Thursday, September 1, 2011

Banks practicing regulatory arbitrage to boost profits

A Bloomberg article discusses how multi-national banks are exploring ways to shift where they book their business to minimize capital and liquidity requirements.  Regular readers know that there is nothing unexpected, surprising or fundamentally wrong with this behavior.

It simply highlights a fundamental problem with the practice of banking regulation and supervision.  The problem is that there are opportunities to benefit from regulatory arbitrage as it is difficult to get every country to adopt the same regulations.

One of the reasons that this blog has pushed for disclosure of current asset and liability-level data is that it is not subject to regulatory arbitrage.  Either a financial institution discloses all of its data regardless of where it is booked or it does not.

If it does disclose all of its data, market participants should reward it with a lower cost of and better access to capital because they are able to do a better job of analyzing its risks.

If it does not disclose, market participants know that it has something to hide and should increase its cost of and decrease its access to capital to reflect this risk.

Banks in Europe are exploring ways to cut costs by routing more of their trades and other business through overseas subsidiaries, a plan that may shift tax revenue away from London and loosen European regulators’ influence over the lenders. 
Nomura Holdings Inc., HSBC Holdings Plc (HSBA) and UBS AG (UBSN) are among lenders preparing plans to book as much business as possible through legal entities in jurisdictions where tax rates are lower and rules on capital and liquidity are less onerous, the banks and lawyers and accountants working with them say. 
“Every bank is trying to work out the best way to be structured under the new rules,” Chris Matten, a partner at PricewaterhouseCoopers LLP in Singapore, said in a telephone interview. “It’s not just a question of what activities banks are in. It’s about which entities they put that business through and in which jurisdictions.” 
Banks could record as much as 30 percent of the value of their trades through Hong Kong, Singapore and other jurisdictions instead of hubs such as London and New York without running into trouble with regulators, Matten said. 
Such a move would hurt traditional hubs such as London because assets are treated for tax and regulatory purposes in the country where they are booked. It would also allow banks to sidestep the U.K. bank levy, introduced last year to raise 2.5 billion pounds ($4.1 billion) from lenders operating in Britain, as well as any financial transaction tax imposed by the European Union.

“It is really about trying understand where all the different regulatory pressures are going to squeeze the hardest and looking to see if there are more efficient ways of reorganizing the booking model and business model so as not to have too many restraints,” Matten said in an interview with Bloomberg TV today. 
Lenders aren’t required to publish which entities they book their assets through globally.... 
“Capital scarcity has meant there is greater focus on where activity takes place and where it is booked,” Peter Muir, a London-based tax partner at Deloitte, said in a telephone interview. “People are likely to be looking to arbitrage the rules in a fair way to see if they can avoid more highly regulated markets.” 
... The most attractive booking model will vary from bank to bank, according to analysts and lawyers. Options under consideration include setting up new branches or subsidiaries in more favorable jurisdictions such as Hong Kong and Singapore, where taxes and capital surcharges are lower; booking a higher proportion of trades through multiple existing entities rather than through one global hub; and switching from a model based on a network of global branches to one based on a series of ring fenced, fully capitalized global subsidiaries. 

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