The financial crisis has led economists and policymakers to think more carefully about how global banks are regulated. Before the crisis, foreign banks had operated their U.S. branches and subsidiaries mainly under rules set by the countries where they were based.1 But as the crisis made clear, financial shocks are transmitted internationally. And efforts to resolve them can be hampered when there are multiple regulators with opposing interests and different resolution mechanisms. In response to these concerns, the Federal Reserve Board, in accordance with the Dodd-Frank Act, has approved rules to strengthen the regulation of foreign banks operating on U.S. soil in coming years.

The new framework’s organizational restrictions and higher regulatory costs may reduce the efficient flow of funds within global banks. These costs and restrictions may also induce global banks to shift activities to other countries, switch from subsidiaries to branches, or take other steps to avoid the full impact of the regulations. However, the new rules reflect heightened concerns about financial stability that came into sharp relief during the crisis. To understand the tradeoffs, this article will examine: How did banking become globally interconnected in the years leading up to the financial crisis? How does the presence of foreign banks benefit a country, and what are the costs? Why had foreign banks been lightly regulated before the crisis? And postcrisis, what are the new regulations’ likely costs and benefits?

This article appeared in the First Quarter 2015 edition of Business Review. Download and read the full issue.

[1]I use the terms foreign and global bank more or less interchangeably. See William Goulding and Daniel Nolle for precise definitions of terms used to describe foreign banks and foreign units of global banks. Their article also contains a description of U.S. foreign banking statistics.