Aspects of the International Banking Safety Net

G. Johnson, and Richard Abrams

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 1983
• eBook ISBN: 9781557750587

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Contents

Prefatory Note

I. Introduction

Safety Nets in Domestic Banking

Scope of the Study

II. Recent Developments

Country Risk and Sovereign Lending

Confidence of Depositors

Interbank Relationships

Regulatory Adaptations

Conclusions

III. Financial Consequences of International Banking Problems

Types of Financial Consequences

Scale of International Bank Lending

Scale of International Bank Deposits

Cost of Disruption of International Intermediation by Banks

The 1974 Bank Failures

IV. Possible Sources of Banking Problems

Country Risk

Other Risks in International Banking

Bank Liquidity and Contagious Effects

Interbank Relationships

Changes in Risk Perceptions

V. Prudential Safeguards for Bank Solvency

Bank Capital

Control of Country Exposure

International Coordination of Bank Supervision

VI. Prudential Safeguards for Bank Liquidity

Matching of Maturities

Quality of Short-Term Assets

Interbank Borrowing and Stand-By Credit Lines

VII. International Aspects of Official Support for Banks

Deposit Insurance

Financial Support for International Banks

Resolution of Bank Failures

Lenders of Last Resort and System-Wide Liquidity

APPENDICES

I. International Coordination of Bank Supervision

Background

The Basle Committee and International Cooperation

Initial Work and Concordat

Consolidation of Reporting

Solvency and Liquidity Regulation

Country Risk Assessment

Information Flows

International Cooperation and Understanding

Future Work in International Coordination

II. National Lenders of Last Resort in an International Banking System

The Lender of Last Resort

Need for Lenders of Last Resort

Criteria for the Effectiveness of Lenders of Last Resort

Motivations of Lenders of Last Resort with Respect to International Banks

Evidence on the Provision of Lender of Last Resort Services

TABLES

1. Dependence of Non-Oil Developing Countries on Borrowing from International Banks, 1977–81

2. International Bank Claims on Non-Oil Developing Countries at the End of 1981

3. Foreign Liabilities of Deposit Banks at the End of 1981

4. Country Exposure of International Banks at the End of 1981

5. Consolidated Country Exposures of U.S. and U.K. Registered Banks at the End of 1981

6. Bank Deposit Insurance Schemes in Selected Industrial Countries

REFERENCES

The following symbols have been used throughout this paper:

… to indicate that data are not available;

— to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;

– between years or months (e.g., 1979–81 or January–June) to indicate the years or months covered, including the beginning and ending years or months;

/ between years (e.g., 1980/81) to indicate a crop or fiscal (financial) year.

“Billion” means a thousand million.

Minor discrepancies between constituent figures and totals are due to rounding.

Appendix I International Coordination of Bank Supervision

During the 1960s and early 1970s, a potentially significant imbalance began to develop in the international banking system. While international banking was evolving rapidly, there was little corresponding evolution in international bank supervision and regulation. The rise in multinational banking and the increased importance of liability management in international finance had also greatly increased the integration of the world’s financial system, but national regulators had as yet devoted little attention to increased international regulatory cooperation.

National attitudes toward international banking super-vision and supervisory cooperation changed abruptly following the major bank failures of 1974. In September 1974, the Committee on Banking Regulations and Supervisory Practices (the Basle Committee) was formed at the BIS by the Group of Ten and Switzerland. This Committee was to become the most important force in the improvement of national regulation of international banking and the advancement of cooperation between national regulatory authorities.

This Appendix discusses various problems in international banking supervision and notes the progress made in regulatory cooperation since 1974, focusing on the work of the Basle Committee because of its paramount importance in this area. The presentation is divided into three parts. The first part reviews the evolution of international banking prior to 1974 and identifies gaps in national supervision of international banking and in international cooperation among national supervisory bodies. The second part examines the work of the Basle Committee and notes the progress toward effective international supervision and regulatory cooperation. This part discusses the early decisions of the Committee, with emphasis given to their most important agreement, the Concordat. Next, work in the areas of consolidation of reporting, solvency and liquidity regulation, country risk assessment, information flows, and other operational topics is examined. The part concludes with a discussion of the progress in, and the benefits from, international cooperation and understanding.

The third part discusses areas in which international cooperation in banking supervision could be strengthened within the forums already available for international dialogue. It is argued that an important gap remains in international banking regulation and cooperation vis-à-vis many countries outside the Basle Committee. Efforts to establish cooperative relationships with these countries are only now beginning to evolve. In the meantime, some banks involved in international intermediation may well not be subject to effective official supervision.

Background

International banking expanded rapidly in the 1960s and early 1970s, as banks throughout the world increased their foreign lending and opened foreign offices worldwide. Much of the expansion involved the opening of foreign subsidiaries in locations that permitted activities that were prohibited to the foreign branches of the banks. New organizational entities also began to appear. Joint ventures, often with international ownership, began to be formed, and many banking offices were opened in locations that had little or no regulation. Other areas had secrecy laws that made information unavailable to the regulators of parent banks and, in some cases, to the parent banks as well.

This period was also marked by a change in the lending strategy of many larger, wholesale banks. Rather than basing lending decisions on availability of deposits, banks began to practice more active management of their liabilities by borrowing as needed from other financial institutions to finance new loan commitments. As a result, the market for interbank funds flourished. The growth of this market increased the integration of the international financial system. With integration, problems in one part of the market could be easily and rapidly transmitted to other parts of the market.

The expansion of international banking took place with the tacit approval of most national regulatory bodies. In general, supervisors initially viewed as minimal the potential impact of these activities on domestic bank safety and monetary control. Many regulators were also willing to exempt banks’ foreign subsidiaries and joint ventures from certain domestic regulations to allow domestically based banks to provide international banking services more competitively. Prior to 1974, therefore, most regulatory agencies devoted only minimal efforts to the study of the foreign activities of domestic banks, and in some localities, the international activities of foreign-owned domestic banks were largely ignored. Although some regulations affecting international banking were enacted, most were designed to curb capital flows rather than to assure more effective supervision and regulation of international banking.

The increased integration of the world’s financial system suggested the need for greater international cooperation and coordination between national regulators, but this need was not regarded as pressing prior to 1974. This is not to say that no cooperation was present. Starting in 1960, central bankers of the Group of Ten and Switzerland began meeting monthly at the BIS in Basle to discuss monetary and economic problems. One of the outgrowths of these meetings was the Eurocurrency Standing Committee. Composed of senior officials of central banks in countries of the Group of Ten and Switzerland, the Committee was charged with examining the expansion of the Eurocurrency market. Two significant policy decisions were reached prior to 1974. The first was an agreement to refrain from placing foreign exchange reserves in the Euromarkets. The second led to considerable improvement in statistical data on international banking.²⁷ At this juncture, the focus was on the macroeconomic implications of market operations rather than on questions of adequate supervision and market stability.

On the supervisory front, an important early advance toward international cooperation took place within the European Community in the form of the Contact Group. This Group, made up of national supervisory authorities and founded in 1972 by members of the Community as an independent consultation group, has subsequently met periodically and informally to foster mutual understanding and practical cooperation.

Nevertheless, the perceptions and techniques of banking regulators were not keeping pace with the integration and adaptations of the world’s financial system. Supervisory techniques were primarily domestically oriented, and systems to oversee banks’ international operations were not yet fully developed. The difficulties following the international banking problems that emerged in 1974 not only highlighted problems in national regulatory and supervisory policies but also raised doubts about the viability of the international financial system. These problems were confronted in July 1974 at the regular meeting of central bankers at the BIS two weeks after Bankhaus I.D. Herstatt’s failure. In September 1974, the Governors issued a communiqué assuring the international banking community that the infrastructure for the provision of the services of lender of last resort to international banks had been created, and such support should, if necessary, be forthcoming. At the same time, “the Governors concluded that a better co-ordination of the surveillance exercised by national authorities over the international banking system was necessary, and to that end they created a new standing committee—the Committee on Banking Regulations and Supervisory Practices—with members drawn from the Group of Ten major industrialised countries and Switzerland” (Cooke (1981), p. 238). The Committee is often referred to as the Basle Committee; it is also known by the names of its chairmen, originally George Blunden and currently Peter Cooke, both of the Bank of England.

The Basle Committee and International Cooperation²⁸

Initial Work and Concordat

The Basle Committee was initially charged with developing international early warning systems and identifying problems in national banking systems that could have international repercussions. It was also authorized to examine the condition of the international banking system, coordinate supervision across national boundaries, and respond to international banking problems as they arose.

During the Committee’s first year, understandings were reached on several important matters, including at the outset a definition of the Committee’s two primary objectives: “The first was the need to adapt the national supervisory system within each country in order to cope with the wider dimensions of their major banks’ businesses. The second and complementary task was the promotion of close co-operation between national authorities in monitoring the activities of the overseas branches, subsidiaries and affiliates of their own banks, and the offshoots of foreign banks in their own territories” (Cooke (1981), p. 239). The members also determined that the Committee could be used as a forum in which national supervisors could discuss and learn each other’s techniques and consider problems emerging in different national systems. The fostering of close, personal contacts between supervisors was to prove to be an important service of the Committee, since this permitted, inter alia, more rapid and effective cooperation when banking problems crossed national jurisdictions.

A portion of the Committee’s early work involved defining the limits to international cooperation. Recognizing that banking supervisory procedures vary in reflection of national history and differences in national legal systems and that these systems were viewed as a national prerogative, the Committee decided not to press for standardization of national regulatory procedures (Blunden (1977), p. 326). Second, as a corollary, the creation of a supranational regulatory authority to provide an early warning system was deemed to be neither feasible nor necessarily desirable. This partly reflected the concern that such an agency would result in a wasteful duplication of regulatory efforts. The Committee therefore decided that any type of early warning system should be handled through informal consultations among individual members of the Committee or associated groups.

The Basle Committee next directed its efforts to the demarcation of responsibilities of national supervisory authorities in international banking. These efforts resulted in the Concordat on international supervisory cooperation,²⁹ which was endorsed by the participating Governors in December 1975. The principal guidelines of the Concordat, as summarized by Cooke (1981, p. 240), were as follows:

• The supervision of foreign banking establishments should be the joint responsibility of host and parent authorities.
• No foreign banking establishment should escape supervision, each country should ensure that foreign banking establishments are supervised, and supervision should be adequate as judged by both host and parent authorities.
• The supervision of liquidity should be the primary responsibility of host authorities since foreign establishments generally have to conform to local practices for their liquidity management and must comply with local regulations.
• The supervision of solvency of foreign branches should be essentially a matter for the parent authority. In the case of subsidiaries, while primary responsibility lies with the host authority, parent authorities should take account of the exposure of their domestic banks’ foreign subsidiaries and joint ventures because of the parent banks’ moral commitment in this regard.
• Practical co-operation would be facilitated by transfers of information between host and parent authorities and by the granting of permission for inspections by or on behalf of parent authorities on the territory of the host authority. Every effort should be made to remove any legal restraints (particularly in the field of professional secrecy or national sovereignty) which might hinder these forms of cooperation.

It should be noted that the provisions of the Concordat related only to banking supervision and not to the allocation of responsibilities of lenders of last resort among national authorities. Unlike the case with banking supervision, national authorities have deliberately avoided any formal, public delineation of the relative responsibilities of lenders of last resort. This reflects the traditional reluctance of lenders of last resort to specify in advance the extent and nature of the support they are prepared to offer under particular circumstances. The question, however, has not been ignored. In the BIS communiqué of September 1974, for example, the Governors “recognized that it would not be practical to lay down in advance detailed rules and procedures for the provision of temporary liquidity. But they were satisfied that means are available for that purpose and will be used if and when necessary.”

The Concordat represented a significant advance toward generalized international regulatory cooperation. The Concordat, however, was not without its shortcomings. In the words of Peter Cooke, “it should be stressed, though, that the Concordat’s guidelines are not fully implemented in practice and certainly not in law, and there remain areas where the division of responsibility is not entirely clear cut and where banking secrecy provisions are to a degree an impediment to its effectiveness” (Cooke (1981), p. 240).

The Concordat received additional attention in 1979, when its contents were outlined before the supervisory authorities of more than 80 countries at the International Conference of Banking Supervisors in London, hosted by the Bank of England, in association with the Basle Committee. Subsequently, supervisors of major offshore centers were invited to meet with the Basle Committee in October 1980, and on this occasion, the principles of the Concordat were generally accepted by the representatives of the supervisory authorities present. Thus, the landmark guidelines embodied in the Concordat have received a significantly wider international understanding and acceptance.

After establishing this broad framework for the international coordination of banking supervision, the Basle Committee devoted its efforts to several specific areas of banking supervisory practices. Reflecting the nature of the 1974 bank failures, for example, its first topic of discussion was standards for foreign exchange trading by banks. These discussions resulted in implementation of improved standards in the supervision of foreign exchange trading practices.

More recently, major topics of discussion have included consolidation of the reporting of solvency, monitoring of solvency and liquidity, analysis of country risk, and flows of information.

Consolidation of Reporting

In recent years, the Basle Committee has devoted much effort toward reaching a common understanding on the need for consolidated reporting requirements (i.e., reports on the financial position of the parent bank, overseas branches, and subsidiaries taken together). Its conclusion has been that supervisory authorities cannot be fully assured of the soundness of an individual bank unless they can be assured that the banking group’s total commitments and risks on a consolidated basis are not disproportionate to the group’s capital base (Baeyens (1979), p. 43).

Supervisors in many countries have long examined their domestic banks by consolidating the parent offices’ balance sheet with those of its branches. Even where they do not, the potential problems are usually minimal, since in practice foreign branches usually follow the same general prudential...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Prefatory Note
• I. Introduction
• II. Recent Developments
• III. Financial Consequences of International Banking Problems
• IV. Possible Sources of Banking Problems
• V. Prudential Safeguards for Bank Solvency
• VI. Prudential Safeguards for Bank Liquidity
• VII. International Aspects of Official Support for Banks
• Appendices
• References
• Footnotes