Agustín Carstens of BIS Examines Global and EU Financial Integration

Adapting financial regulation to national specificities may help strengthen domestic financial systems, thus enhancing global financial stability. A case in point is the ring-fencing measures of internationally active firms. For instance, the TLAC standard aims to appropriately distribute loss-absorbing and recapitalization capacity within a group and provide for pre-positioning in material subsidiaries or subgroups. It has recently been proposed that consideration be given to replacing pre-positioning requirements with cross-border guarantees, under which parent companies commit to support subsidiaries in case of need, both in normal times and in resolution. That would, of course, weaken the rationale for ring-fencing and allow international groups to centrally manage a larger amount of resources, thereby supporting their efficiency and promoting market integration. However, work remains to be done to determine whether and how those guarantees could offer sufficient comfort to host authorities and, more broadly, to financial markets.

Moreover, enhanced information exchange among authorities and better functioning of supervisory colleges and crisis management groups could reduce the need for extraterritorial and other unilateral actions to ensure financial stability and market integrity in all jurisdictions. Recent reports on market fragmentation by FSB and IOSCO have spelled out those ideas, together with a concrete action plan. Even in the sensitive area of ring-fencing, international cooperation may facilitate a better outcome. A fully cooperative solution that would remove any need for ring-fencing is not achievable. However, progress could undoubtedly be made within crisis management groups toward deciding on an allocation of resources within international groups that would strike a good balance between the need to protect stability in each host jurisdiction and the need to preserve sufficient flexibility for the management of the group as a whole.

Mr. Carstens highlighted that within the European banking union, the existence of single supervisory and resolution authorities provides for consistent policy approaches for both crisis prevention and crisis management. Yet it seems that regulatory harmonization and the creation of the banking union have not yet delivered substantive results in terms of banking integration. One explanation for this could be the insufficient incentives for banking integration. Authorities within the euro area can still impose specific capital, loss absorption, and liquidity requirements on subsidiaries of pan-European firms beyond the obligations imposed at the group consolidated level. Ring-fencing of local subsidiaries could be seen as fundamentally inconsistent with a fully functioning banking union. Though it could also be a natural consequence of the still limited degree of financial integration within the euro area and the insufficiency of the existing risk-sharing mechanisms.

Logically, progress in deepening the economic and monetary union and completing the banking union would strengthen the case for a full transfer of financial stability responsibilities to EU authorities. The availability of a common deposit guarantee scheme would provide arguments for reducing the current ring-fencing possibilities for the local subsidiaries of pan-European groups. In the European banking union, achieving such integration and removing ring-fencing is even more relevant than at the global level and it also looks more feasible. For instance, together with local authorities, both ECB and SRB are already involved in defining the requirements for banks' liquidity, capital, and loss-absorbing capacity at both the consolidated and the subsidiary level. That could reduce the need to pre-position large amounts of resources with the subsidiaries and help to achieve a balanced allocation of resources within pan-European groups, which would mitigate the potential impact of ring-fencing practices on the integration of the European banking industry. Regardless, he concluded that close international cooperation will become an essential element of any regulatory framework aiming to protect the integrity and stability of the financial system.

Related Link: Speech

Keywords: International, Europe, Banking, Financial Integration, Financial Stability, Market Fragmentation, Financial Stability, Ring Fencing, TLAC, Crisis Management, Banking Union, BIS, EU