bail out
• Assign losses up front
• Can keep systemic operations going
• Ex post guarantee
• Can act fast enough in a crisis
• PCA early and unavoidable, information available
• Previously agreed loss-sharing among countries
  and procedures for resolution, with clear leader
• Clear and full macroeconomic accounting

25
ISSUES FOR EU RETHINK

• Pure home country control collegial
• Deposit insurance - transferability
• A resolution agency
• Insolvency law

26
OTHERS FACE THE SAME PROBLEM

• New Zealands banks are mainly foreign owned
  largely Australian
• Australia has domestic depositor preference
• Option 1
• ensure systemic banks are locally incorporated
  not branches
• Make sure they can be viable units on their own
  do not outsource vital functions avoid
  dependence on parent
• Structure information system so they can be
  viably taken into administration in 48 hours
• MoUs on information and crisis management
• Option 2
• Joint supervision under Australian leadership
• NZ depositors treated same as Australian

27
CURRENT POSITION

• Joint committees on options in 2004-5
• Following Option 1 but discussing greater
  harmonisation and co-operation through
  Trans-Tasman Council on Banking Supervision
• Key difference is outsourcing policy

28
OPTION 1 REQUIRES
29
(No Transcript)
30
OUTSOURCING REQUIREMENTSOCTOBER 2005

• The banks clearing and settlement obligations
  due on a day can be met on that day
• The banks financial risk positions on a day can
  be identified on that day
• The banks financial risk positions can be
  monitored and managed on the day following any
  failure and on subsequent days
• The banks existing customers can be given access
  to payments facilities on the day following any
  failure and on subsequent days.

31
MUTUAL LESSONS

• Available functions matter rather than branch vs.
  subsidiary status for territorial solutions
  (Nordea subsidiaries already not individually
  viable?)
• Effective supervision and ability to act in the
  event of a problem requires close co-operation
  and information beyond current EU/EEA and
  Australia/NZ levels. Need a resolution agency?
• Cannot operate a universal common pool solution
  without equal treatment and tackling host country
  systemic issues
• Need to have agreed PCA, early intervention, use
  public law?, minimise demands on public funds,
  act within the value day
• Cannot marry very different regimes