Geofinance, or the impact of geography on financial regulation, will be "the defining challenge of the next few years," according to Bank of England deputy governor Sam Woods.
The challenge for the global banking system will be "striking the right balance" by putting appropriate geographical boundaries and oversights in place, but also recognizing the intrinsically international nature of wholesale banking, Woods said, speaking at the Mansion House City banquet in London on Oct. 4.
It is a positive for the global financial system that wholesale banks are highly active across borders and that, to date, regulators have been able to agree on global capital standards. However, cooperation between governments is essential, he said.
"Doing all of these things efficiently and effectively relies on a strong degree of trust and cooperation between public authorities across borders. We hope we can secure that in the years ahead," Woods said.
This challenge is particularly relevant for London because it is host to such a large number of subsidiaries of international banks with exposures across the globe, Woods said.
"The broader the reach of an international bank, the greater its vulnerability to cyclical trends in the global economy," he said. "The more that banks are concentrated in certain overseas markets, the greater the U.K. entities' potential vulnerability to stress on distant shores."
London is "the host with the most" when it comes to global banking, as it supervises around 170 international banks from over 50 countries, Woods said.
"This includes every single foreign global systemically important bank and is more than any other EU country. International banks' U.K. banking sector assets amount to more than twice U.K. annual GDP," he said.
Additionally the BoE is announcing a "new approach" to ensure that U.K.-headquartered banks with significant international operations are "at least as strong as their parts." This includes a requirement that banks demonstrate their ability to manage the risks associated with the practice of "double leverage," that is to say, financing the additional capital requirements of their overseas subsidiary by raising debt externally in the U.K. While this is cheaper than equity, banks rely on dividend income to service this debt, which can prove unpredictable.
The BoE also proposes bringing in additional reporting requirements that will give insights into whether banks are allocating resources appropriately across different countries, Woods said.
"In doing this, we are getting to grips with an important geofinancial issue and showing how we as a home supervisor can ensure that cross-border banks do not present excessive risks to financial stability," Woods said.