IX. ANÁLISIS DE LA ESTRATEGIA CRM
IX.3. Medición de la productividad
IX.3.4. Servicios
The costs associated with major fi nancial crises are not only large but far- reaching. They not only affect fi nancial institutions and their creditors and stakeholders, they also extract a toll from taxpayers and the real economy. One aim of regulation is to internalize these negative externalities. This can be done by reducing the incidence of distress at individual fi nancial institutions and by intervening in an effi cient manner if insolvencies or fi nancial crises do occur. However, these objectives are complicated by the rise of large cross-border banks which operate on a global scale across several jurisdictions. Most national authorities generally only address the spillover effects generated by a distressed bank within their national perimeter and ignore cross-border spillover effects.22
Those who seek to reduce these international externalities while also achieving other policy objectives, such as improved fi nancial integration, must address what we have labelled a ‘trilemma’ head on.
The trilemma arises because three principal policy objectives – preserving national authorities, fostering cross-border banking, and maintaining global fi nancial stability – are not always mutually consistent. One reason for this is that the endgame, the resolution of failing banks, is not well defi ned at a cross-border level. To date, resolutions, ranging from outright bankruptcy to government-led restructurings, have largely taken place along national lines. This is to be expected. Insolvencies and bankruptcies are dealt with by national courts and resolution agencies based on national legislation. The dominance of the national perspective arises because the direct costs of resolution have been borne by domestic taxpayers, so authorities have tended to focus on minimizing the local impact of any failure. This, in turn, means supervision will be nationally oriented. And that creates the trilemma.
So far, solutions to this trilemma have been sought by enhancing international coordination of regulation and supervision. But these approaches will not suffi ce. Regulation and supervision need to be integrated with resolution in order to enhance fi nancial stability. While a number of rescues have been improvised,
22 There are variations, however, across countries and across time. Apart from Lehman Brothers, which was not a bank, the United States has always intervened to protect all creditors and counterparties of US banks, even very small ones that were not remotely systemic in the United States and it improvised an unprecedented bailout of AIG. It also arranged a private-sector bailout of LTCM, a hedge fund. Aside from Lehman Brothers, however, there have been many other cases in which countries have let foreign subsidiaries or even branches fail without assistance from the home country. Among the most notorious have been the recent Icelandic banking crisis and Banco Ambrosiano.
they are often very expensive, as measured by actual outlays and by the damage done to market discipline. Without an understanding of a plausible endgame for each SIFI, one which spells out procedures that would be undertaken and indicates where the losses are likely to fall, it is impossible to make a rational choice about what institutions need to be supported and how the fi nancing should be provided.
Given the complexity of contemporary SIFIs and their international engagement, it is not only clear that improved resolution procedures are needed at the national level but also that they must be better harmonized with those abroad. Effective resolution of cross-border fi nancial institutions requires a degree of coordination between national authorities that genuinely refl ects mutual national interests. It should include an understanding of the extent to which losses will be shared. It is equally important to understand which countries will want to ring-fence assets so that appropriate adjustments can be made in the way each part of the SIFI is supervised.
2.1 Cross-border externalities are ignored by national
authorities
The potential failure of a bank can generate negative externalities by affecting other banks and the real economy. There are several reasons for such externalities (reviewed in the 2009 Geneva Report by Brunnermeier et al., 2009). Externalities are spillover effects which markets cannot solve. When assessing the private costs of a bank failure, market participants do not consider the wider impact on the fi nancial system through the exposure or information channels. Governments try to incorporate these externalities in their actions and decision-making. The challenge banking supervisors face is that they do not want to undermine market discipline by intervening unnecessarily, yet they are often uncertain about the potential damage externalities may cause. In most nations, private sector solutions to fi nancial system problems are the preferred route; public intervention is considered only when there are substantial negative externalities. And even then, it is thought that governments should not bear the full loss if they expect market discipline to be effective in the future. When a rescue is undertaken, shareholders and junior debt-holders should lose money fi rst. However, that has not happened during the recent fi nancial crisis. Aside from the Lehman Brothers failure, no creditor or counterparty lost money in a SIFI. An improved resolution process for SIFIs is needed to address this moral hazard problem (see Chapter 4).
How, in a world with cross-border fi nancial institutions, can transnational externalities be addressed? National authorities will inevitably place a priority on their domestic objectives (Hardy, 2009; Herring, 2007; Schoenmaker, 2010b). These objectives include safeguarding the domestic fi nancial system and minimizing the costs incurred by taxpayers for recapitalization or insolvency. Guided by these objectives, national authorities typically only take into account externalities in their own national fi nancial system while cross-border externalities are often ignored (Schoenmaker and Oosterloo, 2005). This leads to
Cross-border Resolution: The Financial Trilemma
29
globally ineffi cient outcomes, as several theoretical analyses show (e.g., Freixas, 2003). But others, including Kane (2009) and Herring (2009a), have argued that bailouts tend to be overprovided because resolution policies are so weak and ineffectual.
Several authors have applied game theory to a bank recapitalization in order to model the impact of externalities in a multi-country setting (e.g., Freixas, 2003; Schinasi, 2007; and Goodhart and Schoenmaker, 2009). In these models, the decision rule is that it is only socially optimal to recapitalize a failing bank when the benefi ts of preserving fi nancial stability exceed the costs of recapitalization; otherwise the bank should be put into liquidation. In a single country setting, national authorities can make this welfare calculation and reach the appropriate solution. In a multi-country setting, however, this decision rule can result in an undersupply of bank recapitalizations because national authorities have an incentive to play down their share in potential recapitalizations. Since the home country typically has the largest stake in the game, their choices are reduced to deciding whether to rescue a failing bank as a whole or to let it fail. Thus, the externalities in the home country are weighed against the total cost of recapitalization, ignoring the global impacts.
2.2 Potential for confl icts of interest between national
authorities
In a more general setup, whether or not there will be an undersupply of recapitalization for cross-border institutions depends on the overlap of national interests.23 When national interests diverge, there may be no motivation for
cooperation. When national interests converge, there is a possibility of a joint solution for a failing cross-border bank. One key issue determining the overlap of national interests is whether the bank is systemically important in either or both of the countries involved. When the banks has asymmetric positions, coordination problems can arise, as formally modelled by Freixas (2003).
Coordination failures can, however, also occur when the systemic relevance (and thus the potential level of externalities) is large in both the home and host countries. This is because other interests may still confl ict, thus leading to overall coordination failures. Herring (2007) lists three additional asymmetries between home and host countries that may create further confl icts of interests.
The fi rst is an asymmetry of resources. Supervisory authorities (as well as central banks, deposit insurance funds and fi scal authorities) may differ in terms of staff skills and fi nancial resources. This means that even if the fundamental confl icts of interest could be set aside, the home country supervisory authority may not be able to rely on the host country supervisory authority (or vice versa) simply because it may lack the capacity to provide effective oversight.
23 In addition to the potential cost of recapitalization, various authorities may value domestic fi nancial stability differently, which can create further externalities. Consider one country that is willing to take more risk domestically because it has a more diversifi ed real economy. Its fi nancial sector risks can then spill over internationally, even when it does not consider recapitalization costs.
Second there may be an asymmetry in the accounting, legal and institutional infrastructures. Weaknesses in accounting standards and in the quality of external audits may impede the efforts of supervisors in a country just as informed, institutional creditors and an aggressive and responsible fi nancial press may aid them in another country. The legal infrastructure matters as well: ineffi cient or corrupt judicial procedures may undermine even the highest quality supervisory efforts. In short, differences between countries in these attributes create asymmetries in responses.
Third, there may be a differential impact of national resolution regimes, which can vary greatly. Triggers for fi ling for bankruptcy vary across countries. The question of which entity fi les for bankruptcy, when, and where may all have a profound infl uence on the allocation of losses. In addition, ring-fencing of assets may make creditors in one jurisdiction better off than they would be in a coordinated resolution. This may be perceived as unfair and generate a race for assets that can disrupt markets and make national responses hard to coordinate. The larger the difference in rules, the greater is the scope for coordination failures.
The key issue in overcoming these asymmetries in national interests is whether the bank is systemically important in either or both countries. The various possibilities are arrayed in Table 2.1 where the columns indicate whether the parent bank is of systemic importance to the home country. The rows indicate whether the host country entity can be considered to be of systemic signifi cance to the host country.
In case (d), confl icts of interest are not likely to be a problem. In this case, the local entity is not of systemic importance in the host country. Therefore, apart from issues that might raise concerns about the reputation of the host country’s fi nancial system, its supervisors will lack an incentive to take an active role in supervision. Moreover, the bank is not suffi ciently large to be systemically important in its home country. As a result, both the home and host country supervisors are likely to exercise relatively light oversight. And if a troubled entity
Table 2.1 Alternative patterns of asymmetries
HOME country/parent bank
HOST country entity Systemic Non-systemic Systemic (a) Potential for
coordination
(b) Confl icts of interest and potential for coordination problems
Non-systemic (c) Confl icts of interest and potential for coordination problems
(d) Not a big problem
Cross-border Resolution: The Financial Trilemma
31
does not pose a systemic risk in either the home or host country, the situation is not likely to pose a serious threat to the international fi nancial system.
The most diffi cult situations are likely to arise when supervisory responsibility for managing the resolution process and meeting its cost are misaligned. From the home country’s perspective, the worst case is (c) where a foreign offi ce is not regarded as systemically important by the host country, but is a signifi cant part of a systemically important bank in the home country. Regardless of whether the foreign entity is a branch or a subsidiary, the home country may feel that it needs to have primary supervisory oversight of this foreign entity. The Basel Concordat on Supervisory Coordination not only provides it with the right but also the responsibility to do so in the case of a branch. The situation is a bit more ambiguous with respect to a subsidiary, because both the home and host country can claim to be the primary supervisor.
Case (b) represents the biggest nightmare scenario for host country supervisory authorities. In this case, the foreign entity is assumed to have a large enough role in the local market to be systemically important, while at the same time, the parent banking group is not systemic in its home country. In this case, the home country lacks an incentive to exercise strong, consolidated supervision, creating risk for systemic stability in the host country. This kind of situation is increasingly prevalent in Central and Eastern Europe, Latin America, Africa and to some extent in emerging Asia. The situation becomes a bit more tractable when the foreign offi ce is systemically important to the host country and also large enough to be economically signifi cant to the parent banking group. Although the parent banking group is not considered to be of systemic importance, the fact that the foreign entity is a signifi cant part of the banking group may elicit more attention from the home country supervisor (see the case study on Western banks in Central and Eastern Europe in Chapter 3).
Case (a) may lead home and host countries to coordinate supervision because the entity is assumed to be both systemically important in the host country and of economic signifi cance to a systemically important bank in the home country. As a result, both the home and host country will have an incentive to supervise the entity intensively. Although this may result in some confl icts, it is unlikely to result in large gaps in supervisory attention. Nonetheless, cooperation and joint actions may, but not necessarily, occur in all cases. In Chapter 3, there are examples of diverging national interests, such as the handling of Lehman Brothers by US authorities and the 49 other countries around the world in which Lehman operated. There have also been examples of largely converging national interests, such as the handling of Dexia by Belgian and French authorities.
The Fortis case illustrates the way in which other factors can play a role in creating coordination problems. Belgian and Dutch authorities have had a long tradition of cooperation, but Fortis was systemically important in both Belgium and the Netherlands. The Belgian authorities wanted to rescue Fortis as a whole, keeping the home base in Brussels while the Dutch authorities wanted to return ABN-AMRO, which had just been acquired by Fortis, to Dutch control by divesting it from Fortis. In other cases, cooperation has occurred even when interests were
asymmetric, as, for example, in the cases of foreign banks in emerging markets that were large for the local markets, but small by home market standards.
How can these asymmetries in national interests be addressed without imposing excessive compliance costs on SIFIs? This requires addressing the fi nancial trilemma.
2.3 Resolution authorities have to confront a fi nancial trilemma
The Freixas model of cross-border externalities provides the theoretical foundation for the fi nancial trilemma (Schoenmaker, 2010a). The trilemma is that the three policy objectives – maintaining global fi nancial stability, fostering cross-border fi nancial integration, and preserving national resolution authority – do not easily fi t together. Figure 2.1 illustrates this fi nancial trilemma.24 Any two of the threeobjectives can be combined with relative ease, but it is diffi cult to achieve all three. The fi nancial trilemma forces policy-makers to make a choice. Maximizing global welfare means considering global fi nancial stability25 and other global objectives,
such as reliability of fi nancial contracting and effi ciency of global allocation of funds. As cross-border fi nancial integration progresses, policy-makers will have less scope for independent policy-making, including fi scal independence. That is in particular true for countries within a monetary union.
24 In this report, we apply the trilemma idea to the fi nancial sector (Schoenmaker, 2010a). See Rodrik (2000) for an overview of the more general trilemma of monetary policy, international fi nancial integration and exchange rate fl exibility in an international environment.
25 Achieving fi nancial stability has several dimensions. At the global level, it means all adverse externalities (both national and cross-border) are taken into account in policy-making. In the case of national fi nancial stability, only national externalities are taken into account. The latter leads to sub-optimal global solutions.