Cooperation between home and host countries on the supervision of multinational banking groups

With regard to oversight of multinational banks, supervisory authorities in home countries used to play a greater role than those in host countries. However, the recent global financial crises underlined the need for more intervention by host countries. As a host to many multinational banking groups, the Korean government needs to inspect whether there are regulatory loopholes in financial supervision, and to make greater efforts to strengthen global-level cooperation.

The bankruptcy of the German bank Herstatt, in 1974, highlighted the need for international cooperation in supervising multinational banks. At the time, the German supervisory authorities started the bank’s bankruptcy proceedings after the local market closed for the day, but, it upset the global FX market as the bank failed to make settlements worth $600 million in the New York market which was still open. The term, Herstatt risk, came from this episode which refers to a counterparty risk associated with FX settlements. Immediately afterwards, central bank governors of the G10 countries formed the Basel Committee for Banking Supervision (BCBS) for the better coordination on banking oversight.

The BCBS issued the Basel Concordat in 1975, a guideline on the collaboration between home and host countries over banks’ overseas operations. Its main purpose was to ensure effective supervision without regulatory blind spots, and as such, it promoted information sharing between home and host countries’ supervisory authorities. In 1983, the Committee revised the Concordat and gave a mandate to a home country for the worldwide consolidated supervision. It put together supervision criteria in 1992, emphasising the home country’s information-collection right. These changes followed several banking scandals in which multinational banks (eg Italy’s Ambrosiano bank in 1982, and Luxembourg’s BCCI in 1991) moved their operations to tax havens or other loosely regulated places to circumvent supervision in their home countries.

However, the recent global financial crises and the collapse of Lehman Brothers underscored the importance of more active intervention by host countries. When large multinational banking groups go bankrupt, the shock spreads to their subsidiaries and branch offices in the host countries. As the Concordat was made during the time when banks’ overseas operations had much less influence on both home and host countries, ‘systemic risks’ were hardly taken into account. If a bank’s offshore business is not as systemically important in the home country as in the host country, the former would be reluctant to share information with the latter (see Table 1). Further, if the business of a multinational bank deteriorates, the home country is likely to conceal related information in case the host country ringfences the local branches to block out the adverse effects.

Cooperation between home and host countries on the oversight of multinational banks continues to be a controversial issue because of the financial trilemma among the conflicting policy goals: free cross-border banks, global financial stability, and national authorities. To break the impasse, the euro-area countries are considering a universal approach of forming a banking union, forgoing the national authorities. Conversely, a territorial approach may be considered to strictly ringfence business of local branches from that of the headquarters, which would deter free cross-border banking activities. Between these two extreme scenarios, countries are exploring how to gradually deepen cooperation through stronger supervisory colleges, elimination of legal barriers, and better incentive systems. Also, it is important to clarify bankruptcy proceedings for G-SIFIs to further promote cooperation between supervisory authorities in both home and host countries.

Against this background, Korea, as a host country of many multinational banks, needs to check for regulatory loopholes in banking oversight, and work closely with authorities of home countries to share information. Last but not least, the Korean government needs to voice its opinions more clearly in global discussions on the issue of regulating G-SIFIs to promote the perspectives of the emerging economies.