Related reading Britain tightens grip on foreign banks

Brooke Masters

The Economist, December 2012

The UK’s chief financial watchdog has sharply tightened its grip on overseas banks that want to take deposits in Britain, pressuring them to open locally-regulated subsidiaries with their own access to cash and capital. The Financial Services Authority is at the forefront of moves by global regulators to force the arms of overseas banks to have separate capital and liquidity to protect depositors and taxpayers from a bank collapse. Since 2007, the FSA has allowed just four banks to open branches, which rely on their parent for capital, while approving 14 new subsidiaries and six new UK-only banks, according to new statistics obtained by the Financial Times. Five of the subsidiaries are arms of banks that previously had branches.

US Federal Reserve officials are also talking about imposing tougher capital and liquidity standards on overseas banks and US and UK regulators on Monday will unveil proposals to force their biggest banks to hold capital at the group level so that foreign and domestic subsidiaries could be kept open even if the parent goes bankrupt. The moves are aimed at protecting depositors and preventing a repeat of the financial crisis, but bankers and industry analysts say the statistics are an early-warning sign that the global market in financial services is fragmenting, potentially driving up lending costs and forcing international banks to pull out of some markets. The FSA’s push started in 2008 when the UK government had to step in to protect British depositors in branches of Icelandic banks that collapsed. Its drive has accelerated recently. In September, the FSA announced plans to force non-European Union banks to use subsidiaries if they are from countries such as the US and Australia that give preference to home depositors in the case of a bankruptcy.

For many banks, though, operating through a subsidiary is more expensive. China’s largest state-owned banks recently wrote to the UK Treasury complaining about the FSA’s refusal to let them open branches and said they were routing business to Luxembourg instead. “Local banks will have a clear advantage over foreign banks,” said Ernie Patrikas, a former US bank regulator now with the law firm White & Case. “Subsidiarisation would be the end of international banking.” The watchdogs argue that customers of subsidiaries are covered by their home deposit insurance schemes, and local regulators keep closer tabs on banks in their jurisdiction.

Andrew Bailey, who heads prudential regulation at the FSA, told a Parliamentary committee last month that he would also like to seek an exception to EU rules that in theory allow any bank from the 27-nation bloc to open a London branch. “I do not think that a bank should be able to branch in and the host authority have to accept it come what may,” he told the Banking Standards Commission. Several banks privately cited FSA’s initiative as a key reason for their decision to open subsidiaries. Bank of Ireland, Bank of Ceylon and Bank of Cyprus all converted from branch status, while Macquarie and Bank of China opened subsidiaries alongside their branches. A sixth branch, Cyprus Popular, is in the process of converting to a subsidiary. An executive there said the FSA “exerted pressure” by suggesting that if they failed to make the switch, they would have to write each customer warning that their accounts were not covered by UK deposit insurance. A top executive at an EU bank that continues to operate as a branch said he has regular conversations with the FSA on the topic. “More and more questions are being asked about our ability to manage liquidity,” he said.