An “America First” trade-in-goods policy means a similarly protectionist U.S. approach to trade in finance, including banking. However, such a financial trade policy would not construct impregnable armor that strengthens the U.S., but would rather be something akin to Superman’s “Fortress of Solitude.”
After having cut himself off from the rest of the world, Superman would return from his fortress to the civilized world feeling refreshed. But that’s just in the comic books. In real life, a Fortress of Solitude for U.S. banking would lead to the lowest common denominator of regulations imposed differently by each country, which in turn would quickly crumple the financial stability on which even the smallest community banks depend.
One day after Federal Financial Analytics issued a brief on increasing protectionism in global financial services trade — which was reported on by American Banker — the European Union’s top finance official made very clear that the EU would retaliate if the Trump administration were to divorce the U.S. from the cross-border financial regulatory framework.
These comments might lead one to assume that Europe is determined to maintain its own Fortress of Solitude from banks in the U.S. and the U.K. — which is experiencing its own protectionist wave with Brexit — that EU officials fear would be poorly regulated. But in fact, the EU’s regime is often less stringent than either the U.S. or U.K. Even more importantly, it’s completely dysfunctional on the most critical financial-stability question of all: how to ensure that weak banks fail without taking their sovereign governments along for the ride.
What is really at the heart of the EU’s concern is a long-established principle of cross-border trade in financial services: If we can’t operate freely in your country, then you’re out of ours. Other critical trade-in-finance centers, especially those in emerging markets and China, are at least as bound by this principle, often establishing express barriers to entry with little regard for safety and soundness.
The more the U.S. isolates itself from trade with these formidable competitors, the faster and more certainly they will buttress their own financial fortresses, widening the moat and adding a few pikestaffs just in case the U.S. misses the point.
President Trump’s first few weeks in office demonstrate that he tries to do what he promised on the campaign trail. He is also influenced by what top congressional Republicans think, and most join him in opposing continuing U.S. participation in global bodies such as the International Monetary Fund and the World Bank. The president’s Feb. 3 executive order on financial reform set out a principle to “advance American interests in international financial regulatory negotiations and meetings,” presumably referring to the Financial Stability Board and the Basel Committee. The tenor seems aimed squarely at enhancing U.S. competitiveness, not at crafting the global framework demanded after the 2008 crisis.
A global rulebook that advantages American banks would of course be one stoutly opposed by other nations, including even very close allies such as the U.K. These allies also joined with other nations in strong opposition to U.S. efforts, prior to Trump’s election, by the Federal Reserve Board to force large foreign banks into intermediate holding companies. Recent statements about putting foreign branches under U.S. capital regulation are even more antithetical to the position of foreign companies and their governments.
To be sure, increased scrutiny of global agreements on financial services could bring benefits.
Up to this point, U.S. regulators have not only largely adhered to the global framework, but often “gold-plated” it to make the U.S. standards still tougher without a clear rationale for why U.S. banks are riskier than their peers. That gold-plating has consequences. Each of these global rules is piled into the broader framework of U.S. requirements without clear-eyed, transparent assessments of cumulative cost. For example, does the U.S. really need the net stable funding ratio given all the other Basel and U.S.-specific liquidity standards?
With fresh eyes at the Trump administration and in some of the U.S. regulatory agencies over the next few months, a full review of the body of post-crisis rules should identify those that are unlikely to meet their intended objectives, are unnecessary in light of other rules, or can be tailored to the U.S. without risk of destroying a body of global rules critical to efficient, prudent cross-border finance.
But going too far in closing off the U.S. from the global financial system would have drastic fallout.
Some cross-border capital flows are complex ones conducted through esoteric financial instruments that rely on structured foreign-exchange transactions, complex clearing arrangements and giant lending facilities. Others are straightforward, such as remittances and cross-border purchases. Regardless, all are vital to the institutions and families that rely on them. Added costs, impediments to efficiency, or even prohibitions to transaction execution are immediate challenges that could worsen under a protectionist policy, threatening financial institutions for which these cross-border products are core to franchise value.
Added barriers to cross-border finance would also threaten financial stability. Cordoning off a foreign bank’s operations in the U.S. or doing the same abroad to a U.S. bank traps capital and liquidity in regulator-dictated subsidiaries. With subsidiarized banking, each host country hopes to build its own fortress banking system, subsuming under its authority both domestic companies and foreign companies doing business within their borders.
From each host country’s perspective, trapping capital and liquidity within borders makes individual jurisdictions within the global banking system safer, but it surely makes the global financial system as a whole a lot more fragile. Under stress, regulators will raise the drawbridge to keep all of the resources they can under their own control.
Finally, barriers to cross-border banking are simply bad for U.S. banks’ bottom line. The U.S. now enjoys a trade surplus when it comes to international banking, one that’s good not only for U.S. employment, but also for the franchise value of cross-border financial companies. These aren’t all giant banks. Many small banks rely on trade finance, remittances and similar products for a significant percentage of their revenue base, with some small banks designing their franchises exclusively for international banking.
So what should banks now do, not only to preserve their ability to provide cross-border services but also to the financial stability on which they depend?
First, bankers should identify their own stress points in the fast-changing framework of protectionist policy on trade in goods and financial services. This is particularly critical for banks with large exposures to countries targeted by the Trump administration for trade sanctions, those being cited as currency manipulators and those showing an increasing willingness to sanction U.S. banks before the Trump plan even advances. Banks looking for M&A opportunities must take this strategic challenge on with particular urgency.
Second, it is time for the industry to revisit the shape of global financial regulation and resolution. This is not limited just to the safety-and-soundness terms that have understandably dominated discussion since 2008.
Now, we must also ensure that the structure of home- and host-country rules permit free flows of capital without putting core national interests (e.g., cybersecurity) at risk. Do U.S. banks have a position on subsidiarization at home and abroad? What about the implications of a Nafta rewrite on financial relationships through funding flows and subsidiary banks in Mexico? Is the harmonious flow of capital between the U.S. and Canada safe in this trade environment? What about the critical EU market, including from the standpoint of how Brexit redefines the Eurozone?
The rapid fire of U.S. and global actions redefining cross-border banking shows that standing by and letting governments slug this out could do a tremendous amount of collateral damage to individual banks and the banking system more generally.