Yesterday, the U.K.’s Financial Services Authority (FSA) released a report entitled “Financial Risk Outlook 2009.” The report criticized the EU single market rules, which cover members of the European Economic Area (EEA), that “allow banks in one country to operate as branches in another, with the supervision of solvency and of whole bank liquidity resting with the home country supervisor (this right is known as ‘passporting’).” The EEA consists of the 27 EU member states plus Iceland, Leichtenstein and Norway.

The FSA, as host-country supervisor for the U.K., has “limited powers relating to the supervision of local liquidity in cooperation with the home supervisor, conduct of investment business and financial crime.” Therefore, depositors in one country are “are vulnerable to the failure of banks in another country if the home country concerned lacks the supervisory resources to ensure bank solvency, or the fiscal resources and willingness to fund bank rescue, and if the deposit insurance cover is low and unfunded.” This is a not-too-veiled reference to the initial reluctance of the Icelandic government to extend deposit guarantees to U.K. depositors of Landesbanki was a significant source of friction between the two countries, and shined a spotlight on the lack of enforcement mechanisms to ensure compliance with, among other things, the passporting requirement.

The FSA suggested several options for changes to EEA bank branch passporting rights:

  • The restriction of branch passporting rights and the requirement that retail deposit gathering be conducted through fully capitalized subsidiaries supervised by the host-country regulator.
  • Host countries’ supervisory powers to conduct a whole bank assessment and to refuse local branches the right to operate if not satisfied.
  • European-wide processes to assess the effectiveness of home-country supervision of those banks wanting to conduct retail business in other member countries.
  • Cross-European requirements for pre-funded and ring-fenced deposit insurance, combined with more overt warnings to consumers of the limits of deposit insurance.
  • Host country to have powers requiring engagement by the home country on contingency planning and resolution options.