Capital Markets

Now Moving Offshore: Your Next Loan

U.S. bank officials warned in a Senate hearing Tuesday that European and Asian banks will soon be able to offer cheaper funds to U.S. corporations ...
Rob GarverSeptember 26, 2006

U.S. companies may increasingly turn to foreign financial institutions for lines of credit and other funding if federal banking regulators don’t loosen proposed rules for U.S. banks, industry representatives and a prominent Senator warned Tuesday.

In Senate hearings on a proposal to change the rules by which banks are required to allocate liquid reserves, known as capital, for loans and other assets, Jim Garnett, head of risk architecture for Citigroup, said that less restrictive rules in Europe and Asia would make it difficult for U.S. banks to offer financing at competitive rates.

The question at issue is how regulators, including the Federal Reserve, the Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency, should implement an internationally negotiated capital accord, known as Basel II, within the U.S. The plan currently under consideration by U.S. regulators would be more restrictive than rules already put in place by European and other foreign regulators.

The concern is about cost of funds. As cross-border financial transactions become easier to execute, the difference to a U.S. firm between a line of credit in Boston and line of credit in Berlin will eventually boil down to price. If a U.S. bank needs to hold $6 of capital for every $100 it lends, while a European bank only needs to hold $4, the U.S. bank will need to charge a higher rate of interest to generate the same return as its competitor.

“It is . . . important to note that competition and capital flows do no stop at national borders,” said Citigroup’s Mr. Garnett, who testified on behalf of the American Bankers Association. “Therefore, even those U.S. banks that have mostly domestic operations will be put at a disadvantage in competing for major business customers who can easily turn to foreign banks operating under more appropriate Basel II rules.”

Sen. Charles Schumer (D-NY), cautioned that the regulators risked accelerating the demise in importance of the United States, and New York City in particular, as the heart of the international economy.

“We are fighting to remain competitive in the financial markets, and we have a tremendous dilemma here,” he said.

“As the world economy becomes internationalized and financial markets become one,” he said, the United States must deal with the “tension” between a system of strict domestic regulation of banks and an international market in where even an incrementally looser standard may create significant pricing differences.” (Ironically, CFO magazine reported in March that European banks have complained that they may be put at a competitive disadvantage by U.S. regulators who decided to delay Basel II implementation for U.S. financial institutions).

After noting that the vast majority of major initial public offerings worldwide are already taking place outside the United States, Sen. Schumer said that the regulators’ proposal could well worsen the trend of financial business moving out of the U.S.

“We’ve all heard about IPOs, but listen to this: London already accounts for 70 percent of global bond trading, 40 percent of derivatives trading, 30 percent of foreign exchange, and 30 percent of cross-border equities,” he said. “As a senator from New York, these are the kind of things that keep me awake at night.”

Not all the members of the panel were as concerned as Mr. Schumer about the long-term strength of U.S. financial markets. The two senior members of the Senate Banking, Housing, and Urban Affairs Committee, Chairman Richard Shelby (R-Ala.) and Sen. Paul Sarbanes (D-Md.) both noted that U.S. banks are the most profitable in the world in spite of historically high capital levels.

A greater concern, said Sen. Sarbanes, would be a repeat of the savings & loan crisis of the mid 1980s, when scores of thinly-capitalized banks across the country failed and had to be bailed out by taxpayers.

Noting that many members of the committee had been in Congress at that time, he said, “I don’t think we want to experience that again.”