Branches of Foreign Credit Institutions
General economic integration and the creation of the single market are cornerstones of European cooperation. Harmonised regulation of financial companies and common standards have paved the way for the single market for financial services. As a result, cross-border banking activities in the EU have expanded.
The possibility of creating a European Company in the EU as from October 2004 will facilitate mergers across national borders. Hereafter it is expected to become more common for banks to have branches than subsidiaries in other countries. As the first bank, Nordea has announced its intentions of becoming a European Company in 2005, with its registered office in Sweden and branches in the other Nordic countries, including Denmark. Foreign branches, in particular branches that are very large and thus systemic in the host country, present new challenges to the authorities responsible for financial stability.
The existing EU regulation and structure of supervision and oversight do not sufficiently allow for systemic foreign branches. There will be a need for increased binding cooperation between authorities. This issue should be put on the European agenda.
Status of financial integration
Since the end of the 1990s credit institutions in the EU have increasingly engaged in cross-border activity. This trend is driven by intensified competition between the different financial sectors and the utilisation of synergies in the development of various financial products. The development should be seen in the light of further consolidation in the domestic markets being a limited possibility.
The form of cross-border establishments, i.e. branches or subsidiaries, does not show an unambiguous pattern across EU member states. In general, cross-border establishment of branches is the most frequent form, but the units are often very small. Measured in terms of asset size, however, subsidiary establishments dominate. At present, statistics on the frequency of transformation from subsidiaries into branches are not available.
The Nordic countries have seen a number of cross-border mergers. Several of the groups in category A have thus become pan-Nordic with considerable market shares in several countries, cf. Box 13. Financial integration of the credit-institution sector is more advanced in the Nordic countries than in the rest of the EU, but cross-border activity is also found in other parts of the EU and will expand as a consequence of the enlargement by 10 new countries.
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Box 13
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The structural development in the Nordic credit-institution sector provides several examples of cross-border acquisitions with subsequent creation of a branch structure.
Similarly, other EU member states have seen examples of cross-border groups. So far, these groups mainly conduct cross-border business in the form of subsidiaries.
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In several accession countries cross-border activities of credit institutions domiciled in the EU already account for a considerable part of the financial systems, cf. Chart 38. This applies in particular to the Baltic states where the markets are widely dominated by Nordic credit institutions.
EU regulation and EU authority responsibilities
Financial integration is part of the process towards the creation of a single market for financial services in the EU. EU legislation has contributed to harmonising the basis for conducting financial business and has removed national barriers to the establishment of cross-border financial activities. Thus, financial enterprises from other EU member states are not discriminated in the national markets. This development was initiated in the early history of the EEC/EU and is still one of the cornerstones of European cooperation, cf. Box 14.
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Box 14
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The majority of regulatory measures in the EU have aimed at "removing" national borders for the conduct of financial business. Supervision of financial companies, however, is a national matter. A bank has only one home country – which is where the bank is licensed. Other countries in which the bank conducts business, either through a branch or via cross-border activities, are host countries. A subsidiary's home country is the country where it is resident and independently licensed.
The member states are obliged to recognise that the licensing rules applying in a bank's home country also constitute sufficient provisions permitting the bank to offer its services in other EU/EEA countries.
Home-country supervision means that the principal supervision of a bank's activities, including supervision of its financial soundness, is the responsibility of the authority in the country where the bank is licensed. However, supervision of the branch's liquidity is the responsibility of the host country. This means that the host country's liquidity provisionsapply to branches of foreign banking institutions. The precise implications of the host country's responsibility to supervise liquidity are not clear, however, as a branch's liquidity in practice depends on the bank's global liquidity. Liquidity rules have not been harmonised at EU level, and these rules may vary considerably across member states.
Any central-bank responsibility for an EU branch is not regulated by the EU. The central bank in the host country retains full responsibility for measures taken as part of its monetary policy. However, such measures may not lead to discrimination or restrictive treatment of banks licensed in another member state.
Transformation into branches
A group with cross-border activity in the form of subsidiary banks is subject to its home country's (supervision, company, etc.) legislation applying to the parent company and the group as a whole. At the same time, the individual subsidiaries are subject to regulation in the countries where they are resident and independently licensed. By contrast, as mentioned above, a group with branches is primarily regulated in its home country, and supervision is conducted from the home country.
Transformation from a group structure with subsidiaries into a branch structure may thus reduce the complexity of the group's administration, which is a consequence of, inter alia, being subject to various countries' sets of rules. Such simplification may enhance business flexibility. For example, the allocation of capital and risks in the bank does not have to allow for exposure limits or capital requirements for each branch, as is the case for subsidiaries. Only the bank as a whole must comply with the rules. There are also administrative advantages. For instance, it is easier to integrate branches fully into the bank's systems, e.g. risk-management systems and IT platforms, as, unlike subsidiaries, branches are not required to be able to operate independently of the remaining group. Finally, there is no requirement of external accounts for branches, and supervisory reporting is on a much smaller scale.
In future, it will be much simpler[1] to transform a group with subsidiaries into a bank with branches. As from October 2004 it will be possible to create a European Company, "Societas Europaea"(SE), in all sectors, cf. Box 15. A European Company is a company subject to independent legislation so that companies founded in different member states can merge or form a holding company or a joint subsidiary. Legal and practical problems due to different legal systems are thus avoided.
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Box 15
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The European Company (SE) has been adopted in the form of a regulation1, and the effects of the new legislation are thus expected to be the same in all EU member states. A European Company can be created in four ways: by merger, by formation of a holding company, by formation of a joint subsidiary or by transformation of anexisting national company. Formation by merger and formation of a holding company are available only to EU companies whose registered offices are located in different member states. The registered office of an SE must be designated in its articles of association and must be the place where it has its central administration, i.e. its true centre of operations. However, the registered office can be transferred according to specific procedures. Presentation of annual accounts, winding-up, insolvency and suspension of payments are in large measure to be governed by national law in the country where the company has its registered office. The European Company does not affect the supervisory regulation of financial companies. However, it will in future be technically far simpler to merge across national borders and transfer the registered office, and more financial groups are therefore expected to transform into European Companies. A member state (including the supervisory authority in that member state) can only oppose a merger of companies into a European Company or a change of the registered office under the articles if public interest weighs heavily in favour. |
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| 1 EC 2157/2001 of 8 October 2001. | |
Transformation into a branch must still be approved by the supervisory authorities. The considerations applying to the granting of such approvals will be similar to the considerations applying to the granting of licences to conduct banking activities, i.e. transformation into branches may not prejudice the interests of depositors. A precondition is that the continuing bank's liquidity and solvency are sound, and that the bank is equal to the task in terms of management and operation. In addition, supervision of the continuing bank must be feasible. In case of cross-border mergers, this approval will be granted by the supervisory authority in the home country, and the approval procedure as a whole is subject to EU law.
Large branches and financial stability
Where a bank has foreign branches that are as large as or larger than the home-country entity, or the branch in the host country is large enough to be of systemic importance, the home and host countries have a common interest in ensuring financial stability in the countries concerned. A case in point will be Nordea when it transforms into a branch structure with a registered office in Sweden and branches in Denmark, Finland and Norway.
As regards financial stability, the main difference between branches and subsidiaries is that branches are not legal entities. Branches are an integrated part of the parent company, and the financing of branch activities and cash flows from branches are inseparable from the parent company's total financing and liquidity flows. Unlike subsidiaries, branches thus cannot experience liquidity problems – except very temporarily – or problems complying with statutory solvency requirements. Such problems are reflected solely in the overall picture of the group or parent company.
Thus, it is not possible to assess a branch's financial soundness and resilience separately or take action against a branch to protect the financial system from any contagion arising from solvency or liquidity problems of the parent company.
On the other hand, a branch will interact with the general economy of the host country in the same way as other banks. If a branch's activities and related risks are substantial to the host country's economy, the bank will have an impact on financial stability in the host country.
The legal structure in itself does not influence a credit institution's access to national payment systems. In other words, a branch, on equal terms with other banks, may be a central participant in the individual host countries' payment systems. The risk of problems spreading via the national payment systems is thus the same for branches and other banks.
A general tightening of a bank's extension of credit – for instance, if the supervisory authority in the home country has instructed the group to reduce risks – may affect the total credit supply in the host countries via the bank's branches. In particular, tightening of credit extension to the corporate sector and other banking institutions with relatively large credits may cause problems refinancing terminated exposures. It may be difficult for the rest of the financial system to absorb large exposures involving a substantial capital burden and great demands of credit-rating capacity. In the short term, borrowers may have problems finding alternative sources of credit at no considerable cost, which may influence the extension of credit in society as a whole and thus the macro economy
In principle, the host-country authorities have no knowledge of the risks related to a branch's activities. For supervisory purposes, the bank reports in full to the home-country authority. In addition, branches, unlike subsidiaries, do not prepare separate annual reports, and the consolidated accounts of financial groups do not necessarily provide information that permits external assessment of activities and risks at branch level. Local branch risks cannot always be separated from the overall risk picture of the bank, and reporting to the public is not required unless such risks are relevant or material to the bank as a whole.
A comprehensive picture of the risks in the host country therefore requires knowledge of both specific risks related to the activities of a systemically important branch in the host country and the bank's global risks.
The bank's statistical reporting does not necessarily provide a comprehensive picture of the activities in the individual countries either. If specific activities are all booked in one country, the statistical information may show strange shifts that do not indicate underlying changes in the customers' business. Consequently, the statistics do not provide the intended information. However, this problem may also arise in a group structure with subsidiaries.
The host-country authorities have no insight into a group's risk situation, whether or not the group's activities in the host country may influence financial stability. Furthermore, the host-country authorities do not have access to instruments that can directly contribute to restoring confidence in a bank with a branch in the host country. In other words, a host country cannot on its own prevent or limit the social costs of a crisis in a bank that has a systemically important branch in the host country.
Cooperation between home-country and host-country authorities
When one of the largest financial institutions in a country becomes a branch of a foreign credit institution, it presents new challenges, mainly to the supervisory authority. Furthermore, deposit guarantee schemes are fundamentally national and may thus be difficult to adapt to comprehensive cross-border activities, cf. Box 16. Finally, the role of central banks is closely related to national supervisory issues.
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Box 16
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A banking institution domiciled in Denmark must participate in the Danish deposit guarantee scheme. A branch of a foreign bank domiciled in the EU/EEA will becovered by the deposit guarantee scheme in the bank's home country. The branch may choose to purchase supplementary deposit cover under the Danish deposit guarantee scheme if the home-country guarantee is lower than the Danish scheme (topping up). The general framework for deposit guarantee schemes in the EU member states is based on the directive on deposit guarantee schemes of 1994. The directive contains a set of minimum requirements, e.g. all credit institutions must be part of a deposit guarantee scheme and of a minimum guarantee for the cover of the schemes. In addition, the directive sets up a framework for the use of topping up. The deposit guarantee schemes are fundamentally national and may thus be difficult to adapt to comprehensive cross-border activities. This is reflected in e.g. the differences in amounts and types of deposits covered by the various schemes. Furthermore, the cover criteria of the schemes, their financing models and capital levels, as well as their general institutional set-ups may vary. Examples:
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Cooperation between home-country and host-country supervisory authorities is based on the principle of home-country supervision. The home-country supervisory authority alone is responsible for solvency supervision.
However, a prerequisite is that home-country supervision of branches in the host country is conducted in cooperation with the host-country supervisory authorities, which have more profound knowledge of the local markets.
In 2000, the Nordic supervisory authorities concluded a general Memorandum of Understanding (MoU) on multilateral cooperation. This MoU concerns the establishment of branches, exchange of information on branches, on-site inspection, free exchange of services and acquisition/supervision of subsidiaries. In addition, MoUs have been concluded in relation to specific Nordic banking groups/conglomerates.
If large branches are capable of influencing financial stability in the host country, more binding cooperation between home-country and host-country authorities than already envisaged should be incorporated in EU legislation. The home-country supervisory authority should have an interest in cooperating with the host-country supervisory authorities in order to gain insight into activities in the host countries and benefit from expertise on local conditions. This provides for the best possible overall risk assessment of the bank. Similarly, the host-country supervisory authorities should seek cooperation in order to gain insight into the management of risks, not only in the specific branches, but also in the bank as a whole. In general, home-country and host-country authorities thus have a clear common interest, but there is no framework for binding cooperation as such. EU regulation, and consequent distribution of responsibilities, does not sufficiently allow for large branches.
This problem will be aggravated in the event of a crisis in a bank with systemically important branches in other countries as crisis management and resolution may vary across countries. Reconstruction and winding-up procedures provided by EU legislation are based on the principles of mutual recognition and home-country control. In the event of problems in a bank with branches in other EU member states, winding-up of branches will primarily be subject to rules and procedures of the home country. The home-country authorities have full responsibility for crisis management also in the host country.
In June 2003, the Nordic central banks concluded a MoU on crisis management for Nordic groups/conglomerates with subsidiaries in several Nordic countries.[2] This MoU does not apply to cooperation concerning branches. At present, there is no legal basis for central-bank cooperation on crisis management. It is crucial to the host countries that any formal framework for actual central-bank cooperation entails full and equal access to information on both the branch's and the bank's global financial position and risks. To this end host-country and home-country supervisory authorities have to engage in binding cooperation. The home country should not have an information advantage. Furthermore, cooperation should be based on mutuality while location of home and host countries should not be determinant.