Ring-fencing cross-border banks: An effective supervisory response?

Abstract

Although international policy makers are making good progress on the important work of global resolution mechanism and the preparation of recovery and resolution plans, a growing number of supervisors, home as well as hosts, are resorting to territorial approaches. Higher capital ratios, dividend restrictions, restrictions on liquidity flows and even forced subsidiarization are gaining renewed popularity. Their objective is to protect the interests of the domestic stakeholders of a foreign bank and to limit the effects of cross-border contagion. This type of ‘ring-fencing’ comes with a negative connotation as it comes at a cost for banks and the efficiency of the overall global financial system. But why do prudential supervisors ring-fence and what makes them more likely to ring-fence? And do all forms of ring-fencing really deserve this bad reputation? What are the risks these measures are addressing and which instruments have been used? Finally, what are the implications of ring-fencing for the banking group, financial stability in the home and host country, as well as global financial stability?