Big banks get fines. Small banks lose their license to operate. It is a situation that is understandable but unfair and out of balance. It can create an undesired challenge for customers of small banks.
During recent years we have seen that HSBC, Deutsche Bank and BNP Paribas got enormous fines from international regulators where banks like Banca Privada d’Andorra and FBME see their doors closed due to a (branch) license being withdrawn.
The situation where different measures apply for large banks originates from banks that are too big to fail. These banks are named systemically important financial institution (SIFI), also known as systemic banks. The definition of such an entity is a bank, insurance company, or other financial institution whose failure might trigger a financial crisis.
Another logical explanation for different measurements is the internal organisation of a bank. It seems that diversified banks, having a multitude of business units, are less sensitive for closure. In the case of the above mentioned banks, Banca Privada d’Andorra and FBME, the banks were small in size and had few operational business units. It is therefore understandable that serious accusations can bring the bank, with only a few activities and a small customer diversity, down.
The global financial crisis revealed the interconnectedness of global markets and large international financial institutions. Therefore the international community implemented measures to protect the global financial system through preventing the failure of SIFIs, or, if one does fail, limiting the adverse effects of its failure.
The consequences of the failure of Lehman Brothers and the subsequent domino effect, where total markets got destroyed that almost a decade later still struggle, clearly shows the need for a global protective system that can prevent banking chaos from happening again.
The Basel Committee on Banking Supervision that provides a forum for regular cooperation on banking supervisory matters, encourages convergence toward common approaches and standards. The Financial Stability Board is an international body that monitors and makes recommendations about the global financial system. Both monitor global systemically important financial institutions.
In Basel III, new banking regulations were formed that also target SIFI’s. The main focus of the regulations is to increase bank capital requirements and to introduce capital surcharges for systemically important banks.
It is important to note that both the Financial Stability Board and the Basel Committee are only policy research and development entities. They do not establish laws, regulations or rules for any financial institution directly. They merely act in an advisory capacity. It is up to each country’s specific lawmakers and regulators to enact whatever portions of the recommendations they deem appropriate. Each country’s internal financial regulators make their own determination of what is a Systemically Important Financial Institution. Once those regulators make that determination, they may set specific laws, regulations and rules that would apply to those entities.
Virtually every Systemically Important Financial Institution operates at the top level as a holding company made up of numerous subsidiaries. It is not unusual for the subsidiaries to number in the hundreds. Even though the uppermost holding company is located in the home country, where it is subject, at that level, to that home regulator, the subsidiaries may be organized and operating in several different countries. Each subsidiary is then subject to potential regulation by every country where it actually conducts business.
At present (and for the likely foreseeable future) there is no such thing as a global regulator. Likewise there is no such thing as global insolvency, global bankruptcy, or the legal requirement for a global bail out. Each legal entity is treated separately. Each country is responsible (in theory) for containing a financial crisis that starts in their country from spreading across borders. Looking up from a country prospective as to what is a Systemically Important Financial Institution may be different than when looking down on the entire globe and attempting to determine what entities are significant.
The degree of interconnectedness between financial institutions is almost completely unknown at any specific point in time. When trouble breaks out, fear and contagion effects are extremely unpredictable. Therefore, determining exactly what entities are significant is a difficult assignment, as the real certainty is determinable only well after the fact.
The impact of a bank failure of a ‘small’ bank is disproportionate to a SIFI failure. A SIFI failure triggers global chaos, where small banks often can rely on domestic deposit protection schemes, bankruptcy laws and external liabity insurances. Therefore, there will always be different measures for systemic and smaller banks.