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ABSTRACT
What if global governance mechanisms undermine the capacity of national banking regulators to deal with the deviant activities of their banks? Such was the case, this paper argues with respect to the Basel Accords and the regulation of the bank-based shadow-banking system. Securitization-activities by banks, driven by regulatory arbitrage have been an integral part of the shadow banking sector and a central transmission mechanism during the financial crisis. They have been identified as problematic by the international regulatory community since 1999, motivating reforms in Basel 2. This paper investigates why, nevertheless, regulatory loopholes that allowed banks to engage in these activities without core capital charges persisted in almost all Western jurisdictions pre-crisis. It lays emphasis on the global nature of the securitization business in conjunction with its national regulation, and shows that these national regulations on the fringes of global banking regulation were driven by competitiveness concerns. The Basel Accords were central in this dynamic, as they guaranteed the global nature of this market and gave national banking regulators the leeway to exempt securitization-activities from global regulation. Rather than eliminating competitive inequity concerns, the Basel Accords channelled them to its fringes, where they introduced a regulatory race to the bottom.
ACKNOWLEDGEMENTS
The author would like to thank the editor as well as three anonymous reviewers for their comments. In addition, thanks go to Tom DiPrete, Ewald Engelen, Stephany Griffith-Jones, Martin Hellwig, Till-Martin Kaesbach, Jongchul Kim, Jan Lepoutre, Daniel Mertens, Andreas Noelke, Katharina Pistor, Michael T. Schuyler, Gunnar Trumbull, Natascha Van der Zwan, Josh Whitford and the participants of the workshop on financialization at the University of Dublin on 5 and 6 May 2012 and the workshop on Securitization at the University of Amsterdam on 14/15 October 2012 for helpful feedback and suggestions for this article. All remaining errors are the sole responsibility of the author. Research for this article was supported by the Sciences Po Columbia University Exchange Fellowship 2010/2011, the Columbia Travel Fellowship in autumn 2011 and the Max Planck Visiting Doctoral Student program.
Notes
1. The shadow banking system has been defined by economists at the Federal Reserve as ‘‘financial intermediaries that conduct maturity, credit, and liquidity transformation without access to central bank liquidity or public sector credit guarantees’’ (Pozsar et al. Citation2010: 11). Its most important characteristic is that it is in the business of extending credit to the economy without having the status of a bank and, thus, not subject to banking regulation.
2. Regulatory arbitrage can be defined as ‘‘those financial transactions designed specifically to reduce costs or capture profit opportunities created by differential regulation or laws’’ (Partnoy, Citation1997: 227).
3. These countries are France, Germany, Spain, the Netherlands, the USA, Canada, Portugal, Italy, Belgium, and the UK.
4. This included central bankers, financial regulators, senior bankers, and auditors in France, Germany, the Netherlands, Canada, and the US as well as employees of national and international accounting standard-setting bodies and various rating agencies. The interviews focused on the political struggles over the national regulation of securitization under the background of international regulatory developments. I am therefore able to compare the stated aims of national regulators with respect to regulations with the actual results (congruence analysis) and to verify the motivations and dynamics in interviews via process tracing (Hall, Citation2006).
5. This evolution of the debate has led to the explicit consideration of Mutual Money Market Funds as shadow banking entities (Adrian and Ashcraft, Citation2012b). It has also led to a shift from the sole focus on the supply side of shadow banking, asking why and how financial agents developed products in the shadow banking sector (a main argument being regulatory arbitrage) to ask also how the demand side for shadow banking emerged (Pozsar and Singh, Citation2012) and how the shadow banking system emerges differently in Europe vs. the US (Tyson and Shabani, Citation2013: Jeffers and Baicu, Citation2013).
6. In the external shadow banking system, broker-dealers and other financial companies used banks as ‘‘backstops’’ for their operations, but banks were not the driving force in the evolution of shadow banking activities.
7. How sensitive this activity was to regulation can be gauged from the fact that the growth of the American Asset-Backed Commercial Paper market came to a halt between 2001 and 2004, when it was not clear if SPEs were to be considered part of the banking conglomerate according to US prudential regulation (Acharya and Schnabl, Citation2010: 40).
8. For a study applying it to the Dutch case, see Aalbers et al., Citation2011: 1790.
9. Or, for that matter captured by material incentives.
10. This is the case for France's banking regulator and for the central bank in Germany. In line with this argument, the stance of the French regulator discussed below can be analyzed as the direct opposite of cognitive capture. Nevertheless, final regulation in France is less strict than regulators there desired, suggesting other mechanisms than cognitive capture at work.
11. ‘‘On the basis of the available information, the securitisation activities of these companies loom large in relation to their on-balance sheet exposures. As of March 1998, outstanding non-mortgage ABSs and ABCP issued by these institutions exceeded $200 billion, or more than 12% (25%), on average, of the institutions’ total risk-weighted assets (loans). For several institutions, the combined issuance of ABSs and ABCP approached 25% (50%) of total risk-weighted assets (loans).’’ (Jackson et al. Citation1999:, 24)
12. Indeed, most of the countries investigated in this article have been members of the Basel Committee that debated this framework between 1998 and 2004 (Belgium, Canada, France, Germany, Italy, Netherlands, Spain, UK, USA).
13. The argument bases itself on Andrews Citation(1994), who develops the concept of structural features in the international political economy that constrain national policy autonomy, in his case monetary policy.
14. Regulators of such markets face a delicate task as ‘‘no regulator wants to be held responsible for crushing an industry under the weight of onerous regulation. Regulators, therefore, must walk a fine line between stability and competitiveness’’ (Singer, Citation2007: 23).
15. This exemption of host country regulation applies in particular to branches of foreign banks used for securitization, whereas subsidiaries could be subject to additional regulatory charges. Complete acceptance of foreign banking regulation was instituted in the EU in light of the implementation of Basel 1 with the banking passport in 1990 (Pistor, Citation2010).
16. The international diversity on consolidation regarding securities activities and other financial entities and the role of national law in determining what will be consolidated for regulatory capital purposes is acknowledged in the revised Basel Accord (BCBS, Citation2004: 7). However, the problem is not rectified.
17. The Canadian banking regulator copied the measure.
18. Corporate lending secured by customers receivables and Asset-Backed Commercial Papers
19. A simple Dutch SSPE, issuing $50 million (a rather small sum) was operating with a leverage of 1:2770 (based upon Brinkhuis and van Eldonk, Citation2008).
20. These acronyms stand for the first and second directive on the coordination of laws, regulation and administrative provisions relating to the take up and pursuit of the business of credit institutions from 1977 and 1989, the Second Banking Directive from 2000 and the Capital Requirements Directive from 2006. All of these documents are available at <http://eur-lex.europa.eu/fr/index.htm>.
21. When the SSPE buys loans or an asset-backed security from a seller, it is at least indirectly linked to a credit-activity. The question is, does such indirect linkage constitute credit activity or not? In the case of France for example, ‘‘acquiring receivables on a regular basis constitutes a credit operation’’ (European Financial Markets Lawyers Group, Citation2007a:26, in the following EFMLG, Citation2007a).
22. This was the direct motivation of the regulatory changes in the Netherlands, as a Dutch banking manager confirmed via personal correspondence Dutch bank manager (12 July/2011).
23. The measure copies US regulation, which since the Investment Company Act of 1940 exempts institutional investors from supervision (Horsfield-Bradbury, Citation2008: 24f).
24. It envisioned a 20 per cent conversion factor for the assets that are guaranteed by the liquidity lines of a bank operating in the simple ratings based approach, and a slightly lower measure for those banks operating in the internal ratings based approach. In addition, a framework in which only a significant risk transfer from the banking conglomerate to the SSPE permitted regulatory capital relief was established (. BCBS, Citation2004:116–39).
25. The reader should note that this continued exposure to credit-risks of assets which were securitized was one of the main transmission mechanisms during the financial crisis.
26. S. Calomiris and Mason, Citation2003: 4–9 for a history of these regulatory concerns dating back to the early 1990s.
27. The threat of a deviating implementation in the US, it seems, should be controllable by the three regulators, given that Basel is passed and the new rules are equivalent to Basel.
28. Unfortunately, no access to a Fed official directly responsible for these decisions could be gained, as they had moved on to other, more important global positions with tight schedules.
29. See note de presentation, accessible at <http://www.anc.gouv.fr/sections/normes_privees/avis/avis_2004/note_aviscu_2004d/downloadFile/file/note_aviscu_2004d.pdf?nocache=1318335589.2.>
30. S. Sohn, Citation2012 for an investigation of the East Asia region.
Additional information
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Matthias Thiemann
Matthias Thiemann is a Junior Professor for the sociology of finance, banking and money at the Goethe Universitaet, Frankfurt am Main. Prior to his appointment, he was a Postdoc at ESSEC Business School. Prior peer-reviewed articles have been published in Competition and Change, UNDP Discussion Paper Series, Soziale Systeme and New School Economic Review, Business and Politics.
