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By Robert Lyddon, General Secretary of IBOS

The issue is the introduction of the Net Stable Funding Ratio (NSFR), which aims to avert a repeat of scenarios such as those that brought about the downfall of Continental Illinois National Bank in 1984 and the UK’s Northern Rock in 2007, where banks were running a large mismatch of the final maturity of assets and liabilities.

In future, banks must run a much closer match of the final maturity of assets and liabilities and not just a match of interest re-set period. The typical international or syndicated loan based on the London Interbank Offered Rate (LIBOR) falls foul of this: a five-year life with the rate re-set every three months.

Future of Bought Money Banks

International banks have generally been bought-money banks other than in their home markets. Their stress has been on loan production, with loans funded in the interbank market in the country concerned and in local currency – or else the branch runs a very small loan book funded just with the deposits it can attract direct, and then concentrates on foreign exchange (FX), import/export business, guarantees and other non-funded business.

An international bought-money model could still work if the main funding comes from head office as cross-border inter-branch loans, and if it is permissible to comply with the net stable funding ratio (NSFR) at group level, and not at each branch.

However, this sort of arrangement is subject to the complexities of withholding tax on interest paid cross-border by a branch to its parent and could be costly, unless the parent had such an excess of funds that it was willing to lend them to the branch at a generous rate – in effect a rate in which the impact of withholding tax was neutralised for the borrower.

Curiously the current interest environment could support this for the time being: even if the withholding rate were 25%, interbank rates in US dollars, euros and pounds (USD/EUR/GBP) are so low that the impact could possibly be swallowed on a current basis, with the parent able to reclaim/monetise any deductions under applicable Double Tax Treaties later on.

However, an added limitation is where the local currency of the branch is not USD, EUR and GBP, and where other circumstances prevail:

  • There is no active FX forward market in the currency concerned either in-country or where the parent is, or the forward spreads are wide.
  • Consequently it is costly, or impossible, to create synthetic liabilities in local currency.
  • There is no direct demand for loans in foreign currency, or where those loans attract location-specific taxes or charges.

Impact of Compliance at Foreign Branch Level

Assuming that the branch had to comply itself and it is a bought-money bank, it could only lend with approximately the final maturity of the money it buys – with three- or six-month bought money it cannot go out along the final maturity curve to obtain higher yield.

To obtain an equivalent margin in the three- or six-month loans, it has to go right down the credit risk ladder, but then the credit conversion factor (CCF) on the loan would tie up too much capital.

Overseas Branches

A further complication is the trend among overseas branches of banks being converted to subsidiaries. The rationale derives from the UK’s Vickers Report and has been taken up by Volcker in the US and Liikanen in the European Union (EU).

It is the question of who pays out the depositors in the foreign operation should the operation go under. There is a strong tie-in with the new mantra of ‘home markets’ for where banks will operate geographically, a mantra derived from the government as a bank’s prime regulator:

  •  As we bailed you out, you can concentrate your resources here.
  •  We don’t want you growing abroad and then going under again.
  •  We would then be bailing out foreign operations and customers.

Overseas expansion via subsidiaries means it is the local regulator and deposit-insurance scheme that have to bail out this locally-incorporated bank, not the country of the parent bank.

Individual Capitalisation and Funding

Subsidiaries would need to have individual capitalisation and attract their own deposits. The parent entity becomes more of a holding company than a bank in its own right – this is already the US model, where organisations such as JPMorgan Corp or Citicorp are not themselves banks.

In the subsidiary model the subsidiary has to comply maintain its NSFR in its own right.

Splitting ‘Safe’ Retail Banking from ‘Risky’ Investment Banking

The outcome of Basel III adds fuel to the fire of the main fallout from Vickers/Volcker/Liikanen: making sure that retail and small business depositors do not get burned if investment banking goes under. The fact that governments do not then get burned in turn is the pleasing (to them) secondary effect.

Retail banking sits within the so-called ‘ring-fence’ and investment banking outside. Investment banking cannot borrow from retail banking: it has to get its own funding. Both sides have to maintain a NSFR.

Core and Non-Core: EBA Stress Tests

Were that not sufficient, the European Banking Authority’s (EBA) stress tests require the beefing -up of banks’ capital with three options open as outlined below – of which only one can be accomplished without serious obstacles:

  1. Issue new shares (no buyers other than at a very deep discount).
  2. Cut lending (however governments want banks to increase lending to retail and small business in their home market).
  3. Sell non-core assets.

Furthermore, in accordance with the ‘four legs good, two legs bad’ approach of ‘Animal Farm’ apparently being adopted by governments and regulators:

  •  Core assets are those in home markets (and are probably large).
  •  Non-core assets are in foreign markets (and are probably smaller).
  •  When large quantities of money are required quickly, ‘core’ can suddenly be re-classified as ‘non-core’.

Combined Impact on ‘International’ 

Two ‘blue’ banks have responded by conflating international with investment banking:

  • The international branch network will be run by investment banking.
  • A main role is to get the funding for the investment bank so it can maintain its NSFR.
  • Only global clients are allowed to have accounts in the international branches.
  • What happens to the little guy?


NSFR reinforces several other regulatory and political initiatives to dissuade banks from engaging in international banking and investment banking and, by definition, in long-term loans.

By implication it dissuades banks from engaging in corporate and institutional banking, because they are activities involving international and investment banking, and long-term loans.

Read the full article here.