Regulatory Arbitrage: Some Banks In The US Circumvent The New Capital Rule

The major flaws of the interventionist ideology are that they seem to always figuratively “fight the last war”, treat symptoms rather than the source of the disease and starkly misjudge market dynamics in adapting to a new regulatory environment.

A good example of the last condition, largely known as regulatory arbitrage, can be defined as, according to moneyterms.co.uk, “financial engineering that uses differences between economic substance and regulatory position to evade unwelcome regulation. The term is also sometimes used to describe firms structuring or relocating transactions to choose the least burdensome regulator, but this is better described as regulator shopping.”

The essence is that in search of profits, private enterprises tend to look for loopholes which circumvent unfavourable regulations from where they can operate.

It’s fundamentally a cat-mouse game between authorities and the markets.

Below is a good example.

From the Wall Street Journal, (bold highlights mine)

Some foreign banks are moving to restructure their U.S. operations to avoid one of the most-burdensome requirements of the new Dodd-Frank law.

In November, Barclays PLC quietly changed the legal classification of the U.K. bank's main subsidiary in the U.S. so that the unit would no longer be subject to federal bank-capital requirements. Several other banks based outside the U.S. are considering similar moves, according to people familiar with the matter.

The maneuver allows them to escape a provision of the financial-overhaul law that forces the pumping of billions of dollars of new capital into the U.S. entities, known as bank-holding companies.

"It's just not worth it to have all that capital trapped" in the holding company, said a New York lawyer who is advising banks on how to restructure.

The moves are the latest example of how banks are scrambling to cushion the impact of new laws and rules around the world.

Policy makers are demanding banks hold more capital and cash to help prevent a repeat of the financial crisis. But bank executives are worried that all the changes will crimp profits without making the financial system safer.

Last summer's Dodd-Frank law beefed up rules governing the quantity and types of capital banks must keep to protect themselves from potential losses. The provision also closed a loophole that allowed foreign banks to run their U.S. subsidiaries with thinner capital buffers than those of their local rivals.

All these simply show how markets are much superior to governments and how government regulations may lead to unintended consequences.