European banks start using loopholes in order to avoid tough new regulations

European banks are restructuring their businesses outside their home countries in ways that reduce the impact of tough new regulations that were adopted in response to the financial crisis.

In the U.S., U.K. and Portugal, at least a few large European banks have altered their legal structures or moved assets and business lines between units, partly in an attempt to avoid local rules and oversight, according to bank disclosures and people familiar with the matter.

The latest example came in Portugal this week. Deutsche Bank AG converted its business there from an independently incorporated local subsidiary into a branch of the parent company. The switch means the giant German bank’s Portuguese operations are no longer subject to new capital and other requirements that Portugal imposed in the wake of the country’s international rescue earlier this year.

In the U.K., a number of big European banks, including France’s BNP Paribas SA, recently moved assets between different legal entities, at least partly to reduce the scope of operations subject to aggressive British regulations and oversight, according to people familiar with the matter.

The maneuvering follows recent examples of major European banks, including Deutsche and Barclays PLC, that tinkered with the structures of their U.S. operations in ways that enabled them to skirt last year’s Dodd-Frank financial-overhaul law.

The banks say they are making the changes mainly to improve efficiency, and none of this breaks any rules. But the effect, intended or not, is that they don’t have to adhere to stringent local capital and liquidity rules, as they move outside the jurisdiction of regulators who have been growing more assertive, according to bank executives, regulatory lawyers and other experts.

Some experts say the trend could add risk to Europe’s beleaguered financial system.

At issue is the type of legal entity in which the banks run businesses outside their countries. They have two main choices: a subsidiary or a branch. A subsidiary must maintain its own balance sheet and answer to local regulators. A branch is simply a foreign appendage of the parent and therefore doesn’t face the same financial or regulatory burdens.

Many banks, as well as regulators, prefer the subsidiary approach, partly because it helps instill confidence that problems in one unit won’t spread throughout the company.

Spain’s Banco Santander SA and the U.K.’s HSBC Holdings PLC are among those that rely on local subsidiaries to house their far-flung operations.

In some recent cases, regulators have been pushing banks to embrace the use of subsidiaries. The U.K.’s Financial Services Authority, for example, successfully pressed UBS AG to shift assets such as portfolios of loans and derivatives from its lightly regulated London branch into a U.K. subsidiary that is subject to FSA oversight, according to people familiar with the matter.

But with regulators clamping down on banks, other lenders are starting to inch away from the subsidiary model, partly to avoid having to satisfy local rules that exceed international requirements on capital levels.

Banks’ increasing use of branches, while making it easier for them to move money around their businesses, could prove worrisome for the broader financial system, some experts say.

“The downside for authorities is it makes the bank more difficult to resolve in a windup,” said Jon Peace, a London-based banking analyst with Nomura.

Deutsche Bank recently moved its Portuguese and Hungarian businesses from subsidiaries to branches and is doing the same in Belgium. In a letter notifying Portuguese customers of the planned change, Deutsche said the goal is “to strengthen its commitment to the Portuguese market.” The letter added that the switch meant Portuguese regulators would lose some power over the operations. “The main regulatory authority will be BaFin,” the letter said, referring to Germany’s regulator.

The timing of the move coincided with the intensification of bank regulation in Portugal. The country’s €78 billion ($105 billion) international bailout requires its banks boost their capital ratios and become less reliant on foreign funds to run their day-to-day operations.

 

By PATRICIA KOWSMANN, DAVID ENRICH and LAURA STEVENS, WSJ

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