Royal Bank of Canada recently joined that elite club of 30 too-big-to-fail banks whose demise might trigger another global financial crisis.
Getting the official label was pretty much a non-event because RBC says it already holds the extra 1-per-cent capital buffer, required by the Financial Stability Board, an international banking regulator based in Basel, Switzerland.
But the news is a reminder of how much – and how little – has changed since the near-meltdown of the financial system in 2008.
Forcing key banks to be more resilient is a good thing.
The ultimate goal is to make the entire system stronger and more transparent, including knowing where the big financial risks lie. Last week, global bank regulators reached a deal on a sweeping set of capital rules, known as Basel 3, which includes rules on how banks measure the risk that mortgages, loans and other assets will fail.
That's only part of the problem.
Consider what happened when Lehman Bros. failed. The U.S. investment bank had as many as 8,000 subsidiaries with different names operating in numerous countries. Untangling that murky web of entities and the thousands of parties on the other side of its financial deals proved to be a nightmare.
"After Lehman's demise, participants in the global financial system could not assess their exposure to Lehman, its subsidiaries, and each other because there was no standard system for identifying counterparties in the maze of subsidiaries and affiliates from which banks, insurers, asset managers and other market participants transact," according to a recent McKinsey & Co. report.
The system was messy and opaque. It was extremely difficult to know for sure who anyone was or what they owned. One company would use different names and codes to identify entities it controlled. At Lehman, there was no electronic system to connect participants to each other.
The obvious solution is a global ID – a social insurance number of sorts to identify the real owners of all parties involved in a financial transaction.
If such a system had existed in 2008, banks would have known in real time the extent of their exposure to Lehman as the company faltered and eventually failed. And regulators would have been able to quantify and isolate the ensuing damage to the financial system.
So, at the urging of the Group of 20 countries, the FSB set up the Global Legal Identifier (LEI) regime. The system is now up and running, allowing financial connections to be identified, mapped and linked to their ultimate owner based on a 20-digit alphanumeric ID. As a bonus, the system makes it tougher to engage in money laundering, fraud and tax evasion.
Unfortunately, the system depends on being able to track all parties and their transaction. And it's voluntary.
So far, roughly 825,000 LEIs have been issued worldwide, including nearly 25,000 in Canada and 147,000 in the United States, according to the Basel-based Global Legal Entity Identifier Foundation.
But there is still a long way to go. There are tens of millions of companies in the United States alone. And countries use many types of corporate identifiers.
"The challenge is to ensure that the LEI system includes virtually every firm that is eligible worldwide," economists Stephen Cecchetti of Brandeis University and Kim Schoenholtz of New York University's Stern School of Business pointed out in an article for the Centre for Economic Policy Research. "In the absence of collective action, the risk is that the transition to a universal identifier system will stall."
Part of the problem is that IDs are not mandatory for many financial transactions. Nor does the LEI regime specify what types of transactions are involved – stocks, bonds, derivatives, bank loans, securities financings or insurance contracts.
Prof. Cecchetti and Prof. Schoenholtz say regulators should set a firm deadline for requiring all counterparties to set up LEIs.
Cost shouldn't be an impediment. Setting up an LEI is cheap, at just $75 (U.S.). McKinsey estimates that banks could collectively save $250-million to $500-million a year by identifying international entities and tracing transaction histories when they issue letters of credit.
It's comforting to know that RBC is all bulked and ready to weather a meltdown.
But it's not at all clear that a chaotic financial failure elsewhere wouldn't again send shock waves through the global system, without warning.
We are still a long way from knowing where the big risks are lurking.