Rather we need effective supervision as well, something that is inevitably harder given the cross border nature of the activity and the potential both for gaps and for different priorities. That creates a need for close cooperation between both home and host supervisors to deliver effective global consolidated supervision of international banks. The changing approaches we’ve seen since the crisis There is a spectrum of approaches that supervisors can take to the supervision of international banks. In the absence of a single global consolidated supervisor, let me describe the two logical extremes. First one can have a model of pure home supervisor responsibility, based on branches of the parent group and where the host supervisor relies completely on the home supervisor. By allowing the most rapid allocation of capital around the globe, this model delivers the greatest benefits. But it simultaneously creates the greatest risks to financial stability in host countries because of the potential lack of clarity of remit, information, and responsibility and powers to deal with the risks international banking brings. Alternatively one can have a pure host-led approach. This would require operations overseas to be undertaken in subsidiaries, with those subsidiaries supervised in the same fashion as domestic banks, in effect treating the overseas entity as independent and standalone. This model reduces the risk of an abrupt cessation of financial services following events overseas and so, at first sight, does a better job of protecting financial stability. But it makes the cost of entry much higher.
So, if those are the benefits, what about the potential risks of international banking? The risks from banking are well known – that the failure of an institution can lead to contagion and spillovers that may have direct and indirect impacts on financial stability. These risks may be amplified, accelerated, and transmitted through the increased degree of interconnectedness that international banking brings. This could be through greater exposure to cyclical global macroeconomic trends, or through a greater appetite and capacity for risk without appropriate controls. Successive crises have clearly demonstrated the effects of international banks, and capital markets, “freezing”. Contraction in credit supply is a powerful channel through which financial crises hit global and domestic economies. And the balance between international and domestic services can shift rapidly in a recession as international banks serve the home market. In 2008–09 for example, UK resident banks cut cross-border lending by 30% 5, significantly more than lending in the UK. The same patterns were seen internationally. Lehman of course had global effects, but numerous other entities had substantial cross border effects too. The crisis showed us all too clearly that international banking, interconnectedness, and unrestricted capital flows carry risk as well as rewards. All this underlines the importance of delivering effective oversight of international banks. Prudent international regulatory standards are a necessary part of this, but are not on their own sufficient.