View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

For release on delivery
1:25 p.m. EST (12:25 p.m. local time)
November 5, 2015

Shared Responsibility for the Regulation of International Banks

Remarks by
Daniel K. Tarullo
Member
Board of Governors of the Federal Reserve System
at
“The Future of Large and Internationally Active Banks”
18th Annual International Banking Conference
Sponsored by the Federal Reserve Bank of Chicago and the World Bank
Chicago, Illinois

November 5, 2015

The regulation of financial institutions is necessarily a dynamic exercise. Growth or
innovations in banking may create new risks that prompt regulatory change. The new
requirements, in turn, incentivize or disincentivize certain actions by financial institutions,
including shifts in activity that may start anew the process of regulatory response. The
regulation of international banking reflects this general pattern, but because internationally active
banks can quickly transmit financial problems across national boundaries, it also features the
question of who should be doing the regulating in a dynamic financial environment.
Following the financial crisis, during which some internationally active banks posed
special problems for both home and host countries, this issue has commanded attention
reminiscent of the aftermaths of the Herstatt failure of the 1970s and the Bank of Commerce and
Credit International (BCCI) failure of the early 1990s. Unlike those earlier instances, though,
this renewed prominence of the “who does the regulating” question has accompanied a major
reconsideration of what regulation is appropriate. Today I would like to address both the “who”
and the “what” issues in the regulation of international banking. My theme is hardly an original
one--namely, that in the absence of either a global regulator or completely insular national
banking systems, we must continue to work toward a system of shared responsibilities to assure
both home and host regulators that internationally active banks are subject to adequate oversight
and controls.
I will begin by reviewing briefly the benefits and risks associated with international
banking and then identifying the different models for allocating responsibility for the oversight
of international banks. After noting the shortcomings of the system for regulating internationally
active banks that prevailed before the financial crisis and developments in the intervening years,

1

I will turn to a consideration of the challenges that remain, with a few suggestions on how we
might make more progress.
Benefits and Risks of International Banking
It is worth at least briefly reminding ourselves of some of the more salient advantages
and risks associated with cross-border banking as they help inform development of regulatory
options. 1
Among the potential advantages are facilitating productive capital flows, diversifying
risks associated with growth in host countries, diversifying the earnings and thus the stability of
the global bank, offering counter-cyclical lending through support from the parent when host
country economic conditions constrain domestic banking operations, enhancing efficiency in
financial intermediation in host countries, providing specialized financial services, 2 and
providing price or product competition for banking services in host countries. The magnitude of
these benefits obviously differs from country to country, depending on a variety of factors.
Some of these benefits can be greater if foreign banks have the freedom to deploy capital and
liquidity to whatever markets offer the most attractive opportunities, whereas others are
achievable simply through the bank’s expertise, existing business relationships, and range of
services.

1

By “cross-border banking,” I mean to refer broadly to activities carried on outside of a bank’s home country
through subsidiaries and branches. I do not include direct lending or other financial transactions across national
borders, whether or not facilitated by an agency in the country of the bank’s customer or counterparty. While such
activities can raise concerns pertaining to investor protection, the volatility of financial flows, or foreign exchange
policies, relevant prudential considerations will generally be limited to the country(ies) from which the bank is
initiating the transaction and raising any funds needed to fund it.
For references to many individual studies examining one or more the advantages or risks, see Stijn Claessens and
Neeltje van Horen (2014), “The Impact of the Global Financial Crisis on Banking Globalization,” IMF Working
Papers 14/197 (Washington: International Monetary Fund, October).
2
For an example, see Stijn Claessens, Omar Hassib, and Neeltje van Horen (2015), “The Role of Foreign Banks in
Trade,” mimeo, (Washington: Board of Governors of the Federal Reserve System and De Nederlandsche Bank,
March).

2

On the other side of the ledger are the risks associated with foreign banking that are
distinct from risks associated with banking more generally. These risks tend to be related to the
parent bank’s capacity to support the larger organization. Reversals in the home market or other
significant foreign operations may reduce the ability of the parent to support its foreign affiliates
with needed capital and liquidity. Even if the foreign affiliate is not itself under great stress, the
weakened overall condition of the parent because of problems in other parts of the world may
prompt it to retrench--often rather abruptly--by reducing activity in foreign markets in which it is
active. This response may be driven either by bank management itself or at the instance of home
country officials who want the bank to continue to lend in its home market. Especially in
countries where foreign banks account for a significant part of financial intermediation and
where the underlying problems are not idiosyncratic to a specific bank, the result may be a
significant diminution in intermediation beyond what would have taken place because of
macroeconomic developments.
Even more serious is the risk that the foreign bank will fail, and that the home country
will lack the resources or the will to ensure either that it is recapitalized and continues to function
or that it fails in an orderly fashion. If the foreign operation has been thinly capitalized and is
lacking in liquidity, host country officials may face an unpleasant choice between supporting a
foreign bank (including operations for which they have not had consolidated supervisory
responsibility) or allowing it to fail in a disorderly fashion, with potentially serious knock-on
effects in the host country’s financial system.
Thus, what might have been economic advantages for host countries from foreign banks
in reasonably good times can turn into substantial disadvantages in periods of idiosyncratic or
generalized stress. As with the benefits of foreign banking, the risks vary considerably among

3

host countries. Obviously, countries without well-developed domestic banking systems will both
benefit more and be at greater risk. Yet even the most sophisticated domestic financial systems
can be affected significantly. For example, the risks can be exacerbated by funding patterns and
currency mismatches, as happened in the United States during the financial crisis. Foreign banks
that had been using their U.S. branches to raise dollars in short-term markets for lending around
the world were suddenly left without access to this funding and, as a result, made substantial
and--relative to their assets--disproportionate use of the Federal Reserve’s discount window.
Approaches to the Regulation of Internationally Active Banks
As I mentioned at the outset, international banking raises the question of who should do
the regulating, as well as the question of what regulation is appropriate. The two questions are
related, of course. As I will explain shortly, the nature of regulations in part depends upon the
perspective and aims of the regulator. There are essentially four models, each of which has
benefits and shortcomings.
First, the home jurisdiction can have dominant or exclusive regulatory responsibility for
all of its banks’ global operations through application of consolidated regulation and supervision.
Second, host jurisdictions can have dominant regulatory responsibility for all foreign banking
operations within their borders. This approach requires foreign banks to charter locally and to
meet the same regulatory and supervisory standards applicable to domestic banks. Third, there
can be shared authority between home and host jurisdictions, whereby host countries do some
regulating and supervising of foreign banks within their borders but do not require all foreign
banking activities to be locally chartered and subject to regulation identical to that of home
banks. Finally, there could be one global regulator to oversee all the operations of
internationally active banks around the world.

4

There is an almost unlimited number of variations on the shared approach and, in fact,
one or another variants on that approach have been adopted by most jurisdictions during the
modern banking era (though there have been instances of countries severely limiting or
prohibiting foreign banking altogether). Before turning to a discussion of how the shared
approach has evolved and may be further modified, I think it useful to identify both the appeal
and the problems with the other three, conceptually purer, approaches.
Both the attraction and limitations of the host country model are fairly apparent. On the
one hand, the host country is most likely to be attentive to the risks posed to its financial system
by foreign banks. More generally, the host jurisdiction is at least presumptively best positioned
to craft a regulatory and supervisory framework to protect its financial system from the particular
risks engendered by economic and financial conditions. Having all foreign banking operations
meet local capital and other standards helps achieve that end. The risks of abrupt shifts of capital
and liquidity out of the country can be minimized, and depositors can be better protected.
On the other hand, a fully local regulatory system would make the costs of entry very
high. For example, if no foreign branches were allowed, or were required to operate as if they
were separately chartered and capitalized, the commitment of resources needed to enter a foreign
market would be considerably higher than those typically associated with opening a branch. In
addition, even complete local subsidiarization might not protect a foreign banking operation
from suffering some contagion if its parent is under stress. Thus, the quality of home country
regulation may have some bearing even under the host country model.
Not surprisingly, the home country model presents essentially the obverse set of
advantages and limitations. Having a consolidated set of capital requirements and a single
supervisor allows for the quickest deployment of capital and liquidity where it is most in

5

demand, or most needed to relieve stress, and minimizes compliance costs. However, as has
often been pointed out, the home country regulator will be most responsive to the impact of both
regulation and distress of its banks on its own market. In its regulatory and resolution activities,
it is likely to undervalue the potential risks and costs for host countries. In periods of stress, the
home country regulator, accountable primarily to home country legislators or government
officials, may concentrate on stabilizing its own financial markets and be more inclined to allow,
or even demand, a sharp reduction in activity abroad. The result would, at a minimum, be an
abrupt decrease in intermediation at particularly sensitive times. At worst, foreign operations
could default on obligations and exacerbate financial stress. 3
At first glance, it might seem that the home country and global regulatory approaches
would yield similar substantive results, since in each case, there would be consolidated
regulation and supervision. A global regulator, however, would at least in theory take the
interests of all jurisdictions into account in regulating, supervising, and resolving a global bank.
Of course, how to balance those interests--particularly in the face of unanticipated
circumstances--would be a difficult, and almost invariably political, judgment. This reality
raises the thorny issue of the accountability of a global regulator.
The political factor is one of many reasons why jurisdictions are likely to remain
unwilling to cede much authority to global, as opposed to international, financial institutions.

3

Mindful of the considerations lying behind the limitations of both models, Dirk Schoenmaker has offered his
theory of the “financial trilemma,” which states that a jurisdiction can only have two of the three objectives of a
stable financial system, international banking, and national regulatory policies. Professor Schoenmaker introduced
his theory at a conference in 2008 and subsequently formalized it in Dirk Schoenmaker (2011), “The Financial
Trilemma,” Economics Letters, vol. 111 (April), pp. 57–59; and Dirk Schoenmaker (2013), Governance of
International Banking: The Financial Trilemma (Oxford: Oxford University Press). See also Richard J. Herring
(2007), “Conflicts between Home and Host Country Prudential Supervisors,” in Douglas D. Evanoff, George G.
Kaufman, and John R. LaBrosse, eds., International Financial Stability: Global Banking and National Regulation,
(Hackensack, N.J: World Scientific), pp. 201–20.

6

Indeed, quite apart from political considerations, there may be good reasons not to do so. For
one, a single global regulator of internationally active banks would presumably be something
close to a regulatory monopolist, whose policies and practices could be inappropriately uniform
across quite different national markets and slow to adapt to changing conditions. Also, as with
dominant or exclusive reliance on home country consolidated supervision, it seems unlikely that
a global regulator--no matter how well-staffed--would be fully informed on the varieties of
financial risks posed to regulated institutions across national markets.
A limited exception to the general disinclination to cede financial sovereignty, as in
various other areas, lies within the European Union or, more precisely, the euro zone. With the
creation of a Single Supervisory Mechanism (SSM) in the European Central Bank and a
freestanding Single Resolution Mechanism (SRM), there have been important transfers of
authority, though national regulators continue to play a supporting role. Interesting and
important as this regional initiative is, however, the unique European arrangement of shared
sovereignty makes it less a model for the world as a whole than an extension of the single
currency project, responding to some of the difficulties encountered during the financial crisis.
The Shared Model and Lessons of the Crisis
The shortcomings of each conceptually “pure” model explains why some version of a
shared home/host model has prevailed over time. Given the range of variations in this model,
however, it is useful to bear in mind the relative advantages and disadvantages of the cleaner
models in choosing the elements of a specific shared approach. In considering recent

7

developments, as well as what remains to be done, it is also useful to begin by recalling the
situation that prevailed at the onset of the financial crisis.
In its early years, the Basel Committee on Banking Supervision’s work focused on
elaborating the responsibilities of home and host regulators of internationally active banks. The
principle of consolidated supervision was developed in the early 1980s, and reinforced following
the failure of the BCCI in the early 1990s, in an effort to ensure that some regulatory authority
had an overview of a global bank’s consolidated assets and liabilities. At the same time, though,
the Basel Committee set out expectations for host country prudential oversight of foreign banks
that would be similar to that for domestic banks. 4
The financial crisis painfully demonstrated the inadequacy of both home and host country
regulation. Home country regulators of some large, internationally active banks clearly did not
appreciate the risks those firms were assuming overseas. Host country regulators, including
those in the United States, had not exercised prudential oversight of some foreign bank activities
and had not sufficiently appreciated the risks associated with the funding models and other
activities of some foreign banks that were subject to consolidated prudential regulation. And
there were indeed instances of international bank failures in which the home country authorities
seemed to focus on domestic interests to the possible detriment of the interests of host countries. 5
Of course, regulatory failures were far more pervasive than inattention to the specifically
cross-border activities of banks. The substantive rules governing capital and other requirements
for all banks were woefully inadequate, although the fact that most very large banks around the

4

The current version of this obligation is set forth in Basel Committee on Banking Supervision (2012), “Core
Principles for Effective Banking Supervision” (Basel, Switzerland: Bank for International Settlements, September),
www.bis.org/publ/bcbs230.htm. I have addressed the issue of host state responsibility at somewhat greater length
elsewhere. Daniel K. Tarullo (2014), “Regulating Large Foreign Banking Organizations,” speech delivered at the
Harvard Law School Symposium on Building the Financial System of the Twenty-first Century, Armonk, New
York, March 27, www.federalreserve.gov/newsevents/speech/tarullo20140327a.htm.
5
For a review of these instances, see Schoenmaker, Governance of International Banking, pp. 72–87.

8

world have significant cross-border operations exacerbated the shortcomings. While banks were
growing in size, integrating traditional lending and capital markets in ever more complicated
ways and relying increasingly on vulnerable short-term wholesale funding models, many
regulators around the world were at best failing to keep up with these changes. At worst, they
removed older prudential limitations without substituting new measures designed to address the
new realities of banking. The Basel Committee spent most of the decade before the crisis
dominantly focused on the Basel II framework, which was intended to reduce somewhat
effective regulatory capital levels for large banks in return for their transition to an internalmodels-based approach to capital requirements. This was a choice made by national regulators,
led by those in the United States, and not a byproduct of the structure of the Basel Committee
itself.
Adding the lessons of the 2007–09 financial crisis to those of earlier episodes of financial
stress, I think we can infer some guidelines on host and home responsibilities to help shape
expectations for practice. For host countries, the overarching guideline is that each jurisdiction
should take responsibility for protecting the financial stability of its own markets as its
contribution to achieving global financial stability. The extent of this responsibility obviously
increases with the size and significance of the jurisdiction’s financial markets. Thus the United
States and the United Kingdom--which currently have the greatest concentrations of capital
markets activities--have a particular obligation to oversee the local activities of both domestic
and foreign banks that could pose particular risks to financial stability and are likely to be
especially difficult to observe for a home country supervisor less familiar with those markets.
A corollary of this general guideline is that the scope of host country regulation might
sensibly vary with the size and systemic importance of foreign banks. This notion is consistent

9

with the principle embodied in the Dodd-Frank Wall Street Reform and Consumer Protection
Act that prudential regulation should be progressively more stringent as banks pose greater risks
to financial stability. As I will discuss in a moment, this principle also lies behind some of the
post-crisis frameworks developed by the Basel Committee and the Financial Stability Board
(FSB).
For home countries, the relatively longstanding principle that regulators should exercise
effective consolidated supervision remains critical, though I would emphasize that the regulation
imposed by home jurisdictions is of equal--if not greater--importance. It is important to
emphasize that this obligation is not a substitute for host country regulation and supervision of
foreign banking organizations. The home jurisdiction regulatory structure must ensure that the
banks are fundamentally safe and sound, and that the parent will generally be able to support its
operations around the world. Here, of course, a major shortcoming of the pre-crisis regime
becomes apparent, in that capital and other regulatory requirements for internationally active
banks were simply not strong enough.
Consolidated supervision must contain the risks to the financial system created by
banking activity that is not fully captured by regulations. It must also ensure that banks do not
hide problems by shifting assets or liabilities around their global operations and, more generally,
that the banks are fundamentally safe and sound so as to forestall possible contagion risk to
foreign operations.
Within these admittedly broad guidelines, there is obviously room for host countries to
balance the benefits and risks presented by foreign banking organizations in a number of
different ways. Their choices will be affected by policy preferences, the characteristics of their
domestic financial systems, and the relative importance of foreign banks in those systems. The

10

host country choices will also inevitably be affected by how home countries are carrying out
their regulatory and supervisory roles. This consideration includes, of course, not just
regulations that are nominally applicable, but the manner in which those regulations are
enforced.
Branching presents a particularly instructive example of the tension between assuring
financial stability and permitting foreign banking operations that may carry economic benefits.
Because branches are not separately chartered and capitalized, a bank can relatively easily enter
a foreign market by opening a branch, through which it can make loans--often initially to
companies from its home country--using funds from the home bank. Particularly where (as in
the United States) foreign branches are forbidden by local law from accepting retail deposits, it
might seem that there are minimal risks to the host country if the parent bank (and thus the local
branch) fails. However, U.S. experience with foreign branches in the decade prior to the crisis
shows the very real risks that can arise when a branch is used to raise funds in the host country
(in the United States, in dollars) through short-term wholesale borrowing, and then directs those
funds out of the host country for loans or asset purchases by other parts of the bank. As noted
earlier, when short-term funding dried up, many foreign branches were left seriously short of
liquidity and had to turn to the discount window.
A shared feature of the U.S. and European Union regulatory systems for foreign banks is
that branching is permitted without requiring separate capitalization. Many other jurisdictions
have similar policies. Thus opportunities for foreign bank entry and market access are provided.
In the United States, larger branches do have to meet some liquidity requirements, though they
are less restrictive than the standards applicable to domestic banks and intermediate holding
companies. This requirement is an important example of a prudential measure that balances

11

financial stability and the benefits of international banking. The degree to which we or, I
presume, other jurisdictions will remain comfortable with this balance will depend on two
factors. The first factor is the degree to which local branches are used by foreign banks as
significant sources of unstable funding or for other risky purposes. While this has been a
significant issue in the United States, it is less clear that other jurisdictions face similar risks.
The second is the confidence host jurisdiction regulators have that the parent banks are subject to
effective regulatory and supervisory oversight.
Developments since the Crisis
The profound shift in political and policy environments as a result of the financial crisis
has led to considerable strengthening of minimum international standards for internationally
active banks, at both national and international levels. Basel III enhanced the quantity and
quality of capital requirements and introduced, for the first time, quantitative liquidity standards.
Following completion of Basel III, the Basel Committee developed a structure of slightly
misleadingly named capital “surcharges,” which requires global systemically important banks
(GSIBs) to maintain higher capital levels. 6
The Federal Reserve supported all these measures but was a particularly strong advocate
of the capital surcharges, which established the new principle that some international prudential
standards should be progressively more stringent as the systemic importance of a bank increases.
In meeting its responsibility to promote domestic financial stability, the Federal Reserve last year
followed the lead set by the European Union some years previously and adopted a regulation
requiring subsidiaries of GSIBs engaged in traditional banking as well as those engaged in

6

I say “misleadingly” called capital surcharges because that term implies the banks are faced with a “charge” that
has to be paid to someone. In fact, of course, the requirement is that the bank retain higher capital buffers in order to
increase its resiliency.

12

capital markets activities be covered by local capital requirements consistent with Basel III. But
neither in the United States nor the European Union do the GSIB capital surcharges imposed at
the consolidated level apply to foreign banking operations in their jurisdictions. 7 So even if the
global bank has local capital requirements for most or all of its foreign operations, the parent still
has some flexibility as to where the additional capital buffer can be maintained. More generally,
our requirements for other prudential regulations applicable to foreign banking organizations
(FBOs) are calibrated to the relative importance of the FBOs in the U.S. financial system. Thus
the structure of surcharges also help to create a good mechanism for balancing host country
interests in assuring financial stability and in realizing the benefits that can come from global
banking.
Even with good standards, regulators in host jurisdictions will want assurance that these
standards are being rigorously implemented and enforced. The relative opaqueness of bank
balance sheets makes capital, liquidity, and other common banking regulations difficult to
monitor effectively. This argues for complementing fairly complex regulation that seeks to track
the often-complex activities of large banks with simpler regulations, such as the leverage ratio
and a standardized risk-weighted capital floor. But it also argues for existing international fora
such as the Basel Committee and the FSB to provide effective monitoring mechanisms. Even
with higher standards in place, supervisors in home and host jurisdictions will still face
challenges in assessing cross-jurisdiction vulnerabilities. More regular sharing of information
and assessments among home and key host jurisdictions both formally and informally should be
high on our shared agenda.

7

See 79 FR 17240 (March 27, 2014); and Tarullo, “Regulating Large Foreign Banking Organizations.”

13

At present, both those groups have useful processes for overseeing the implementation of
agreed upon international standards. But they tend to be a bit formalistic, concentrating on
comparing the language of domestic implementation to that of the international standards, rather
than examining whether domestic practice in fact ensures substantive compliance or gaining a
shared understanding of the unique risks in each market.
It would, I believe, be counterproductive to establish in either the Basel Committee or the
FSB the kind of adversarial dispute settlement process associated, for example, with the World
Trade Organization. It is in the interest of all members of those bodies to cooperate in the shared
task of overseeing internationally active banks. Thus, the better approach to compliance would
be one that simultaneously provides regulators with a way to work with one another and to gain
deeper insight into how their counterparts in other jurisdictions are applying prudential
standards.
For example, there has been considerable documentation of the interjurisdictional
divergence in risk weights for similar exposures under the internal models-based capital
approaches of Basel II. 8 While the Basel Committee has been working on this issue, 9 I suspect
that one of the most effective ways of promoting broadly comparable risk weighting would be to
have technically competent supervisory staff from other jurisdictions participate with home
regulators in the actual bank model validations, oversight, and related supervisory functions.
Similarly, as stress testing becomes a more important global financial stability tool, it will be
useful to have staff experienced in stress testing at home participating in the stress testing

8

See generally Vanessa Le Leslé and Sofiya Avramova (2012), “Revisiting Risk-Weighted Assets,” IMF Working
Paper 12/90 (Washington: International Monetary Fund, March).
9
See Stefan Ingves (2014), “Finishing the Job: Next Steps for the Basel Committee,” keynote address to the Ninth
BCBS-FSI High-Level Meeting on “Strengthening financial sector supervision and current regulatory priorities,”
Cape Town, South Africa, January 30.

14

exercises of other jurisdictions. These kinds of interactions, along with the more traditional
device of supervisory colleges, can help foster confidence among host jurisdictions in both the
regulatory and supervisory activities of home country authorities.
Another useful practice for furthering mutual confidence would be a program for regular
contact among the very top officials of key regulators. The original Basel Committee brought
together these officials for what were usually relatively informal meetings. As one of the early
participants in those meetings once told me, the relationships he built with his counterparts
through these regular contacts served everyone well when issues concerning international banks
arose. But with the concentration of the Basel Committee on sometimes highly technical
standards, participation has generally drifted down to the senior staff level. The FSB was created
in part to compensate for this change in the Basel Committee. And the FSB usually does garner
higher levels of participation. However, other features of the FSB--such as including market
regulators and finance ministries in order to provide a broader range of views on financial
stability issues--mean that the FSB cannot serve the original Basel Committee purpose either.
Moreover, even when the right member agencies are represented, the actual individuals
participating may not be the most senior officials in the supervisory function of those agencies.
Finally, the near doubling in size of both the Basel Committee and the FSB, while again critical
for ensuring a representative group to consider financial stability issues, further complicates the
matter.
Thus, while a regular, high-level interaction among all key regulators would be optimal,
for the foreseeable future, we will probably have to live with something less than optimal. Ad
hoc meetings around the fringes of various Basel convocations and bilateral interactions may
have to suffice. In this regard, I note the importance of the creation of the SSM within the

15

European Central Bank as the supervisor for all larger banks in the euro zone. The Federal
Reserve has already established instructive and productive relationships with the experienced
and committed group of supervisors that have been brought in to lead the SSM.
The Limits of Shared Responsibility
It is important to recognize, though, that even with the best of intentions and actions in
home country regulatory and supervisory regimes, there will be limits to how much
responsibility can appropriately be shared for international banking activities. These limits are
most apparent in the context of the possible insolvency of a major foreign banking
organization. 10 The work of the FSB in promoting effective resolution regimes around the world
and in seeking an international framework for building the total loss absorbing capacity (TLAC)
of GSIBs are very good examples of cooperative efforts that promote the aim of ensuring that
even the largest banks can fail without either causing financial disorder or requiring injection of
public capital. My expectation is that the FSB’s framework for TLAC will incorporate the
principle of an extra buffer of loss absorbing capacity at the consolidated level beyond what may
be required in the aggregate at local levels. 11 But the margin may be a little thinner here,
precisely because of the circumstances in which the loss absorption capacity may be needed.
With respect to going concern prudential requirements such as capital levels, host
countries have a continuing opportunity to observe how home country officials are regulating
and supervising their banks. Particularly if effective monitoring mechanisms are developed, host
countries may become comfortable with limited oversight of some or all domestic operations of

10

Indeed, Dirk Schoenmaker developed his notion of the financial trilemma around the conflicts of interest that arise
in the context of the insolvency of a global bank.
11
The TLAC proposal of the FSB contemplates that host authorities will set internal TLAC requirements at 75 to 90
percent of applicable external TLAC requirements.

16

foreign banks. If they see the rigor of home consolidated oversight waning, they will have a
chance to intensify their own supervision. But with the prospect of a failed bank, there will be
no time for such adjustments or, as a practical matter, the capacity to impose new requirements
may become limited by the time the prospect of failure is looming. The imposition of
requirements in the midst of a crisis would in any event likely exacerbate stress. Even with the
best of intentions, today’s home country regulators cannot effectively bind their successors’
response to the insolvency of one of their globally important banks when political and economic
pressures are likely to be high.
The gone-concern loss absorbency requirement for FBO intermediate holding companies
proposed by the Federal Reserve Board on October 30 should enhance the prospects for an
orderly firmwide global resolution of an FBO by its home country resolution authority through
increasing confidence that the U.S. operations of the FBO will obtain their appropriate share of
the loss absorbency capacity of the consolidated foreign bank. Past experience suggests that host
supervisors are most likely to ringfence assets when there is doubt that the local customers and
counterparties of foreign banks will be adequately taken into account. Yet if, for any reason, the
home jurisdiction resolution is unsuccessful, the internal long-term debt will be available to U.S.
authorities for orderly resolution and recapitalization of the intermediate holding companies.
We have calibrated our proposed internal TLAC requirements slightly below our
proposed external TLAC requirements for U.S. GSIBs. This slightly lower calibration for
internal TLAC recalls the difference between local going-concern capital requirements and the
GSIB surcharge, but the gap is somewhat smaller, reflecting the concerns I mentioned a moment
ago. The proposal thus balances support for the preferred resolution strategy of the home

17

resolution authority of the foreign GSIB with assurance of U.S. financial stability if that strategy
cannot be executed successfully. 12
Conclusion
My view of shared responsibility for overseeing international banks emphasizes the
importance of financial stability even as it allows for benefits specific to international banking.
For the reasons I have explained, in the end host countries need to make the judgments on the
tradeoffs between these goals. But I have also explained how a strong set of international
prudential standards and good institutional relationships among regulators could help tilt this
balance toward greater flexibility for internationally active banks.
In response to positions akin to what I have presented today, one often hears complaints
that the emphasis on financial stability will result in the balkanization of international banking. I
would note first that it is not at all clear that developments since the crisis have on net balkanized
banking, so much as shifted some international banking assets from the Organisation for
Economic Co-operation and Development (OECD) countries whose banks were
disproportionately affected by the financial crisis to banks from some emerging market and
developing countries. 13 This development probably reflects both needed changes in some of the
OECD nation banks and a logical reflection of the increasing economic importance of the nonOECD countries.
Second, I wonder how these critics can think that the pre-crisis situation of supposedly
consolidated oversight and substantial bank flexibility was a desirable one. At least some of the

12
Our internal TLAC proposal effects this balance principally by not including parent GSIB surcharges in the
calibration for FBO intermediate holding companies but also by lowering the baseline TLAC requirement for U.S.
intermediate holding company subsidiaries of single-point-of-entry strategy FBOs from 18 percent of risk-weighted
assets to 16 percent of risk-weighted assets.
13
For a discussion of these points, see Claessens and van Horen, “The Impact of the Global Financial Crisis on
Banking Globalization.”

18

flexibility enjoyed by banks in shifting capital and liquidity around the globe was deployed in
pursuit of unsustainable activity that eventually ran badly aground.
Third, as I suggested earlier, even where concerns about “trapped” capital or liquidity are
more sensibly based, reasonable ex ante constraints by host country authorities in pursuit of a
sound and stable domestic financial system are likely to be far preferable to ex post constraints-for example, ringfencing--that are imposed when the foreign bank is under the greatest pressure.

19