Amid an ongoing debate as to whether banks should fully embrace a global operational approach or rather opt for sharper localisation, the Association for Financial Markets in Europe (AFME) warned against the unintended consequences of EU and global policymakers pushing the sector towards the latter option.
In a new report published with financial services consultancy Capco, the industry association said that recent regulatory efforts to increase the financial sector’s resilience against the potential side effects of stronger interconnectedness resulted in a sharper focus on operational resilience and third-party-providers, outsourcing and intra-group arrangements.
However, this policy strategy could adversely steepen banks’ funding costs and hinder investment in safer technologies, the report warned.
“This focus could result in requirements on banks to localise operations and technology services, ultimately impacting broader policy objectives by increasing funding costs for clients and investors and reducing investment in more resilient technologies and operations,” it said.
Urging a “risk and principles-based approach, proportionate to banks existing use of global operating approaches”, the report said collaboration between banks and policymakers will be key to gauge the possible impact of future legislation on these approaches.
“This will account for the controls and regulatory frameworks banks are already subject to and the ability to continue relying on third-party outsourcing, or intra-group arrangements, at a group level,” it said.
“It will be essential that future legislation does not inadvertently impact the development of resilient, secure, and efficient capital markets by seeking to replicate operations or technology services in each location in which a bank operates,” the report said.
The paper highlighted that banks continue to transform their operating approaches for a variety of reasons, including the need to meet changing client and regulatory expectations as well as the urgency of adopting new technologies and data-driven innovation – be it in terms of undergoing IT simplification programs to reduce duplicative systems or the adoption of cloud computing services.
However, increased regulatory requirements towards localisation could force banks to replicate or duplicate operations and technology services in specific locations.
“This localisation would limit the economies of scale and benefits of global approaches and impact EU and global markets client service and resilience,” the report argued.
In the European market, opting for a localising approach would inhibit banks from developing new technologies – such as artificial intelligence – at scale, by placing barriers on global operating arrangements.
Moreover, the report argued that excessive localisation could impact the efficiency of a bank’s allocation of capital and liquidity – with the aggregate buffers held through localised entities “likely to exceed that required to cover the same risks if these were met by the group on a consolidated basis.”
“This fragmentation resulting from separate pots of capital and liquidity leads to inefficiencies by increasing banks’ cost of capital and funding, resulting in a lower supply or higher cost of financing for businesses and lower returns for savers and investors,” it said.
“With restrictions often preventing the free transfer of resources across groups,” measures shaped upon a localising approach risk amplifying the banking system’s financial fragility in times of stress, the report concluded.
Overall, AFME and Capco acknowledged regulators’ concerns over emerging non-financial risks linked to growing cross-border digitalisation – such as cyber-security and outsourcing risk – and argued that “global policies must be complemented by robust local-entity compliance, governance, controls, and oversight, to allow local entities to rely on other parts of the group, especially where there are sub-outsourcings.”
“For example, banks operating in the EU must ensure that outsourcing arrangements are documented on robust contractual and compliance requirements.
“EU financial entities retain full responsibility for their compliance and oversight to relevant NCAs in the locations they are based,” it said.