COC

Big banks good for global trade, says BIS (September 2009)

Rethinking Bretton Woods | Sun, Sep 13, 2009

By Aldo Caliari
In a recent report, the Bank of International Settlements argues that the tendency to fragment the hitherto global banking model may harm international trade. But the link between global banking and trade is not as positive as the BIS suggests, this artlcle argues.

 In the controversy over the viability and desirability of big and global banks, the Bank of International Settlements takes clearly a side in their favor. Surprisingly, the effects on trade are mentioned as a primary reason. In its latest Annual Report, the BIS argues that “By reducing the need to have lenders located physically near borrowers, international banks facilitate trade in goods and services as well as the cross-border movement of capital.” [1] As host country governments become more cautious about allowing foreign banks to operate in their soil the result would be that of reducing the ease with which capital moves across borders. This “would shrink trade in goods and services and thus moderate growth and development.” [2] 

As the pre-crisis global banking model comes increasingly under challenge, several voices are warning about the potential that such measures may have in hindering international trade in the future. Last July, the head of the WTO, Mr. Pascal Lamy said that bank bailouts had "constrained risk-taking" outside the familiar territories of national markets and this was already affecting foreign direct investment, now forecast to fall 50 per cent this year.[3] 

The calls are echoed by the industry. The head of the Institute of International Finance, Mr. Joe Ackerman, warned that the response of regulators may lead to the refragmentation of markets. In such a structure “Banks would not be able to manage their risk, capital and liquidity on a consolidated basis. This would make the allocation of capital in the economy less efficient in normal times and render an efficient response more difficult in times of tension. It would also have severe implications for the growth prospects of smaller countries with a limited deposit base.“[4] 

But the purported benefits of global banking for trade are much less clear than such statements would suggest. In its response to the review conducted by Lord Turner the UK Association of Corporate Treasurers is reported stating that there could be minor conveniences in dealing with a very large bank providing a good range of service across the globe but this was not usually the key selection criterion. The Association “welcomed a diversity of providers in order to access a diversity of products, ideas and expertise. And [was] sufficiently worried about competition policy issues to suggest that there could be a case for breaking up big banks. There would also be advantages in terms of escaping from diseconomies of scale and scope and, most importantly, reducing systemic risk.” The idea that global banking has necessarily led to reductions in cost of credit is certainly at odds with the findings of a number of recent studies.[5] 

The views on the efficiency of global banks, or the lack of margins to adjust without increasing the cost of credit, do not go unchallenged, either. Noting that the financial industry represents between 30% and 40% of the aggregate profits of the quoted corporate sector in the US, UK and globally—compared with 10 % forty years ago-- one analyst states “It seems strange that an industry whose role is that of intermediation rather than the production of consumption goods and services should command such a high share of capital, profits and brains.”[6] 

There is also evidence that low barriers to cross-border banking have been used by banks largely to evade or avoid taxes. A recent OECD study found that most of the aggressive tax planning solutions are designed by structured finance departments and involve cross-border transactions. [7] In many cases, the transactions lack economic substance independent from the tax benefits. “Complexity does not necessarily indicate tax abuse; nor does the use of SPVs” says the OECD, but “some aggressive arrangements are designed to obscure the real economics of the transaction.”[8] 

These conclusions would suggest that tax evasion and avoidance, rather than efficiency, are responsible for a good portion of the profits made by banks. If this is the case, not only efficiency gains are not being transferred to the consumer, but gains could well be coming at the expense of taxpayers, rather than being a result of banks’ efficient management of risks and capital at a global level.

Host country supervisors should be concerned about the role of foreign banks in their countries’ trade. But their concern should not depart from the assumption that such role is always a benign one. Their active intervention in the banking system could actually do a lot to restore the broken link between trade and the building of domestic capital.

[1] BIS Annual Report 2009, 120.

[2] Ib.

[3] Hollinger, Peggy 2009. Lamy in warning over bank bail-outs. In Financial Times, July 6.

[4] Ackerman, Josef 2009. Smaller banks will not make us safer. July 29.

[5] Rules liberalizing financial services, an obstacle to anti-crisis efforts, available at http://www.coc.org/node/6366

[6] Woolley, Paul 2007. Financial Sector Disfunctionality: Is society well-served by its financial institutions?, Transcript of Public Lecture given on 31 October 2007 at the University of Technology, Sydney and subsequently broadcast on ABC Radio, Australia.

[7] OECD 2008. Study into the Role of Tax Intermediaries, Chapter 9.

[8] Ib.