## _sdn1104 — Executive Summary and Selected Appendices

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### Key findings
- Integrated cross-border banking groups may provide important efficiency gains arising from the scale and diversification of their operations, but their failure can also generate spillovers that threaten financial stability in countries in which they operate.
- Cross-border expansion through integrated branch networks appears to be less costly and, in some cases, more efficient than establishing a series of legally independent subsidiaries.
- In the event of failure of a banking group, a subsidiary structure would generally be less costly to resolve.
- There is no one obvious structure that is best suited in all cases for cross-border expansion—“one size does not fit all” when it comes to the choice of organizational structure.
- The ultimate key to ensuring financial stability lies in the design of compatible international mechanisms that ensure effective oversight and orderly resolution of banks at both national and global levels.

### From the banking group perspective (benefits and trade-offs)
- Centralized model (branch-like characteristics)
  - Free flow of intra-group capital and liquidity with integrated organizational and risk management.
  - Funding, asset allocation, and risk management are centralized to maximize returns at the consolidated level.
  - Costs of doing business may be lower under the branch structure than under the subsidiary structure because affiliates need not each hold higher capital and liquidity buffers.
  - Provides greater ability to withstand idiosyncratic adverse shocks for given levels of group capital and liquidity, by mobilizing and re-directing funds across affiliates.
  - Preferred by banks with significant wholesale operations and global universal banks because it facilitates liquidity management, internalization of clearing and settlement, and provision of services to large corporate clients.
- Decentralized model (subsidiary-like characteristics)
  - Independently managed affiliates that are financially and operationally self-sufficient.
  - Each business unit finances itself and manages its own risk; gains from FDI (transfers of technology, product design, systems) continue to benefit subsidiaries.
  - Subsidiary is a separate legal entity, licensed and supervised by local regulators; the parent has no legal obligation to support it if it falls into distress.
  - May contain losses better in the event of affiliate distress because healthy subsidiaries can, in principle, continue as going concerns and can be spun off, sold, or placed into conservatorship by host authorities.
  - Preferred by global retail banks because of focus on local retail clients, reliance on local deposits and local deposit guarantees, and benefits from a local management team.

### Home and host authorities perspective
- Preferences depend on country status and circumstances:
  - Home authorities might prefer subsidiaries (stricter firewalls) when their banks expand into countries with weak economies and risky business environments.
  - Host authorities might prefer subsidiaries if local conditions are conducive to a healthy banking sector, because subsidiaries allow shielding the affiliate from problems of the parent.
  - Countries with underdeveloped financial systems and weak economies may prefer full service branches to provide credit services based on the strength of the parent.
- The quality of a country’s supervision, adequacy of information-sharing and supervisory coordination, and systemic importance of the affiliate influence home/host preferences.
- Division of supervisory responsibility (home supervises foreign branches; host supervises foreign subsidiaries) can raise important burden-sharing issues.

### Implications for financial stability and resolution
- Neither model universally reduces the probability of failure or the cost of failure:
  - Branch structure allows easier mobilization of funds from healthy affiliates to troubled ones but obligates the group to cover fully all losses generated in branches.
  - Subsidiary structure often limits legal obligation of the parent to support troubled affiliates and may lower overall resolution costs by enabling spinning off healthy parts, but reputational risks and confidence effects often force support in practice.
- In the absence of effective international cooperation on oversight and resolution, organization as subsidiaries may make resolution less costly and less destabilizing; healthy subsidiaries that operate independently may better survive failure of the parent or affiliates.
- The “first-best solution” is a combination of national and international arrangements that ensure cross-border banking groups internalize failure costs, including:
  - better risk management by banking groups;
  - effective oversight, information-sharing, and supervisory coordination mechanisms; and
  - satisfactory cross-border resolution regimes and burden-sharing agreements.

### Policy recommendations and priorities
- Prioritize working toward effective, harmonized cross-border resolution regimes and burden-sharing mechanisms.
- Strengthen close supervisory coordination and information-sharing between home and host authorities.
- Ensure equitable treatment of all creditors regardless of jurisdiction as part of establishing effective cross-border resolution regimes.
- Recognize that absent rapid progress on global solutions, there will likely be a growing tendency to ensure greater self-sufficiency of local affiliates to reduce threats to financial stability and resolution costs.
- Continue efforts to make cross-border resolution and oversight arrangements compatible so banks can organize in ways that best fit their business models without creating undue systemic risk.

### Appendix I — Spanish cross-border banking model (overview)
- Spanish cross-border banking model is presented as an example of a decentralized approach toward risk management in a global retail bank.
- Geographic patterns (end-2008):
  - The number of branches is generally larger than the number of subsidiaries in Asia, the Middle East, North America, and western Europe.
  - Subsidiaries outnumber branches in Latin America and central and eastern European countries.
  - For most advanced economies (exceptions: France and Switzerland), number of branches of foreign banks is larger than number of subsidiaries.
  - Subsidiaries dominate (both in terms of number and total assets) in most emerging market economies.
- Drivers of institutional choice (Box 1):
  - Banks optimize legal form based on: (i) regulatory differences; (ii) tax rules; (iii) macroeconomic and political risks in host countries; (iv) group business model and local market nature; and (v) development of local financial markets.
  - Examples of regulatory/tax influences: some home supervisors require prior approval to open branches; EU single passport regime implications; tax differentials influencing repatriation decisions.
  - Macroeconomic/political risk: greater idiosyncratic host-country risk increases attractiveness of subsidiaries; political risk may increase parent preference for branching in some cases.
  - Business model fit: takeovers of incumbents and retail-focused strategies favor subsidiaries; wholesale and corporate-targeted strategies favor branches.
- Spanish model features:
  - Spanish banks more often enter host countries through locally incorporated subsidiaries.
  - Subsidiaries typically rely on local deposits and traditional funding; can tap parent in domestic liquidity shortages at a premium.
  - Subsidiaries have independent governance; group-level policy guidance and oversight remains important.

### Box 2 — Roles of home-host supervisors under Basel and EU rules
- Basel Committee obligations and coordination:
  - Home supervisors must practice global consolidated supervision (BCP 23).
  - Home–host coordination emphasized (BCP 24).
  - Host supervisors must ensure local affiliates meet high conduct and information-sharing standards (BCP 25).
  - Primary responsibility for supervising liquidity rests with the host authority under the Basel Concordat.
- EU-specific arrangements:
  - Home country grants authorization within EU for cross-border activity; subsidiaries require host authorization.
  - Host supervisors enforce MiFID conduct-of-business rules for branches and can examine branch arrangements (Article 32(7) of MiFID).
  - CRD Article 42(a) allows host designation of significant branches, improving host participation in supervisory colleges.
  - Host retains supervision responsibility for liquidity and monetary policy where monetary policy is independent.
- Practical trade-offs and policy responses:
  - Preferences depend on relative economic conditions and supervisory capacity.
  - Without effective information exchange and resolution mechanisms, host authorities may require local capital/liquidity buffers or tighter intra-group limits.
  - Costs of blanket subsidiarization or strict ring-fencing include constraints on group liquidity/capital management, higher capital and liquidity needs above Basel III, and potential regulatory arbitrage.
  - Legal structure does not, by itself, affect likelihood of bank failure; crisis issues tied more to risk management, regulation and supervision, coordination, and crisis tools.
- First-best and interim measures:
  - First-best: joint home/host supervision, harmonized cross-border resolution regimes, clear burden-sharing, effective risk management.
  - Interim: jurisdictions may impose subsidiarization or ring-fencing; living wills and recovery/resolution planning can be facilitated by separate legal subsidiaries.

### Appendix II — Banking industry views on Stand-Alone Subsidiarization (SAS)
- Industry perspectives (selected points):
  - Global Investment Banks: avoid trapping pools of liquidity; need ability to transfer excess liquidity across the group; concerned about loss of flexibility and increased systemic risk from SAS.
  - Global Retail Bank: sees significant stability benefits and manageable costs from subsidiarization; SAS compatible with retail-focused, deposit-funded models; forcing branches into subsidiaries would materially impact corporate lending for wholesale operations.
  - Global Universal Banks: warn SAS will stop consolidation and create country-by-country silos; loss of cross-border support would hurt ability to serve large customers and manage liquidity; prefer a mix of branches and subsidiaries aligned with business model.
  - Common industry call: better monitoring of intra-group capital/liquidity flows, enhanced capital and liquidity regimes, effective home-host coordination, strong risk management, and robust contingency mechanisms.

### Appendix III — Illustrative simulation of capital costs of ring-fencing (method and key results)
- Purpose: illustrate the potential impact of ring-fencing (restrictions on cross-border transfers of excess profits/capital) on cross-border banks by measuring additional capital that might be needed if reallocations are restricted after a credit shock to an affiliate.
- Sample and data:
  - 25 major European cross-border banking groups domiciled in Austria, Belgium, Denmark, France, Germany, Greece, Italy, the Netherlands, and Sweden.
  - These groups have 113 subsidiaries operating in 18 CESE countries.
- Shock and period:
  - CESE credit shock refers to deterioration in macroeconomic conditions over the period of 2009–10 leading to an increase in nonperforming loans (NPLs) and a decrease in returns on assets (ROAs) of the CESE subsidiaries.
- Methodology:
  - Two-step approach:
    - For each subsidiary: capital need = amount required to bring its post-shock capital-asset ratio (CAR) back to either the country-specific (Basel II) regulatory minimum or to the subsidiary-specific pre-shock level.
    - At the group level: total capital needs = sum of individual subsidiary capital needs (and losses on direct cross-border exposures in some simulations) offset by any other funds that can be reallocated within the group.
  - Total group capital needs depend on availability of excess profits/capital and the degree to which these funds can be reallocated.
- Four ring-fencing scenarios (definitions summarized):
  - No ring-fencing: CN(1) = sum of capital needs of all CESE subsidiaries — sum of excess profits and capital of all CESE subsidiaries — profits of the parent bank
  - Partial ring-fencing: CN(2) = sum of capital needs of all CESE subsidiaries — sum of excess profits of all CESE subsidiaries — profits of the parent bank
  - Near-complete ring-fencing: CN(3) = sum of capital needs of all CESE subsidiaries — profits of the parent bank
  - Stand-alone subsidiarization (SAS) / Full ring-fencing: CN(4) = sum of capital needs of all CESE subsidiaries
- Key simulation results:
  - Under stricter ring-fencing, sample banking groups have substantially larger needs for capital buffers at the parent and/or subsidiary level than under less strict (or no) ring-fencing.
  - For the sample cross-border banking groups, aggregate recapitalization needs in the ring-fencing/SAS scenarios are 1.5–3 times higher than in the case of no ring-fencing in response to a simulated CESE credit shock over the 2009–10 period.
  - Results are robust to variations in methodology, including: (i) adding losses on direct cross-border lending and lending through branches in the CESE region; (ii) redefining recapitalization need to restore pre-shock (end-2008) CARs; and (iii) using different approaches to computing post-shock adjustments in risk-weighted assets (standardized versus Basel II IRB).

*Source: _sdn1104 — Executive Summary, Appendix I, Box 2, Appendix II, and excerpt of Appendix III from the supplied IMF content unit.*

### Executive Summary ......................................................................................................

### Executive Summary

### I. Introduction
- Located on page 5.

### II. Choice between Branches and Subsidiaries and Implications for Financial Stability
- Main section located starting on page 7.
- Subsections:
  - A. The Bank Perspective — page 7.
  - B. The Policymaker Perspective — page 15.

### III. Conclusions and Policy Implications
- Located on page 20.

### Figures (titles and page references)
- Figure 1. Geographical Distribution of Subsidiaries and Branches of Foreign Banks, end-2008 — page 13.
- Figure 2. Country Distribution of Branches and Subsidiaries of Foreign Banks, end-2008 — page 14.
- Figure 3. Total Foreign Claims of Sample Banking Groups on the CESE Countries — page 24.
- Figure 4. Aggregate Capital Needs Resulting from a CESE Shock — page 26.

### Boxes (titles and page references)
- Box 1. What Drives Institutional Choice of Legal Model Between Branches vs. Subsidiaries — page 11.
- Box 2. Roles of Home-Host Supervisors for Subsidiaries and Branches Under the Basel and EU Rules — page 17.

### Appendixes (titles and page references)
- Appendix I. Spanish Cross-Border Banking Model — page 22.
- Appendix II. Banking Industry Views on the Stand-alone Subsidiarization (SAS) Approach — page 23.
- Appendix III. An Illustrative Simulation of Capital Costs of Ring-Fencing — page 24.

### Appendix Tables (titles and page references)
- Table A1. Banking Industry Views on SAS—A Survey of Selected Global Banks — page 23.
- Table A2. Definitions of Capital Needs Under Four Ring-Fencing Scenarios — page 26.

*Source: _sdn1104 - Executive Summary (PDF), pages as indicated in the document.*

### EXECUTIVE SUMMARY

### _sdn1104 - EXECUTIVE SUMMARY

### Key findings
- Integrated cross-border banking groups may provide important efficiency gains arising from the scale and diversification of their operations, but their failure can also generate spillovers that threaten financial stability in countries in which they operate.
- Cross-border expansion through integrated branch networks appears to be less costly and, in some cases, more efficient than establishing a series of legally independent subsidiaries.
- In the event of failure of a banking group, a subsidiary structure would generally be less costly to resolve.
- There is no one obvious structure that is best suited in all cases for cross-border expansion—“one size does not fit all” when it comes to the choice of organizational structure.
- The ultimate key to ensuring financial stability lies in the design of compatible international mechanisms that ensure effective oversight and orderly resolution of banks at both national and global levels.

### From the banking group perspective (benefits and trade-offs)
- Centralized model (branch-like characteristics)
  - Free flow of intra-group capital and liquidity with integrated organizational and risk management.
  - Funding, asset allocation, and risk management are centralized to maximize returns at the consolidated level.
  - Costs of doing business may be lower under the branch structure than under the subsidiary structure because affiliates need not each hold higher capital and liquidity buffers.
  - Provides greater ability to withstand idiosyncratic adverse shocks for given levels of group capital and liquidity, by mobilizing and re-directing funds across affiliates.
  - Preferred by banks with significant wholesale operations and global universal banks because it facilitates liquidity management, internalization of clearing and settlement, and provision of services to large corporate clients.
- Decentralized model (subsidiary-like characteristics)
  - Independently managed affiliates that are financially and operationally self-sufficient.
  - Each business unit finances itself and manages its own risk; gains from FDI (transfers of technology, product design, systems) continue to benefit subsidiaries.
  - Subsidiary is a separate legal entity, licensed and supervised by local regulators; the parent has no legal obligation to support it if it falls into distress.
  - May contain losses better in the event of affiliate distress because healthy subsidiaries can, in principle, continue as going concerns and can be spun off, sold, or placed into conservatorship by host authorities.
  - Preferred by global retail banks because of focus on local retail clients, reliance on local deposits and local deposit guarantees, and benefits from a local management team.

### Home and host authorities perspective
- Preferences depend on country status and circumstances:
  - Home authorities might prefer subsidiaries (stricter firewalls) when their banks expand into countries with weak economies and risky business environments.
  - Host authorities might prefer subsidiaries if local conditions are conducive to a healthy banking sector, because subsidiaries allow shielding the affiliate from problems of the parent.
  - Countries with underdeveloped financial systems and weak economies may prefer full service branches to provide credit services based on the strength of the parent.
- The quality of a country’s supervision, adequacy of information-sharing and supervisory coordination, and systemic importance of the affiliate influence home/host preferences.
- Division of supervisory responsibility (home supervises foreign branches; host supervises foreign subsidiaries) can raise important burden-sharing issues, as illustrated by the Icelandic banks’ failure example discussed in the text.

### Implications for financial stability and resolution
- Neither model universally reduces the probability of failure or the cost of failure:
  - Branch structure allows easier mobilization of funds from healthy affiliates to troubled ones but obligates the group to cover fully all losses generated in branches.
  - Subsidiary structure often limits legal obligation of the parent to support troubled affiliates and may lower overall resolution costs by enabling spinning off healthy parts, but reputational risks and confidence effects often force support in practice.
- In the absence of effective international cooperation on oversight and resolution, organization as subsidiaries may make resolution less costly and less destabilizing; healthy subsidiaries that operate independently may better survive failure of the parent or affiliates.
- The “first-best solution” is a combination of national and international arrangements that ensure cross-border banking groups internalize failure costs, including:
  - better risk management by banking groups;
  - effective oversight, information-sharing, and supervisory coordination mechanisms; and
  - satisfactory cross-border resolution regimes and burden-sharing agreements.

### Policy recommendations and priorities
- Prioritize working toward effective, harmonized cross-border resolution regimes and burden-sharing mechanisms.
- Strengthen close supervisory coordination and information-sharing between home and host authorities.
- Ensure equitable treatment of all creditors regardless of jurisdiction as part of establishing effective cross-border resolution regimes.
- Recognize that absent rapid progress on global solutions, there will likely be a growing tendency to ensure greater self-sufficiency of local affiliates to reduce threats to financial stability and resolution costs.
- Continue efforts to make cross-border resolution and oversight arrangements compatible so banks can organize in ways that best fit their business models without creating undue systemic risk.

*Source: EXECUTIVE SUMMARY, _sdn1104*

### Appendix I describes the Spanish cross-border banking model as an example of a decentralized approach toward

### _sdn1104 - Appendix I describes the Spanish cross-border banking model as an example of a decentralized approach toward

### Overview and context
- Appendix I uses the Spanish cross-border banking model as an example of a decentralized approach toward risk management in a global retail bank; it draws, in part, on Asociación Española de Banca (2010).
- Figures 1 and 2 (end-2008) show geographical distributions of branches and subsidiaries of foreign banks:
  - The number of branches is generally larger than the number of subsidiaries in Asia, the Middle East, North America, and western Europe.
  - Subsidiaries outnumber branches in Latin America and central and eastern European countries.
  - For most advanced economies (with the exceptions of France and Switzerland), the number of branches of foreign banks is larger than the number of subsidiaries.
  - Subsidiaries dominate (both in terms of number and total assets) in most emerging market economies, where the frequency of macroeconomic and financial dislocations tend to be higher than in advanced economies.

### Box 1 — Drivers of institutional choice: branches vs. subsidiaries
- Banks optimize legal form based on:
  - (i) differences in regulatory arrangements applicable to branches and subsidiaries;
  - (ii) tax rules adopted by home and host jurisdictions;
  - (iii) relevant environmental (i.e., macroeconomic and political) risks in host countries;
  - (iv) the group’s business model and group-wide expertise, and the nature of the business anticipated in the local market; and
  - (v) the state of development of local financial markets in the host country.
- Advanced market economies hosting major money centers or derivatives exchanges may see relatively more foreign bank penetration via branches to raise large-volume funding for the group’s global activities at lower capital cost.

- (1) Differing regulatory treatment of branches and subsidiaries by home and host
  - Home and host regulations influence the choice of legal form.
  - Examples: Italian and Canadian banks require prior approval by home regulator to open an overseas branch; Bank of Spain can refuse a branch application on a wider set of criteria than for subsidiaries.
  - EU single passport regime: additional constraints for EU-domiciled banks do not apply for affiliate operations in EU member states.
  - New Zealand requires foreign banks to operate through subsidiaries to provide separation and enable more efficient resolution.
  - Banks prefer subsidiaries where additional requirements on branches restrict operations, ensure equal treatment of host depositors in insolvency, or require burdensome home-supervisor approval.

- (2) Tax and cost incentives
  - Cerutti et al. (2007) found a positive and statistically significant relationship between the top corporate tax rate in a host country and the decision of a bank to incorporate its local business as a branch.
  - Differential tax treatment by home authorities of repatriated profits from branches versus subsidiaries (e.g., United Kingdom) can swing the choice.
  - Complex organizational structures can arise: a subsidiary acquired via M&A can serve as a regional hub from which the bank branches out (HSBC and Grupo Financiero HSBC examples noted).

- (3) Macroeconomic and political risks in the host country
  - Greater idiosyncratic macroeconomic risk in the host country increases attractiveness of the subsidiary model: subsidiary obligations limited to equity; parent can legally walk away.
  - Cerutti et al. (2007) find a statistically significant negative relationship between domestic country macroeconomic risk indicator and choice of branching over subsidiarization.
  - Perceived political risk generally results in a preference for branching; legal protections in some home countries (e.g., Canada and the United States) extend contingent limited liability to branches.
  - Cerutti et al. (2007), controlling for other factors, find a significant and positive relationship between host country political risk and parent preference for branching.
  - In practice, parents may extend capital and liquidity support to affiliates (both branches and subsidiaries) when exposures make affiliates systemically important to the parent (examples: Swedish banks in the Baltics; Austrian and Italian banks in CEE; Banco Espirito Santo capital injection into Banco Boavista Interatlantico in 1999).

- (4) Fitting business model to market penetration strategy
  - Takeovers of incumbent domestic banks favor subsidiary incorporation due to local credit-risk assessment advantages and incumbent client base; local funding reliance (deposits) also favors subsidiaries.
  - Branching is preferred when targeting corporate clients and when booking large corporate credit exposures or client risk management (derivatives) at group level to economize on capital and exploit centralized expertise.

- (5) Level of development of local markets
  - Management style may be indistinguishable across structures despite different incorporation choices.
  - Swedish banks in the Baltics and Austrian banks in the Balkans overwhelmingly follow subsidiary models; treasury and risk management of subsidiaries often integrated into group-level decision-making.
  - Spanish subsidiaries in Brazil and Mexico can more easily raise wholesale funding locally compared with Swedish subsidiaries in Baltic countries; Spanish banks prefer decentralized management of capital and liquidity for subsidiary operations.

### Patterns and examples of institutional models
- Large cross-border Spanish banks with a retail focus, as well as the U.K. global bank HSBC, are viewed as closest to the subsidiary-based structure, although they also maintain branches in some countries (example: BBVA has subsidiaries in Latin America and the United States but also operates through branches in the United States, the United Kingdom, and Hong Kong SAR).
- Cross-border banks with wholesale banking and trading activities (example: Standard Chartered) operate mainly through branches, sometimes using a hybrid model with decentralized subsidiaries in a few countries (example: Standard Chartered in Korea, Hong Kong, and China).
- Conclusion: preferences and practical differences between models are not clear-cut.

### The policymaker perspective: growth vs. financial stability tradeoffs
- Host-country considerations in normal times:
  - Branch structure could provide host country borrowers with easier access to foreign credit.
  - Subsidiary structure may be more conducive to local market development.
  - Empirical evidence is inconclusive:
    - Credit supply: no firm evidence that subsidiaries have less ability to supply credit; subsidiaries of western European groups helped rapid credit growth in CEE pre-crisis.
    - No firm evidence that subsidiaries have more/less stable inter-affiliate cross-border capital flows than branches.
    - Staff analysis (available upon request) suggests stability and resilience of intra-group capital flows relate more to idiosyncratic country factors than legal structure.

- Home vs. host regulator preferences
  - Supervisory control and oversight:
    - Host-country supervisory control greater under subsidiary structure; opposite for home country under branch structure.
    - Home supervisor remains responsible for consolidated supervision regardless of organizational structure; effectiveness depends on host supervisory quality and home/host coordination and information-sharing.
    - Two-tier supervision practice is cited for large Spanish banks’ overseas subsidiaries as an example of close home-host cooperation.
  - Source of adverse shocks:
    - Host country better off with subsidiary structure facing adverse external shocks (easier ring-fencing).
    - Host country better off with branch structure facing a shock to the domestic economy or financial system (branch implies stronger parent commitment).
    - Home country preferences are opposite depending on where the negative shock originates.
  - Fiscal costs and contingent liabilities:
    - A distressed affiliate imposes a relatively heavier obligation on the host country if organized as a subsidiary than as a branch (branch responsibilities lie with parent/home authorities).
    - For home countries with limited fiscal capacity, it may be prudent to encourage internationally active banks to organize as subsidiary-based structures rather than branch-based structures (IMF, 2010a).

### Empirical/statistical notes and figures
- Figures referenced:
  - Figure 1. Geographical Distribution of Subsidiaries and Branches of Foreign Banks, end-2008.
  - Figure 2. Country Distribution of Branches and Subsidiaries of Foreign Banks, end-2008.
- Regions and country groupings used in figures:
  - 1/ Africa includes Nigeria and South Africa.
  - 2/ Asia includes Australia, China, India, Indonesia, Japan, Korea, Malaysia, Philippines, New Zealand, Singapore and Thailand.
  - 3/ Latin America includes Argentina, Brazil, Chile, Colombia, Mexico, Paraguay and Peru.
  - 4/ Middle East includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates.
  - 5/ North America includes Canada and United States.
  - 6/ Western Europe includes Austria, Belgium, Cyprus, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Spain, Sweden, and Switzerland.
  - 7/ Eastern Europe and Turkey includes Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, Slovenia, Russia, and Turkey.
  - 8/ Branches and subsidiaries of foreign banks in the U.S. are categorized in specific legal forms (listed verbatim in source).

*Source: _sdn1104 Appendix I (text provided).*

### Box 2. Roles of Home-Host Supervisors for Subsidiaries and Branches Under the Basel and

### Box 2. Roles of Home-Host Supervisors for Subsidiaries and Branches Under the Basel and EU Rules

### Basel Committee and Core Principles (BCPs) — Home and Host Obligations
- Home supervisor obligations (BCP 23): “Home supervisors must practice global consolidated supervision over their internationally active banking organizations, adequately monitoring and applying appropriate prudential norms to all aspects of the business conducted by these banking organizations worldwide, primarily at their foreign branches, joint ventures, and subsidiaries” (BCP 23).
- Home–host coordination (BCP 24): “A key component of consolidated supervision is establishing contact and information exchange with the various supervisors involved, primarily host country supervisory authorities” (BCP 24).
- Host responsibilities (BCP 25): host supervisors are expected to ensure business conduct of local affiliates of foreign banks meets the same high standard expected for domestic institutions and that they have the ability to share information with relevant home authorities for satisfactory consolidated supervision (BCP 25).
- Liquidity supervision under the Basel Concordat: primary responsibility for supervising liquidity rests with the host authority (reference to the Basel Concordat).

### EU-specific Arrangements for Authorization and Supervision
- Authorization rules:
  - Within EU membership, power to grant authorization to conduct business within the membership (outside the home country) rests with the home country, which communicates its decision to the relevant host member state.
  - In the case of a subsidiary, authorization to conduct business must be sought from the host country authorities (potentially in addition to the home country).
- Branch supervision and conduct of business (MiFID):
  - Host supervisor is expected to ensure compliance by locally active branches of cross-border banks domiciled within the EU with conduct of business rules under Article 32(7) of MiFID.
  - Host supervisor/authority has the right to examine branch arrangements and request such changes as are strictly needed to enforce conduct of business obligations.
- Host designation of significant branches (CRD Article 42(a)):
  - Article 42(a) of the EU’s Capital Requirements Directives (CRD) allows the host to designate a branch operating in its jurisdiction as significant (i.e., systemically important).
  - Designation improves the host’s capacity to supervise the branch (e.g., participation of the host supervisor in meetings of the supervisory college where issues specific to the branch or group risks are discussed).
  - Host authority is obliged to facilitate onsite examination of locally active branches by the home supervisor.
- Host retains supervision responsibility for liquidity and monetary policy measures where monetary policy is independent.

### Practical Trade-offs: Branches versus Subsidiaries
- Factors shaping home/host preferences:
  - Preferences depend on relative economic conditions and objectives: stricter firewalls (subsidiary model) when a country’s conditions are better than abroad; weaker firewalls when the home country is stronger.
  - Considerations include supervisory quality, capacity of home authority to support affiliates in stress, level playing field concerns vis-à-vis domestic institutions, and systemic importance of the affiliate.
- Crisis and self-sufficiency considerations:
  - Practical difficulties in global cooperation during a crisis have led some policymakers to explore greater self-sufficiency of local operations regardless of business model.
  - Without effective information exchange, coordination, and cross-border resolution mechanisms, host authorities may require local banks to maintain sufficient capital and liquidity buffers (e.g., through tighter intra-group limits on subsidiary operations).
  - Some view subsidiarization as facilitating resolution because resolution authorities could spin off businesses and affiliates individually.
- Costs and adverse implications of blanket subsidiarization or strict ring-fencing:
  - Potential costs include:
    - Constraints on management of liquidity and capital on a group-wide basis.
    - The need to hold higher capital and liquidity levels at a consolidated level over and above the Basel III requirements.
    - Potential opportunities for regulatory arbitrage due to varying jurisdictional standards restricting intra-group exposures.
  - Stand-alone subsidiarization (SAS) model (extreme variant) may hamstring group liquidity and capital management and could adversely affect group stability.
- Organizational structure and failure likelihood:
  - Legal structure (branch vs. subsidiary) does not, by itself, affect the likelihood of a bank failure.
  - The recent crisis problems were more closely tied to weaknesses in risk management, regulation and supervision, supervisory coordination, and crisis management tools than to legal organization.

### First-best Solution and Short-term Policy Responses
- First-best elements to address cross-border tensions:
  - Joint home/host supervision of cross-border groups in normal conditions.
  - Harmonized cross-border resolution regimes.
  - Clear and effective burden-sharing arrangements in stressed or crisis conditions.
  - Effective risk management by banking groups.
- Interim responses if first-best not achieved:
  - Some jurisdictions may impose structural restrictions (e.g., subsidiarization or ring-fencing) as a price for financial stability.
  - These restrictions can reduce destabilizing effects of cross-border failures but come with costs noted above.
- Living wills and recovery/resolution planning:
  - Constellation of separate legal subsidiaries may facilitate implementation of living wills—recovery and resolution plans with blueprints to facilitate orderly wind-down of systemically important financial groups.
  - Living wills can simplify legal and financial structure and encourage streamlined corporate structure to facilitate resolution.

### Conclusions and Policy Implications
- No one-size-fits-all organizational structure for cross-border banking groups; choices depend on business lines and countries’ development stages.
- Stakeholder perspectives:
  - Banking groups: choice affected by business focus and differences in tax and regulatory regimes. Wholesale-oriented banks favor centralized branch models; global retail banks may prefer decentralized subsidiary models.
  - Home/host authorities: home authorities may prefer subsidiaries to protect domestic interests when expanding into risky countries; host authorities may prefer subsidiaries when local conditions are stronger; underdeveloped financial systems may prefer branches to leverage parent strength.
- Policy priorities to reduce systemic risk and make structure choices less consequential:
  - Strengthened capital and liquidity regimes to provide sufficient buffers (e.g., along the lines proposed by the Basel Committee).
  - Adequate risk governance assuring prudent risk management systems to cover liquidity and funding pressures in domestic and global markets.
  - Sound home and host supervisory regimes acting preemptively when a parent or an affiliate gets into difficulties, regardless of branch or subsidiary form.
  - Effective dialog and information-sharing mechanisms between home and host supervisors (e.g., via supervisory colleges), including ensuring participation by host supervisors when affiliates are systemically important in host financial systems.
  - Effective contingency planning arrangements with a robust safety net that covers deposits in foreign branches.
  - Satisfactory cross-border resolution regimes and burden-sharing arrangements between home/host authorities to provide legal powers to restructure viable businesses and resolve unviable ones without major systemic disruptions.
- Interim view on resolution costs:
  - Until adequate progress on cross-border resolution regimes, resolving cross-border banking groups organized as subsidiaries may, in principle, be less costly or destabilizing than resolving groups organized as branches.
  - Healthy subsidiaries operating independently of the parent are better able to survive failure of the parent or other affiliates than individual branches, though remaining subsidiaries could face confidence effects.
  - Separate subsidiaries may be sold more easily to other investors and banks in restructuring scenarios.
- Final policy stance:
  - While subsidiary structures may address certain financial stability concerns, they do not obviate the need for the first-best solution: effective and harmonized cross-border resolution regimes, equitable burden-sharing mechanisms, adequate risk management, strong capital and liquidity frameworks, and effective home/host supervisory coordination.

### Appendix I — Spanish Cross-Border Banking Model (key features)
- Spanish banks more often enter host country systems through locally incorporated subsidiaries than other large, mature market banks.
- Subsidiary funding and liquidity:
  - Subsidiaries typically rely on local deposits and traditional funding sources sufficient for retail-oriented businesses.
  - In domestic liquidity shortages, subsidiaries can tap the parent for assistance, albeit at a premium.
  - In normal conditions, subsidiaries are designed to be decentralized and self-sufficient in funding, often raising funding under their own name.
  - Some subsidiaries have decentralized management of different currencies operated by their business units.
- Governance and risk management:
  - Subsidiaries have independent governance; boards of directors are appointed by the head office.
  - Credit risk is managed at the subsidiary level subject to limits and tailored to host regulatory requirements.
  - Risk management and control functions at group and unit levels are characterized by common policies, tools, information systems, processes, and models.
- Determinants of the Spanish model:
  - Subsidiary structure reflects a retail business strategy aimed at long-run viability and a philosophy that self-financed networks provide better risk management.
  - Decentralized model partly arises from legacy corporate structures and de-localization during acquisition phases, especially when country risk was perceived as high.
  - The home regulator, the Bank of Spain, supported decentralized liquidity management and can limit overseas branching on a broader set of factors than those used to limit subsidiaries.
- Group-level oversight:
  - While funding management is decentralized, broad liquidity growth strategy and funding policy guidelines are often set at group level.
  - New funding tools in a country unit are decided by the group Asset Liabilities Committee with subsequent technical support from the parent.

*Source: Box 2, _sdn1104 - Roles of Home-Host Supervisors for Subsidiaries and Branches Under the Basel and EU Rules.*

### APPENDIX II: BANKING INDUSTRY VIEWS ON THE STAND-ALONE SUBSIDIARIZATION (SAS)

### APPENDIX II: BANKING INDUSTRY VIEWS ON THE STAND-ALONE SUBSIDIARIZATION (SAS) APPROACH

### Banking industry perspectives (Table A1)
- Global Investment Bank
  - Trapping pools of liquidity in legal entities should be avoided, and banks should be able to transfer excess liquidity across the group.
  - Uses branches in certain locations and subsidiaries in emerging markets and is concerned about losing flexibility in managing capital and liquidity within the group, which may in turn increase systemic risk.
- Global Investment Bank
  - Concerned about the possibility of trapped liquidity at individual subsidiaries (through cushions of liquidity at subsidiaries and treatment of affiliates).
- Global Retail Bank
  - The benefits to stability are significant and the costs manageable.
  - Subsidiarization provides a medium-term orientation for the business model, including funding stability and discipline for the local subsidiaries.
  - An important side effect is the development of local capital markets.
  - Business models heavily focused on local retail banking with minimal reliance on short-term wholesale funding are very compatible with SAS.
  - Broader franchise and reputational concerns are “an element” in the decision to provide a subsidiary with capital and liquidity support during a crisis (but at market prices or higher).
  - Forcing branches to convert into stand-alone subsidiaries would likely have a material impact on corporate lending activity for the bank’s wholesale operations.
- Global Universal Bank
  - Capital and liquidity pools in each affiliate and the way the bank is structured to ensure self-sufficiency have served the bank well.
  - Concerned about the loss of ability to initiate cross-border support within the group to cope with a temporary liquidity crisis and support affiliates when needed.
  - The loss of these capabilities would be detrimental to the group as a whole. Reputational cost of not supporting subsidiaries is high. It is good to keep flexibility in structure.
- Global Universal Bank
  - SAS will stop consolidation. Country by country silos will reduce banks’ ability to expand in other countries and fund large customers.
  - Direct effects on business models as banks tend to use a branch model for wholesale activities and a subsidiary model for retail activities.
  - What is needed is an articulation of an effective exchange of information between home and host authorities.
- Global Universal Bank
  - There should not be a forced change to a banking group structure; a mix of branches and subsidiaries should be permitted based on the business model of a particular group.
  - What is needed: better control/monitoring of capital and liquidity flows within the banking group; enhanced capital and liquidity regimes; effective coordination of regulation and supervision by home/host authorities; strong risk management and governance by banks; establishment of crisis management and contingency mechanisms.
  - Capital and liquidity being ring-fenced in different parts of the world will reduce the ability to serve large clients, manage liquidity risks, cope with stressful conditions; will lead to higher cost and reduced availability of credit; and cause increased concentration of risk.
- Global Universal Bank
  - Worried about a growing number of jurisdictions that are imposing restrictions on liquidity transfers not only on the subsidiaries but also branches.
  - This development is inefficient from a liquidity risk management perspective as well as from a systemic risk perspective, with the inability of the group to transfer liquidity from one location to where it is most needed.
  - Questions the benefit for a bank holding company of having a stand-alone subsidiary and the limited resolution benefits given the importance of reputational costs.
- Global Universal Bank
  - Significant concern about various jurisdictions adopting restrictive and nationalistic approaches on liquidity management of affiliates, which would raise the cost of funding and affect liquidity risk management capacity of the group.

### Illustrative simulation of capital costs of ring-fencing (Appendix III excerpt)
- Purpose
  - Illustrates the potential impact of ring-fencing (different restrictions on cross-border transfers of excess profits and/or capital between a parent bank and its subsidiaries) on cross-border banks.
  - Measures cost as additional capital that might be needed if banks are restricted in reallocating excess profits and capital across jurisdictions following a shock to credit quality in an affiliate.
- Sample and data
  - Focus on 25 major European cross-border banking groups domiciled in Austria, Belgium, Denmark, France, Germany, Greece, Italy, the Netherlands, and Sweden.
  - These groups have significant presence in the CESE region, including through their 113 subsidiaries operating in 18 CESE countries.
  - Analysis mainly on groups’ indirect exposures through CESE subsidiaries; direct cross-border lending and lending through branches in the CESE region are also considered.
- Shock and period
  - CESE credit shock refers to deterioration in macroeconomic conditions over the period of 2009–10 leading to an increase in nonperforming loans (NPLs) and a decrease in returns on assets (ROAs) of the CESE subsidiaries.
  - Simulation relies largely on actual data for 2009 and projections using panel regression models for CESE country-level NPLs and ROAs for 2010.

### Methodology to estimate capital needs
- Two-step approach
  - For each subsidiary: capital need = amount of capital required to bring its post-shock capital-asset ratio (CAR) back to either the country-specific (Basel II) regulatory minimum or to the subsidiary-specific pre-shock level (the latter is conservative because it requires subsidiaries not to run down pre-shock buffers).
  - At the group level: total capital needs = sum of capital needs of individual subsidiaries (and also losses on direct cross-border exposures of parent banks, in some simulations) offset by any other funds (excess profits and/or capital) that can be re-allocated from other parts of the banking group.
- Dependence
  - Total group capital needs depend on the availability of excess profits and/or capital in subsidiaries and parent bank, and on the degree to which these funds can be reallocated within the group.

### Four ring-fencing scenarios (definitions summarized)
- No ring-fencing
  - CN(1) = sum of capital needs of all CESE subsidiaries — sum of excess profits and capital of all CESE subsidiaries — profits of the parent bank
- Partial ring-fencing
  - CN(2) = sum of capital needs of all CESE subsidiaries — sum of excess profits of all CESE subsidiaries — profits of the parent bank
- Near-complete ring-fencing
  - CN(3) = sum of capital needs of all CESE subsidiaries — profits of the parent bank
- Stand-alone subsidiarization (SAS) / Full ring-fencing
  - CN(4) = sum of capital needs of all CESE subsidiaries

### Key simulation results
- Under stricter ring-fencing, sample banking groups have substantially larger needs for capital buffers at the parent and/or subsidiary level than under less strict (or no) ring-fencing.
- For the sample cross-border banking groups, aggregate recapitalization needs in the ring-fencing/SAS scenarios are 1.5–3 times higher than in the case of no ring-fencing in response to a simulated CESE credit shock over the 2009–10 period.
- Results are robust to variations in methodology, including:
  - (i) adding losses on direct cross-border lending and lending through branches in the CESE region;
  - (ii) redefining the recapitalization need of a subsidiary as the amount of capital required to bring its post-shock CAR back to the subsidiary-specific pre-shock (end-2008) level (instead of the country-specific regulatory minimum);
  - (iii) using different approaches to computing the post-shock adjustment in risk-weighted assets for the post-shock CARs (standardized versus the Basel II Internal Ratings Based (IRB) approach).

*Source: APPENDIX II and excerpt of APPENDIX III from the supplied IMF content unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2011/_sdn1104.pdf_