Governance of International Banking: The Financial Trilemma
International banking is at the cross-roads. Are we heading for the decentralised banking model, by which banks are split in national subsidiaries supervised by national supervisors? Or can we maintain the integrated business model for international banks? In a new book on Governance of International Banking, published by Oxford University Press, the author Dirk Schoenmaker explores the trade-offs between internationally active banks and national supervision.
The Global Financial Crisis has shown that the international financial system is vulnerable to breakdown. The financial trilemma demonstrates that financial stability, international banking and national financial supervision cannot be combined. National supervisors force international banks to keep local liquidity pools and capital buffers, which cannot be transferred. This national approach is a very costly solution to the trilemma. Governance of International Banking advocates an alternative solution to keep international banking alive. The central element is an international coordinated approach to supervision and resolution of international banks. International financial institutions, like the Bank for International Settlements and the International Monetary Fund, should take on a supervisory role of global systemic banks, broadening their mission for monetary stability to one that includes monetary and financial stability. At the European level, the European Central Bank is currently assuming the financial stability mandate for the European banking system.
“The Global Financial Crisis has shown that the international financial system is vulnerable to breakdown. The financial trilemma demonstrates that financial stability, international banking and national financial supervision cannot be combined.”
The financial trilemma
The financial trilemma states that policy-makers have to choose two out of the three policy objectives: 1) financial stability, 2) international banking, and 3) national financial policies. The outcome of the financial trilemma is crystal clear. Financial authorities need to operate over the same terrain as banks, if one wants to maintain financial stability. So, the public domain will need to assert itself on the global banks, which underpin the wider global financial system (giving up the 3rd objective). Alternatively, national regulators will need to require the current global banks to turn their banking group into a string of nationally licensed stand-alone-subsidiaries (giving up the 2nd objective). The model of the financial trilemma, developed in a new book on Governance of International Banking1, has laid the theoretical foundation for this strong conclusion. The game of cooperation between national supervisors is basically an application of the prisoner’s dilemma. By putting their own self-interest first, supervisors cannot reach the cooperative equilibrium. The handling of international bank failures during the Global Financial Crisis confirms this non-cooperative behaviour in practice.