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By Bob Lyddon, General Secretary, IBOS Association, London, UK

Government and regulator action to de-risk the banking industry continues apace.  Basel III, the European Banking Authority Stress Tests, FATF 2012 Recommendations and regional implementations such as the 4th European Union (EU) Anti-Money Laundering Directive all contribute to this trend.

The only problem with de-risking is that banks have to take risks in order to offer services and deal with customers, and that the risks increase disproportionately when either the services or the customers are sophisticated or both.

Regulator action derives from government policy, where de-risking is synonymous with:

  • do your business in our country because it was us and our taxpayers who bailed you out;
  • customers are retail customers and small to medium sized entities (SMEs), they are simply structured and can be met face-to-face;
  • your main business is lending.

To this last point, we are seeing the dismantling of the Bancassurance concept that has been key to banks like Lloyds TSB in the UK and the main continental banks. KBC in Belgium has been forced to sell off several in-house insurance companies, as well as its Polish subsidiary, in order to please the EU and do penance for the state support it received. Lloyds is in full retreat from the one-stop-shop concept that included insurance and pensions: the sale of Scottish Widows to Aberdeen Asset Management is the latest divestiture.

Government policy to split and ring-fence the safe retail banking (as practiced by Northern Rock, Britannia, Bradford & Bingley) from the casino-like investment banking has led to Barclays’ stated policy regarding their overseas units in Europe and Asia-Pacific, that these presences are to raise the separate funding needed by the investment bank: it is no longer about serving the corporate client with international commercial banking services.

The historical proposition to both the retail and commercial customer – “I can offer you all the financial services you need at one point-of-entry” – is reducing: neither offering will be universal in its scope, neither geographically for the commercial side nor in terms of product scope for the retail side.

The one that should be of greatest concern to governments is international banking for commercial customers. Governments have shown themselves to be keen on Foreign Direct Investment (President Obama declaring that America is “open for business”). The EU recently held another summit on how to fuel economic growth. The Single Euro Payments Area – supposedly going fully on stream on 1February 2014 – aims to enable SMEs to trade more actively cross-border within the EU. The UK government repeatedly points to the SME sector as the engine for job creation.

These statements are all well and good, but you need a bank account to trade in a country, and a bank to run it for you. The EU might well counter this by saying that the freedom to incorporate anywhere in the Single Market combined with Single Euro Payments Area should allow SMEs to trade without national level bank accounts. This may be fine for small SMEs or SMEs whose trading is distributed over many EU countries and remains small in each, but it is not fine for:

  • SMEs that generate considerable sales in one EU member state;
  • SMEs that trade with counterparties (like governments) who resist making cross-border payments;
  • SMEs in certain industry sectors known for distance selling;
  • SMEs invoicing in currencies other than the Euro.

While Brussels may be talking about integrating the Single Market, member state governments are introducing various bureaucratic and reporting measures to make it more burdensome to operate as a non-resident at all and at least to make it difficult to sell without holding an in-country bank account. An example would be Italy’s requirement for non-residents to obtain a non-resident tax ID.

Having made it essential for customers to hold bank accounts, governments and regulators are putting every possible barrier in the way of customers getting them. On a visible level this is caused by their compelling banks to sell or close their foreign operations. On a less visible level it is the effects both of FATF 2012 and its implementation. In all of this the sector that will suffer most is the SME sector, noting that:

  • if the parent company is an medium sized entity, the sales in any one foreign country will make it look like an Small Entity (SE) to the bank running its account there;
  • if the parent decides to open a local subsidiary, that will also be an SE;
  • to the bank in that foreign country the ultimate beneficial owners will all be foreign, whether the local account is owned by a resident or non-resident, as will most if not all of the principals and the signatories.

Let’s start with the most visible sign of a bank being compelled to reduce its international footprint. A recent high profile case is RBS planning to reduce its holding in its Citizens Bank subsidiary in New England, initially in the form of an Initial Public Offering of 10%-20% of the shares in a few years’ time.

This move is linked to the driver mentioned at the start of this article “Do your business in our country because it was us and our taxpayers who bailed you out”. It could equally derive from Basel III or the European Banking Authority Stress Tests. The application of Basel III has shown most banks to be undercapitalised for the risks they are running – de-risking the banks would then be achieved by their running a lower risk-to-capital ratio. The European Banking Authority Stress Tests showed the 100 biggest European banks to be running too much risk compared to their capital. The ubiquitous prescribed medicine is:

  • raise more capital by issuing shares (impossible. The market is unreceptive; any new issuance would have to be done at such a deep discount as to hardly raise any more capital);
  • cut lending (no, your main business is lending – see above);
  • sell off non-core assets.

Non-core = insurance and international, given that core business is lending to domestic consumers and SMEs. There is a reasonable market for insurance assets, because you can sell them to insurance companies. The problem arises with the international banking assets, when all the other 99 biggest players are also sellers, so your only buyer of a foreign banking asset is a smaller bank in that specific foreign country that is not trying to raise capital itself. Small buyer’s market = low price.

In order for the bank to raise its capital the non-core asset has to be sold for more than its book value: if it sells for below the book value, the transaction causes a write-off and reduces capital. In such a situation – and with the clock running – it is the best assets that go up for sale because they can be sold quickly and for above book value. All that is then needed is a quick re-write of the group’s strategy to remove that asset from the statement of core business issued last week.

As stated, RBS has announced a plan to sell off 10%-20% of its US subsidiary, justifying this because the subsidiary has its own funding and IT. That message, known as coat-trailing, reads more clearly to anyone who has worked in the industry as “come on, TorDom, Wells or BofA, get your cheque book out for the whole thing”.

The ramifications even of a 10% disposal for the bank’s customer proposition in the UK would be that Citizens Bank would immediately have greater autonomy as to what type of business to take on and with what paperwork and assurances. With 90% ownership still in the hands of RBS it would still have a case for treating referrals of RBS customers as having been vetted by an employee of the same bank. But when the ownership falls further and when there is a clear direction towards a sell-off, there is a stronger case for treating such referrals as arm’s-length both commercially (we only take them if they stand on their own feet, not because they come from the parent) and legally (we need the same assurances as if the referral came from an unrelated party).

Taking this second point and expanding upon it, the legal one, there is a combination of factors at play here that bear upon the ability of companies to get foreign bank accounts. Traditionally a UK company would ask a UK bank with a branch over there, or the London branch of a bank from over there. Commercially, banks with foreign branches are looking at the financial viability of each branch. There is a trend for the branch to increase its revenue and cut its costs by:

  • refusing to take on small accounts in its country even if they are accounts belonging directly to a customer of the parent bank (non-resident account) or of that customer’s subsidiary (resident account);
  • refusing to run the relationship with a large local client who may do business with many branches in the bank’s group, but not with our branch. For example: a US bank’s branch in Frankfurt serving German multinationals: lots of business in US, Brazil and Mexico…but none in Frankfurt, only costs.

One might say, then, that there would be a potentially large flow of business in terms of customers that the branches of foreign banks will not take on, which would then flow to indigenous banks eg into German banks in Frankfurt instead. But those indigenous banks are in turn subject to restrictions, both on commercial/servicing grounds, and caused by the application of anti-money laundering (AML) legislation:

  • commercial/servicing: it is small so it has to go into the retail division and no-one speaks English there, and they only have e-Banking in German
  • commercial/servicing: past experience has been that such referrals were small and the AML work just gets bigger so we have closed our inward referrals desk;
  • it is a foreign customer so it is automatically classified as high risk and the ultimate beneficial owners must be identified down to a level of 10% ownership;
  • our bank has no branch in the customer’s country so there is no-one in our bank whose job it is to do that identification work or – see above – our branch in that country has stopped doing that work;
  • our bank’s policy is to accept proof of beneficial ownership only when it comes from an official source – and there isn’t one in the country of incorporation of the customer or the intermediate owners
  • Politically Exposed Persons involved with the customer and ultimate beneficial owners must be identified at a branch of our bank, or at a notary in their own country: the notary’s document must be translated and apostiled;
  • our bank does accept attestations from a lawyer or accountant, but only if they are in EU white listed countries;
  • our bank requires all background documents to be in our local language or in English.

The permutations are endless. There is a great need for clarity as to what sources and types of attestation are acceptable. The loser in the meantime is the SME who may find that their own bank cannot help them, they are not interesting to foreign banks in their own right, and then even that the combination of the customer’s profile (home country, ultimate beneficial owners, intermediate owners) so mismatches the banks’ appetite and restrictions that they cannot get a bank account at all, or that it takes eight months to do so.

The Organisation for Economic Co-operation and Development has just cut its global economic growth forecast. It would be interesting to see if the shortfall in economic growth for 2013 was caused entirely by the global SME sector being unable to get its accounts open for eight months and start trading, while there was a willing buyer out there for their goods and services.

The full article can be found at the following link: International and universal banking go into reverse gear as sell-offs continue