Post-crisis regulation and supervision of the biggest banks

by the biggest countries: Consensus on principles, variation in practices

Financial system policymakers around the world continue to respond vigorously to the problems in financial markets, financial institutions, and financial system regulation and supervision brought into high relief by the 2007-2009 global financial crisis. However, the overall understanding of the nature and scope of those responses remains rather vague and, perhaps, inaccurate in key respects.


That is true even for a major subset of policy responses which have been a central focus – some would say the central focus – of policy makers, the financial press, and market participants: measures to address risks to the financial system posed by large, globally-active banks. The purpose of this article is to add clarity and depth to the understanding of this issue.

At first blush, our title would seem to get things off to a particularly awkward and imprecise start, referring as it does to the “biggest countries” and the “biggest banks.” There is method to our madness, of course. Specifically, our title immediately raises two questions: first, what, exactly, do we mean by the “biggest countries”? And second, what, exactly, do we mean by the “biggest banks”? This article is structured to answer both questions precisely, highlighting key information about regulatory and supervisory policies and practices that is either new or not yet widely perceived.

“The biggest countries”? The G20

There is of course no “official” answer to the question of “What constitutes the ‘Biggest Countries’?” However, we submit that the Group of Twenty (G20), our answer to the question, is by far the most appropriate choice for such a designation. There are two commonly-understood definitions of the G20, both of which bear on our choice. Under the first definition, the G20 is understood to be comprised of the 20 political jurisdictions (19 countries plus the European Union – see Table 1 at the end of this article) that agreed in 1999 to actively cooperate on international economic and financial policy issues.

These jurisdictions, as a group, unquestionably constitute “the biggest” economic and financial powers in the world, accounting for 85 percent of global GDP, 90 percent of global banking assets, as well as 90 percent of total financial system (banking + bond market + stock market) assets.

The other commonly-understood definition, and the one of most relevance here, is that the G20 is the financial policy-making entity comprised of the finance ministers and central bank governors of the 19 member countries plus an equivalent level representative from the EU, either the president of the European Council or the head of the European Central Bank (ECB), on a rotating basis. At first an obscure group, the G20 (specifically, in the form of the finance ministers and central bank governors – the definition we use in the remainder of this article) became the main go-to entity at the depth of the global financial crisis in late-2008.

The G20’s ascension to the lead role in responding to the global financial crisis was underscored when the political heads of the G20 jurisdictions met in summit, for the first time, in November 2008. Furthermore, at their next summit, in April 2009, G20 leaders declared that the G20 was “the premier forum” for reform of the global financial system. They also established the Financial Stability Board (FSB) as the G20’s operational arm for developing a comprehensive program for reforming the global financial system, and for coordinating, monitoring – and, in key respects guiding – the work of the Basel Committee on Banking Supervision, the IMF, and the other major international standard-setting bodies and international institutions.

Table 1    Countries Represented among Member Jurisdictions: G20, FSB, Basel Committee on Banking Supervision

“The biggest banks”? Systemic trumps size – and guides supervision

Since the onset of the global financial crisis, it is generally understood that use of the term “biggest banks” is shorthand for the actual or potential systemic impact of given institutions, rather than a reference to their size per se. That perspective is the starting point for our answer to the question “What do you mean by the ‘Biggest Banks’?” We offer a two-part answer, each of which starts with conceptual considerations. Because those concepts are likely to be familiar to most financial industry professionals, we address them only briefly before turning to important concrete information about regulation and supervision which, we believe, covers unfamiliar and possibly even new ground for many financial professionals.

Our first answer is that by “biggest banks” we mean those which are systemically important banks (SIBs). SIBs are banks whose distress or disorderly failure would cause significant disruption to the wider financial system, and, hence, to the economy. The systemic risk posed by a SIB is a function not just of its size, but also its complexity and interconnectedness within the financial system. The less than complete dominance of size as an indicator of systemic risk is underscored by information in Table 2 at the end of this article. The table includes the rank among the top 100 banking companies in the world, by asset size, of a special subset of SIBs – global SIBs or “G-SIBs,” currently numbering 29.

Table 2    FSB Designations of Global Systemically Important Banks

Two points in particular are worth noting: (1) some of the very largest banks in the world (including the 9th largest) have not been officially designated as G-SIBs; and (2) several officially designated G-SIBs rank in the middle or lower end of the list of 100 largest banks group (see our recent study, referenced in footnote 1 above, for the complete details about the size calculations).

There is a broad and deep consensus that SIBs merit heightened supervisory attention and, many argue, a somewhat more rigorous regulatory response as well. What is obvious now, however, was not universally appreciated in the pre-crisis world. In those circumstances, the World Bank’s new, detailed, country-specific information about the regulation and supervision of SIBs is an especially important contribution to our understanding of how countries have responded to the global financial crisis. In a recent study, the current authors along with two other co-authors analyzed the results of new World Bank data on national policies in place for the regulation and supervision of SIBs by 135 countries (see footnote 1 for information about our study). Drawing on that study, we summarize key highlights for the 19 countries in the G20:

  • The World Bank surveyed supervisory authorities on twelve factors they could potentially use to assess whether a bank is a SIB, and found a rather low degree of uniformity among the 19 G20 countries. For any given factor, about half of the G20 countries considered it, and half did not. The main exceptions to this generalization are bank capital ratios (used by 12 of the 19 countries), bank liquidity ratios and bank nonperforming loan ratios (each used by 11 of the 19 countries), and housing prices (used by only 7 of the 19 countries).
  • Almost all of the G20 countries answered that they supervise systemic banks differently from non-systemic ones, with only three countries answering “no” to the question (Canada, South Korea and Turkey). In a majority of the G20 countries (11 of 19), there is a specialized department within the supervisory agency(ies) that focuses on systemic supervision.
  • The World Bank asked about the use of eight “tools” that could be used under a special supervisory regime for SIBs. Among the 16 G20 countries saying they supervise SIBs differently from non-systemic banks, only one of those tools was employed by a majority, with 11 of the 16 countries saying they conducted close and/or more frequent exams and/or other oversight for SIBs.
  • There was a broader consensus among those 16 countries about what not to use: only two of the 16 said there were special restrictions on the legal structure of SIBs; and, for both “restrictions/limits on size of institution,” and “additional corporate taxes,” only one of the 16 answered yes (respectively, South Africa and France).

Supervision of SIBs – the global response

Even so, thoughtful, and continually improving, post-crisis measures at the national level to address risks posed by SIBs represent a substantial advance over the pre-crisis regulatory and supervisory environment. However, in profound respects national efforts fall short, almost by definition, of hitting the main target: risks posed to the global financial system by global systemically important banks – known now by their acronym, G-SIBs.

If asked, many (most?) analysts, market participants, and even policymakers, would identify the Basel Committee as the lead entity on reforming the global banking system, including in particular with respect to G-SIBs. In a who-is-doing-the-daily-work sense, that is true; what remains largely unknown, or at least under-appreciated, is that since it took the initiative in responding to the full eruption of the global financial crisis in late-2008, the G20 has in fact been in the driver’s seat on this issue. Indeed, as we intimated above, and explicitly explain in our recent study, the G20’s increasingly broad and deep array of financial system issues has the best claim to be considered “the” global agenda on financial system reform.

A major element of the G20’s global agenda is addressing risks posed by global systemically important financial institutions (G-SIFIs), following a set of initiatives developed and overseen by the FSB, with the blessing of the G20 Leaders, a point Leaders have reiterated  in the communiqué issued at each of their Summits since 2008. The status of those initiatives was described in detail by the FSB in its progress report to Leaders at their St. Petersburg Summit in September 2013, a moment in time that was widely considered the five-year anniversary of the full eruption of the global financial crisis.

The degree of success reported by the FSB varies substantially from major initiative to major initiative, making it impossible to characterize the overall progress of the G20’s global financial system reform efforts with a single thumbs-up or thumbs-down statement. Nevertheless, from the FSB’s report one can unambiguously conclude that the greatest degree of progress has been made for a subset of the SIFIs initiatives, i.e., those dealing with G-SIBs.

That is a direct result of the G20 leaders early on firmly endorsing strategic recommendations by the FSB to focus first on the relatively small number of truly “global” SIFIs, and within that group to start with the banking industry. It is likely that those recommendations were based in part on the relatively greater reliance on banking finance, compared to market-based finance, among many countries (unlike, for example, the U.S.).

Another major justification (perhaps the major justification) for that choice of strategy was the considerable expertise in, and work already underway by, the Basel Committee. With that as context, highlights of progress on the G20’s G-SIBs work as of the five-year anniversary of the financial crisis can be summarized as follows:

Determining and designating banks that are G-SIBs. Using methodology developed by the Basel Committee, the FSB published in November 2011 its first annual list of G-SIBs (which, as indicated in Table 2, were called “G-SIFIs” that year, but “G-SIBs” thereafter). That list was updated and modified on schedule in November 2012, and most recently in November 2013. Progress in this regard compares favorably to that for nonbank SIFIs, although in July 2013 the FSB designated an initial set of global systemically important insurance firms (G-SIIs).  For other nonbanks, the best that could be reported by the FSB to G20 leaders at their September 2013 summit was that a consultative paper on the identification of global significant nonbank, non-insurance firms (NBNI G-SIFIs) would be forthcoming by the end of 2013.

Development and implementation of higher loss absorbency (HLA) requirements for G-SIBs. At or just ahead of the St. Petersburg summit the FSB highlighted continuing success for initiatives targeting the banking industry:

  • By August 2013, 23 of the 25 FSB member countries had issued final rules for implementing the Basel III risk based capital (RBC) standards.
  •  In 11 of those member jurisdictions, RBC rules were already in force, and 12 other members were on track for implementation of their final RBC rules by end-2013.
  • he Basel Committee published in January 2013 the final detailed guidelines for the liquidity coverage ratio (LCR) component of Basel III. Ahead of the phase-in of those standards, slated to start in January 2015, just under half (11) FSB members had, by August 2013, issued final or draft rules at the national level for the implementation of the LCR standards.
  • In September of 2012, the Basel Committee fulfilled its commitment to the G20 ministers & governors to update its Core Principles for Effective Banking Supervision.  Subsequently, the Basel Committee has broadened and deepened its work on the supervision of G-SIBs with the issuance of guidance and/or consultative documents on internal and external audit practices, foreign exchange transactions, liquidity management, and anti-money laundering measures. Further, in consultation with the FSB, the BCBS will monitor members’ implementation, by January 2016, of higher supervisory standards for the G-SIBs designated in November 2012.

Conclusion

To the extent this article has contributed to a better understanding of the supervision of systemically important banks in the post-crisis era, its value-added rests on our presentation of new and/or under-appreciated information. One dimension highlights detailed, country-by-country supervisory data recently collected by the World Bank. Our analysis of the relevant information for the G20 yields two main conclusions about their national supervisory regimes for SIBs: (1) supervisory authorities strongly agree that SIBs merit special oversight and treatment; but (2) authorities hold a range of opinions on how best to do that. Time will tell whether those different approaches do the job and, if not, in what directions “best practices” move.

Our second perspective is international in scope and starts with the observation that the most important systemic banks are those posing risks to the global financial system. We point out that among the internationally cooperative financial system reform initiatives underway, and perhaps somewhat at odds with common perceptions, it is the G20’s agenda which by far comes closest to being “the” global agenda.

Our brief summary of what happened, when, and how concludes that the greatest progress has been made on initiatives targeting G-SIBs. Substantial as that progress has been, the work left to be completed is considerable. That is certainly true for the global banking industry where, for example, how to deal with the failure of a large, globally active bank remains one of the most difficult challenges facing regulators and policy makers.  And, of course, beyond that are the many challenges presented by systemically important nonbanks and the shadow banking system.

Endnotes:

  1. Dr. James R. Barth is Lowder Eminent Scholar in Finance at Auburn
    University and a senior fellow at the Milken Institute; Dr. Daniel E.
    Nolle is a Senior Financial Economist at the Office of the Comptroller
    of the Currency. The views expressed in this article are those of the
    authors’ alone and should not be interpreted as reflecting those of the
    Office of the Comptroller of the Currency or the U.S. Treasury
    Department. For a detailed treatment of the topics discussed in this
    article, readers may wish to consult the September 2013 Milken Institute
    Research Report “Systemically Important Banks in the Post-Crisis Era,”
    by James R. Barth, Chris Brummer, Tong Li, and Daniel E. Nolle at  http://www.milkeninstitute.org/publications/publications.taf?function=detail&ID=38801434&cat=resrep
  2. G7 member.
  3. Russia is not a G7 member, but meets with the G7 members when they constitute themselves “the G8.”
  4. The EU per se is not a member; the European Central Bank, the European Commission, the European Banking Authority all have observer status
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James R. Barth

James R. Barth is the Lowder Eminent Scholar in Finance at Auburn University, Senior Finance Fellow at the Milken Institute, and a Fellow of the Wharton Financial Institutions Center. He has served as leader of an international team advising the People's Bank of China on banking reform and lectured on bank regulatory issues in China, India, Russia, and Egypt for the U.S. State Department. Barth was an appointee of Presidents Ronald Reagan and George H. W. Bush as chief economist of the Office of Thrift Supervision and previously the Federal Home Loan Bank Board. He has also been a professor of economics at George Washington University, associate director of the economics program at the National Science Foundation, Shaw Foundation Professor of Banking and Finance at Nanyang Technological University and a visiting scholar at the U.S. Congressional Budget Office, Federal Reserve Bank of Atlanta, Office of the Comptroller of the Currency, and the World Bank. Barth has recently co-authored The Rise and Fall of the U.S. Mortgage and Credit Markets: A Comprehensive Analysis of the Meltdown (John Wiley & Sons, 2009), Rethinking Bank Regulation: Till Angels Govern (Cambridge University Press, 2006), Financial Restructuring and Reform in Post- WTO China (Kluwer Law International, 2007), Guardians of Finance: Making Regulators Work for Us (MIT Press, 2012), Fixing the Housing Market (Wharton School Publishing, 2012) and Research Handbook on International Banking and Governance (Edward Elgar Publishing, 2012). He also is the co-editor of The Journal of Financial Economic Policy and overseas associate editor of The Chinese Banker.
 

James R. Barth
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Daniel Nolle

Daniel Nolle is a senior financial economist with the U. S. Office of the Comptroller of the Currency. He is responsible for policy analysis on U.S. and international banking structure and performance issues. Previous professional experience includes the position of Economist at the Federal Reserve Bank of New York, and Assistant Professor at the Georgetown University School of Business. Dr. Nolle has contributed directly to the work of the Basel Committee on Banking Supervision, and in the period following the global financial crisis of 2007-2009, he served on details to the U.S. Treasury Department and the Federal Reserve Board. His publications include articles on international banking, the U.S. banking system, and Internet banking.

Daniel Nolle
Senior Financial Economist
Office of the Comptroller of the Currency
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Milken Institute

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OCC

The OCC's primary mission is to charter, regulate, and supervise all national banks and federal savings associations. We also supervise the federal branches and agencies of foreign banks. Our goal in supervising banks and federal savings associations is to ensure that they operate in a safe and sound manner and in compliance with laws requiring fair treatment of their customers and fair access to credit and financial products.
 

Headquartered in Washington, D.C., the OCC has four district offices plus an office in London to supervise the international activities of national banks. The OCC's nationwide staff of bank examiners conducts on-site reviews of national banks and federal savings associations (or federal thrifts) and provides sustained supervision of these institutions’ operations. Examiners analyze loan and investment portfolios, funds management, capital, earnings, liquidity, sensitivity to market risk for all national banks and federal thrifts, and compliance with consumer banking laws for national banks and thrifts with less than $10 billion in assets. They review internal controls, internal and external audit, and compliance with law. They also evaluate management's ability to identify and control risk. 

 

Office of the Comptroller of the Currency
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