The quarter-century leading up to the financial crisis saw a remarkable leap in globalisation. In particular, cross-border financial flows grew rapidly. Western investors piled into China and the other Brics. The new phenomenon of south-north flows emerged, as sovereign wealth funds from Asia and the Middle East acquired developed economy assets on a massive scale. But the fastest growth was in cross-border bank lending, much of it intermediated in London. Citibank’s ambition was to be seen on street corners from Manhattan to Manama; HSBC proudly told us, every time we got off a plane, that it was “the world’s local bank”.
Since the crisis that last trend has gone into reverse: cross-border lending has fallen sharply and the ambitions of major American and European banks have been scaled back. HSBC has withdrawn from a number of countries; Citibank and Barclay’s have other preoccupations. The continental European banks are struggling to strengthen their capital bases, and emerging market assets have been realised to bolster the parents’ balance sheets.
So are we entering a new age of financial deglobalisation? If so, should we care?
Some of the retrenchment was inevitable, so we may as well welcome it. Banks had become overextended. Their appetites exceeded the capacity of their digestive systems. We need not regret the retreat of Icelandic and Irish banks to their geysers and Loughs. But there are signs that some of the withdrawal may be traced to regulatory actions, and to a form of financial protectionism, which could be as dangerous as protectionism in the trade of physical goods.
In some cases, particularly in Europe, home state regulators have required their institutions to pull liquidity back from overseas markets to protect the parent bank. Host regulators are requiring pools of liquidity to be held in their jurisdiction, perhaps over-learning the lessons of the messy Lehman’s bankruptcy.
US regulators are pressing overseas banks to set up local subsidiaries, with separate capitalisation (as the Canadians have done for some time). Even in the EU, where banks have the legal right to operate across the union from one member state authorisation, they are being pressed to set up local subsidiaries. No-one wants a repeat of the Icelandic debacle, when the British and Dutch governments found themselves bailing out depositors in banks they had never authorised.
But these are not costless measures. They cause liquidity and capital to be trapped where they are not needed, and mean that capital is therefore not optimally used, which will increase the cost of credit. In response, banks withdraw from marginal markets, reducing competition. The local authorities respond by biasing their regulation in favour of domestic entities. A cycle of discrimination and domestication is established.
The Financial Stability Board is concerned about these trends, as is the IMF. They recognise the dangers. 2013 will be a decisive year. Will central banks and regulators embrace financial deglobalisation enthusiastically, in response to local political pressures, or will it be possible to find a new equilibrium, in which the crisis learnings are embedded in a new approach which preserves many of the benefits of open international financial markets? Finding the right answer to that question is crucial.