Transaction Banking and the Impact of Regulatory Change

Basel III and Other Challenges for the Global Economy

R. Wandhöfer

• Publisher: Palgrave Macmillan
• Year: 2015
• ISBN:
  9781137351777
• Topic: Commerce
• Subtopic: Services financiers

This book takes you on a journey through post-crisis regulatory reform, highlighting the unintended consequences of some of the measures on transaction banking, a business that provides the backbone of financial markets.

1

Regulation and Transaction Banking: A journey through a relationship at the crossroads

Since banking has been public enemy number one for the last few years, little has been said about the relevance of banking to the real economy. Having witnessed the financial meltdown over the last few years, and having been closely involved in following, analysing and discussing the set of regulatory measures that followed – and continues to pour out from various committees, institutions and governments – I felt that writing a book dedicated to the topic of regulation and banking to be a rather appealing and interesting project.

Banks continue to be the focus of attention and supervisors continue to get tougher and tougher with their fines. A great example is the UK supervisor, which fined Credit Suisse GBP £4 million in 2002 for attempting to mislead the Japanese regulatory and tax authorities in the nineties. In 2013 they fined RBS GBP £87.5 million for misconduct relating to the Libor. A mere 2000 % increase in the level of fines over just little more than ten years – clearly adjusted for inflation, or rather over-adjusted. US bank fines have been extraordinary so far: HSBC $1.9 billion in 2013, Credit Suisse $2.6 billion in 2014 and BNP Paribas with a fine of $9 billion in the same year.

It turns out, however, that not all banking is necessarily bad; indeed, despite the known culprits, certain bank businesses are quintessential to the well being of the world economy. Transaction banking is a business that had just about nothing to do with the financial crisis and it is a business that provides the fundamental basis of financial markets and the real economy by moving money, securities and trade finance flows around the world. Writing about this particular business in light of the explosion of regulatory measures, developed to ensure that a systemic crisis of the scale of 2007 can be prevented in the future, is to my mind a necessity. And the reason for this is that many of the new bank regulations can often have unintended consequences on a business that needs to be able to continue to deliver the service of connecting the world’s financial flows.

When searching the term ‘transaction banking’ on the Internet, it turns out that there is no clear definition of this area of banking. There are more general definitions that explain the nature of ‘wholesale banking’, which is close, but not right to the point. This is one of many indicators of the fact that the mainstream lacks an understanding of what this business actually does. Regulators are often also not aware as to the specific role of this business, which of course threatens to become a major problem when detailed rules and regulations are defined.

At the same time, the amount of regulations that have been developed since 2007 is mind-boggling. The problem here is that on the one hand regulators have been designing more and more detailed legislation for banks as a measure to avoid future crises, but in doing so regulators had little time to concentrate on the different business models and services that banks provide. The plethora of reforms that have been issued are now the major focus of banks with significant resources and time being spent in order to understand and be able to comply with the broad set of measures. Furthermore, the political arm of the regulatory decision-making process has played an increasingly important role and often contributes to modifying initial proposals in significant ways. In this regard, to ensure a future proof and impactful legislative framework, political long-term objectives continue to be a crucial element of the reform, such as economic growth, employment, stability and resilience of the banking industry, etc. In the broader context banking is one of the pillars that supports the economic cycle, which is why governments are taking great care in the design of legislation as well as enhanced supervision going forward.

In Chapter 2 I will introduce the background of the large scale of regulatory reform that the banking industry is faced with. An outline and brief analysis of key regulatory developments that target financial stability, customer protection, and standardisation and harmonisation will be given to that effect.

Then I will move on to an in-depth explanation in Chapter 3 of what transaction banking actually is. Essential services such as payments, trade finance, securities settlement, issuer and fund services as well as liquidity management are all part of this field of services and regulators should be careful when designing broad one-size-fits-all measures that could unintentionally impair the delivery of these services.

In Chapters 4 and 5, I develop two areas in the form of regulatory case studies, one global and one regional.

First I will focus on Basel III. This broad Accord of prudential rules is complex and requires detailed analysis in order to assess its implications. My objective is to provide a clear and easy to understand version of what regulators have developed at a global level, in order to reform banking and help ensure financial stability.

The second case study, this time of regulation that directly impacts transaction banking, comes from the area of payments legislation. For those readers that have already been eagerly awaiting a sequel to my first book, EU Payments Integration, I will discuss the continuing evolution of the European payments landscape in light of equally continuous regulatory measures. Here, the European rules to harmonise the payments landscape with SEPA and the Payment Service Directive will feature as examples of significant regulatory measures in this area. Consequences and challenges for users of payment services, in particular corporate clients, are being assessed in detail with potential measures for remedy being outlined. Interestingly, the European ideal of consumer protection in payment services has made its way across the Atlantic. Hence I will also provide an account of the US payments environment, where regulation of cross-border funds transfers will be subjected to detailed analysis and comparison with some features of European legislation.

I then go on to analyse the effect of the regulatory reform agenda in Chapter 6, in particular Basel III but also many other identified laws and regulations, on the key business areas of transaction banking. Having identified a number of unintended consequences on this business I will also provide several solutions that would need to be put into action. This section will be of practical advice for the reader (including regulators), on what provisions and angles in the regulatory space will need tweaking to ensure continued and unimpaired provision of vital transaction banking services.

The overall implications of regulatory change, both in terms of positive stabilising consequences as well as with a view to cumulative impacts on the broader economy, will need to be considered carefully. In many regions of the world economic recovery is an important imperative. Transaction banking provides essential support for economies around the globe. The continued delivery and viability of these types of services will be important towards the objective of economic progress and development. Measures that risk to impair transaction banking could have direct implications on the economy, some of which may not be intended.

In conclusion, in Chapter 7 I review the key learnings, summarise some of the identified problems encountered and propose a set of measures to solve these. I suggest an alternative model for prudential regulation of banks and propose solutions to various questions including that of being ‘too big to fail’. It is clear that the culture of the banking industry has to change, but in addition to that, more transparency and standardisation, clearer principles, closer cross-border co-operation of regulators and governments and protection of consumers combined with full responsibility of investors can help to create an environment where even large banks can continue to operate without creating the risk of global financial breakdown.

For the transaction banking space in particular, the creation of local ring fencing, bank subsidiarisation and other measures to increase local government control over a foreign bank will threaten to destroy the global network, which the economy so vitally relies upon. There are other ways that can bring more stability and certainty without removing the benefit that global transaction banking provides.

So, all that remains for me to say is that I wish you an interesting, stimulating and, hopefully, rather pleasant reading experience from which you will have taken away key learnings and insights that may be of use in your day-to-day life, whether you are a practitioner, regulator, politician, supervisor or student. As we will see through the course of this book the regulatory reform process plays the important role of stabilising the banking industry with a view to significantly reducing the risk of future crisis. Whilst the path will be long, it is clear that regulatory change is essential to achieve this goal.

2

Post-Crisis Regulatory Change

Introduction

I will look at two building blocks: regulatory reform and transaction banking. We will begin with an overview and analysis of the plethora of banking regulation that is focused on the bank as a whole. Usually known by the term ‘prudential regulation’, the regulation of deposit-taking institutions aims to ensure the safety of customer deposits and stability of the financial system. This overview will constitute the background to understanding and analysing the potential impact and implications of all these changes to the business of global transaction banking. The overview will be followed by an in-depth explanation of what transaction banking services actually are – payments, trade finance and securities services – and how these services support the real economy at a local, regional and global level. Armed with these insights we can then analyse the effect of key regulatory reforms, such as Basel III, in the following chapters. Given the many uncertainties in the implementation of new banking regulation, this analysis cannot cover every consequence for transaction banking. However, it provides an essential overview of the key regulatory pillars that support banking services today and how these are impacted by twenty-first century law reform. Alongside the many intended consequences, there is also a risk of unintended consequences that some of these reforms could bring for the transaction banking business and thus the functioning of financial markets as well as the and growth of the global economy overall.

Post-financial crisis, the amount and speed with which regulatory change is being proposed and pushed for implementation is impressive. We are still in a phase of continued implementation of measures as well as ongoing design of new legislations, which means that the regulatory reform agenda is still in motion.

Even though international coordination of regulatory reforms has substantially increased – and we will review the new global regulatory architecture below – the array of regulatory developments is slowly but surely creating barriers to international finance, in the absence of a full analysis of their potential impacts on a deeply globalised, interconnected and digital world where business and financial flows are expected to be ubiquitous and far reaching. The regulatory floodgates have been opened far and wide but no one really knows at this stage what this will mean.

In the old days, banking followed the simple pattern of, as the English put it, ‘Borrow for £3, lend for £4 and go to the pub at 5 o’clock!’ As it turns out, history has changed the course of this traditional banking business. Classical bank lending no longer generated sufficient revenue for banks and this is not a recent phenomenon. In consequence, some banks began to look into other ways to make money and in several cases this involved taking more risks. But it is clear that a number of factors played a role in pushing the overall systems into crisis.

So let us now review some of the current regulatory proposals and high-level decisions that have thus far been put forward and partially implemented in reaction to the financial crisis; a crisis that is also often understood to be a US–European crisis, rather than a truly global one. After all, Latin American and Asian markets already went through their own crises during the 1990s and early 2000s, although even today the stability of some emerging market countries is certainly not a given.

To my mind, some of the regulatory changes will have the power to completely change the face of banking … and regulators, supervisors and politicians will need to consider the consequences and factor them into their future policy approach. For me the key question really is whether there is a future for global banking in any shape or form once the current list of regulatory measures – which continues to evolve – is implemented. In that regard, this book will also constitute a reminder of the benefits that a global universal highly diversified banking structure brings to the economy and how a mix of bank models ranging from small, medium and large with de-centralised or centralised set-ups actually supports the overall resilience of the global financial market.

2.1What is in store for the global banking industry

The first set of measures proposed in response to the financial crisis was a revision of the international framework for prudential supervision, or what we call for short ‘Basel III’. The key amendments to the existing framework were focused on improving the quality and quantity of bank capital as well as introducing liquidity requirements and a cap on banks’ leverage. We will examine the Basel regimes in detail in Chapter 4 of this book.

One could argue that if banks were to follow Basel III, not many additional reforms would be required, as more capital and more liquidity combined with leverage limits should really do the job and create a streamlined and stable safety buffer for the global financial industry. However, once the process of regulatory reform was initiated, the breadth and depth of measures continued to increase.

In the current state of affairs (2014) the banking industry is faced with a myriad of regulatory measures, which broadly fall into three categories of policy objectives:

I. Financial Stability

II. Consumer/Investor Protection

III. Standardisation/Harmonisation

Some measures along these policy objectives have been developed and endorsed at global level (G20), whilst others are more specific to certain countries or regions such as the European Union or the US. Let’s look in more detail at a selection of key measures in these categories and understand the challenges, benefits and potential consequences of implementing them.

I. Financial Stability. Measures to address and improve financial stability, that is the resilience of banks, with the objective of limiting risks of future financial crises and bank bailouts, broadly cover the following areas: the Basel III Accord, the Recovery and Resolution regime for financial institutions (so-called ‘living wills’), mandating central trading and clearing of OTC derivatives and most recently measures to ring-fence certain bank operations in order to reduce the risk of taxpayer money being spent for bailout purposes. Structural reform and limitations on certain bank activities, such as proprietary trading with the US Volcker Rule and proposals by the EU that go along similar lines add to this list. Furthermore, discussions around changing the behaviour and freedom of internationally operating banks by trapping liquidity and capital in local legal entities are becoming more and more a reality, threatening the efficient cross-border operation of financial markets at their core. The question of how to deal with ‘too big to fail’ banks remains unanswered as long as close international cooperation is not being progressed.

Bank supervision is another area that is being strengthened. In particular, the experience of the Eurozone crisis has led to an approach of more centralised supervision of large European banks by the European Central Bank (ECB) via the Single Supervisory Mechanism (SSM).

In parallel, compliance requirements around Anti-Money Laundering (AML) and Know Your Customer (KYC) continue to be fragmented but are further increasing in toughness, especially when it comes to regulatory fines for non-compliance.

Rules on intraday-liquidity monitoring – also laid out by the Basel Committee on Banking Supervision (BCBS) – raise another significant challenge, which has yet to find a practical solution for implementation.

II. Consumer/Investor Protection. One of the objectives of consumer protection post crisis is to reduce the likelihood of taxpayers having to pay for a bank’s failure through bailouts. In addition to strengthening banks at the core via measures introduced to support financial stability, specific actions to further protec...