Transcript Cross Border Exposures and Financial Contagion

Implications of Ring-Fencing for
European Cross-Border Banks
Eugenio Cerutti (with A. Ilyina, Y. Makarova and C. Schmieder)
Vienna – October 3 , 2011
Bankers without Borders? - Motivation
On the one hand,
many cross-border banking
Statement at the end of the European Bank Coordination Initiative’s Second Full Forum Meeting
IMF Press Release No. 10/106
March 22, 2010
“The large bank groups with systemic presence in
those [Eastern European] countries have committed
to maintain their exposure and keep their
subsidiaries well capitalized.”
groups acted as Lenders of Last
Resort for their CESE subsidiaries
during the crisis.
Bankers without Borders? - Motivation
On the other hand, host country
regulators might ring fence foreign
affiliates within their jurisdictions
The Croatian National Bank Governor,
due to:
• Banking-stability considerations (e.g.
the need to protect the domestic
banking system from negative
spillovers from the rest of the group)
• Macro-stability considerations (e.g.
avoid capital outflows)
Željko Rohatinski,
Press conference held on 18 February 2009
“the CNB would not look favorably upon attempts
[by foreign parent banks] to withdraw capital,
deposits or pay out total accumulated profits,
because that would destabilize the domestic
banking system. In such a case, the CNB would be
forced to undertake protective measures,
regardless of thus connected risks.”
Bankers without Borders? - Motivation
Ring Fencing Outcome: cross-border banking groups’
ability to re-allocate funds from subsidiaries with excess
capital/liquidity to those in need of capital/liquidity is
limited.

The Question we attempt to answer in the paper:
What are the capital needs of banking groups
under different ring-fencing assumptions?
Bankers without Borders? – Stylized Example
A “stylized” cross-border banking group:
with subsidiaries in countries A, B, C
Parent Bank
Regional credit shock
Sub A
Sub B
Sub C
Profits and Capital at each of the subs
Sub A
Outcome
Sub C
Losses (net of provisions) at each of the subs
Sub A
Buffers
Sub B
Sub B
Sub C
Recapitalization needs (if any) at each of the subs
Sub A
Sub B
Sub C
Bankers without Borders? – Stylized Example
Bankers without Borders? – Stylized Example
At the group level, the capital need (CN) is the total amount of
capital required to restore the CARs of all of the group’s affiliates
to their regulatory minimums.
Degree of
ring-fencing
Capital needs (post regional credit shock)
under different ring-fencing assumptions
No ring-fencing
CN(1) = sum of recapitalization needs of all subsidiaries –
sum of excess profits and capital of all subsidiaries –
profits of the parent bank
Partial ring-fencing
CN (2) = sum of recapitalization needs of all subsidiaries –
sum of excess profits of all subsidiaries –
profits of the parent bank
Complete ringfencing
CN (3) = sum of recapitalization needs of all subsidiaries –
profits of the parent bank
Stand-alone
subsidiarization
CN (4) = sum of recapitalization needs of all subsidiaries
Dexia
Belgium
KBC
Belgium
DNB Nord
Denmark
BNP Paribas
France
SocGen
France
Credit Agricole
France
Bayern LB
Germany
Commerzbank
Germany
Deutsche
Germany
Alpha
Greece
Eurobank EFG
Greece
NBG
Greece
Piraeus
Greece
Allied Irish Bks
Ireland
Intesa
Italy
Unicredit
Italy
ING
Netherlands
Nordea
Sweden
SEB
Swedbank
Sweden
Sweden
Belarus
Ukraine
Russia
Lithuania
Latvia
Estonia
Serbia
Croatia
Bosnia
Austria
Albania
Austria
Hypo Alpe Adria Group 2/
Hungary
Bank Austria 1/
Romania
Austria
Bulgaria
Austria
Volksbank
Turkey
Austria
RZB
Poland
Erste Group
Slovakia
Parent bank's
home country
Czech Republic
Parent Bank
Slovenia
Bankers without Borders? – Data Sample
25 Banking Groups/113 CESE subsidiaries
Bankers without Borders? – Scenario Analysis
Description and Calibration of the shock
Time frame: 2009-2010 (2 years):
Description of the shock:
2009: Use of preliminary data (GFSR)
2010: Use regression models to determine (a)
“baseline” (WEO forecast for GDP, CPI and
interest rates); (b) “Adverse Shock” (same
as baseline, except for GDP growth - half of
the one in 2009)
Method: Use of dynamic panel models to
forecast i) NPLs and ii) Profit for 2010
Bankers without Borders? – Scenario Analysis
Capital Needs arising from a regional credit shock affecting the CESE
subsidiaries (in percent of group’s regulatory capital):
CN(1) – no ring-fencing (both excess capital and profits can be re-allocated)
CN(2) – partial ring-fencing (only excess profits can be re-allocated)
CN(3) – complete ring-fencing (only transfers from parent bank are allowed)
CN(4) – stand-alone subsidiarization (no intra-group transfers are allowed)
Bankers without Borders? – Conclusions
• The capital needs of cross-border banking groups to
ensure adequate capitalization of all parts of the group
(after a shock) are higher under complete/partial ringfencing than under no ring-fencing.
• These differences are more significant for more
geographically diversified banking groups.
• Hence, the standard stress tests of cross-border
banking groups based on consolidated balance sheet
data (which implicitly assume no restrictions on intragroup transfers) may lead to the wrong conclusions
about the adequate level of the group’s capitalization.
Bankers without Borders? – Policy Implications
• A credible and well-designed framework for the
resolution of cross-border banking groups could help
to avoid unilateral and likely more costly solutions.
• Setting minimum capital requirements for cross-border
banking groups would have to take into account the
potential presence of ring-fencing.
• The capital buffer needs for cross-border banking
groups could be even larger in future crises if recent
reforms, pursuing logical individual country
perspectives (e.g. UK), trigger new higher levels of
ring fencing during crisis.
Background Slides
The Dynamic Panel Regression:
CESE NPLs
Variable
Fixed Effects
Arellano-Bond
Arellano-Bover
NPL (t-1)
0.6113***
0.6445***
0.728***
GDP (t)
-0.2597***
-0.2902***
-0.3558***
Interest (t)
0.1544***
0.1758***
0.1048**
Inflation (t)
-0.0352
-0.0577
-0.0514
Constant
2.1217***
1.9921***
2.173***
# of Observations
170
143
161
# of Groups
18
18
18
R2
0.69
NA
NA
Wald Chi2
NA
359
425
Calibration of the shock:
NPL assumptions
2008
Median
2009
Median 1/
2010
2010
Baseline
Adverse
Median 2/ Median 3/
16.0
18.5
Baltic
countries
CEE-4
3.6
15.0
3.3
5.5
6.3
7.9
CIS/4
3.8
9.5
9.3
10.9
SEE
4.3
6.1
7.5
8.4
Footnotes:
1/ Most recent provisional data is available for each country (GFSR);
2/ Estimated based on a dynamic panel regression;
3/ Adverse scenario assumes a double-dip recession, i.e., 2010 GDP growth
is equal to ½ of 2009 GDP growth
The Dynamic Panel Regression:
CESE ROAs
Variable
Fixed Effects
Arellano-Bond
Arellano-Bover
ROA (t-1)
0.0856
0.1326**
0.0834
GDP (t)
0.0723***
0.0840***
0.0768***
Interest (t)
-0.0523***
-0.0318***
-0.0230***
NPLs (t)
-0.0479***
-0.0514***
-0.0799***
Constant
1.7519***
1.5055***
1.7181***
# of Observations
157
139
157
# of Groups
18
18
18
R2
0.52
NA
NA
Wald Chi2
NA
146
232
Calibration of the shock:
ROA assumptions
2008
Median
2009
Median /1
2010
2010
Baseline
Adverse
Median 2/ Median 3/
-0.5
0.1
Baltic
countries
CEE-4
1.2
-0.1
1.2
1.1
1.3
1.0
CIS
1.4
0.5
0.9
0.4
SEE
1.7
0.8
0.9
0.8
Footnotes:
1/ Actual data from GFSR (and model output for Albania, Croatia,
Romania and Slovenia)
2/ Estimated based on a dynamic panel regression using CESE 19992008 NPLs, GDP growth, nominal interest rates and NPLs;