International banking is at the cross-roads. Are we heading for the decentralised banking model, by which banks are split in national subsidiaries supervised by national supervisors? Or can we maintain the integrated business model for international banks? In a new book on Governance of International Banking, published by Oxford University Press, I explore the trade-offs between internationally active banks and national supervision.

1. Governance of International Banking:
The Financial Trilemma
Dirk Schoenmaker
Duisenberg school of finance
June, 2013

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Split up or stay together?
International banking at the crossroads, after the crisis
• Decentralised model with national subsidiaries, or
• Integrated business model?
Depends on governance:
• National supervisors in charge, versus
• International financial institutions with a strong role, such
as ECB and IMF

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Governance of
International Banking:
The Financial Trilemma
Oxford University Press,
New York
March 2013

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Idea behind book
1. Coordination failure between national authorities in
resolving international banks
2. Develop game theoretical model to explain lack of
coordination: the financial trilemma
3. Provide empirical evidence internat/European banking
4. Develop new governance framework
§ Political economy
§ Global and European governance solutions
5. Conclusion: policy-makers have to make a choice

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International banking
Problem:
• Failure of large banks poses national and cross-border
externalities
• Cross-border externalities are ignored by national
authorities
Why?
• Accountability to national politics (i.e. domestic taxpayers)
• National legislation/procedures for insolvency

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Na#onalism
“My
country
is
my
castle”

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Global Systemic Banks
5 criteria for systemic importance
• Size (total assets)
• Global activity (international assets/claims)
• Interconnectedness (within financal system)
• Substitutability (readily available substitutes)
• Complexity (OTC and trading)
List includes all major international banks:
Ø Large banks (> $1 trillion assets) with
Ø Size-able cross-border busines (>25%)

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Global Systemic Banks

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Global Systemic Banks

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Game theory
• Schelling (2005) and Barrett (2007) apply game
theory to international cooperation
• Crisis is one shot game: no cooperation between
national authorities
• Solution: ex ante binding agreement
Ø hard law (treaty); soft law (MoU) does not work
Ø prespecify burden sharing (no fight about key)

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1. Financial stability
3. National financial policies
2. International banking
Financial trilemma

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Two outcomes
Two stables outcomes from financial trilemma model:
1. Supra-national solutions to keep international banks
a) Banking Union
b) Joint supervision and resolution -> burden sharing
2. National solutions with subsidiary-based banking
a) New Zealand (significant retail operations from
Australia)
b) US (Federal Reserve Proposed Rule) versus UK
(FSA consultation)

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National approach
National approach keeps full national control, but
comes at a cost
• Local liquidity pools
• Local capital buffers
Which cannot be used at the wider group in case
of emergency

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Liquidity pools
Example of European bank, which has to maintain
local liquidity pools
• € 20 billion extra liquidity
• 1% opportunity cost for holding liquid assets
Ø annual cost of € 200 million

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Local capital buffers
IMF study (Cerutti et al, 2010)
• Group of 25 European banks
• Scenario: GDP 2% ê and interest rates 2% é
Raise extra capital of
Ø € 45 billion in case of ring-fencing
Ø € 20 billion in case of no ring-fencing

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UniCredit
Germany
Italy

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UniCredit
Germany
✕
Italy

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Is splitting up effective?
Separate national subsidiaries, but
• Common risk management, Treasury, IT, etc
• Central management versus local independence
Ø Most importantly: reputation risk (brand name)
Extra cost will lead to higher lending costs and/or
lower deposit rates without extra safety

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Stay together
• Supervisors follow political reality
• Political choice for international cooperation
• Issue of solidarity (group cohesion)
Ø prepared to do burden sharing?
• But some countries fully national approach
Ø US + Australia: national depositor preference

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Fiscal backstop
• Stability financial system ultimately depends on
credibility fiscal backstop (Obstfeld, 2011; 2013)
Ø Iceland/Cyprus: no credible backstop
• No world government, which can raise taxes; so
burden sharing is needed
Ø Europe: ESM
Ø International: IMF
• But international institutions operate with one
hand tied behind their back (Barrett, 2007)

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European governance
EDIRAECBEC ESMECB

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Global governance
IMFBISFSB IMFBIS

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Conclusions
• Financial protectionism comes at a cost for banks
and ultimately their clients, but will it work??
• Financial Trilemma: no way out, politicians have
to choose between national and international
• Role for international financial institutions
Ø For European banks: ECB + ESM
Ø For truly international banks: BIS + IMF

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