How Deinstitutionalization influences institutionalization of alternative actors : a legitimacy-based perspective on global banking and shadow banking actors in the EU financial organizational field

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How Deinstitutionalization Influences Institutionalization of Alternative Actors:

A Legitimacy-based perspective on Global Banking and Shadow Banking Actors in the

EU Financial Organizational Field

written by

Li-Sien CHEN (6176356)

MASTER OF SCIENCE

in

BUSINESS ADMINISTRATION

(International Management Track)

Date submitted: June 29, 2015

Supervisor: Mw. Francesca Ciulli

Second supervisor: Dr. Ilir Haxhi

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STATEMENT OF ORIGINALITY

This document is written by Student Li-Sien Chen who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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FOREWORD

This thesis has been written as final piece of a Master of Science in Business Administration specialized in International Management at the University of Amsterdam.

It was interesting to study and explore institutional pressure and strategic responses with a focus on the European financial sector. The research process was not easy and obstacles had to be overcome. At the end of the process, while writing the foreword, I can say that I enjoyed writing this thesis.

I would like to express my deepest appreciation to mw. Francesca Ciulli for all her patience, her supervision, her time and her generous feedback. At Ernst & Young I was well supervised by Robert Hoek. I would also like to thank Robert for his support, supervision, and his effort to review my thesis.

Yours sincerely, Li-Sien Chen

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1. INTRODUCTION

Following the global financial crisis of 2008-09, regulatory pressure in the European banking industry became more coercive and intense. Institutional change spread to many jurisdictions in the European Union where regulatory institutions were realigned to afford greater state oversight over key aspects of banking activities. The Basel III regulatory framework created an environment that discouraged international banking activities. In particular, Basel III regulations ushered a wave of “deglobalization” among European banks. The Economist (2013) reported in a special issue on the topic that “forward march of globalization has paused since the financial crisis, giving way to a more conditional, interventionist and nationalist model”. In a word, European global banking has seemingly become “deinstitutionalized”. However, in its place an alternative industry called shadow banking established itself to gradually become institutionalized. Against this backdrop, this study investigates which strategic responses these two actors adopted to manage legitimacy issues, with institutionalization and deinstitutionalization processes as underpinning mechanisms. We elaborate on how the isomorphic pressure of regulation (DiMaggio and Powell, 1983) influenced the institutional environment in which the actors operate. We do this within the context of the financial organizational field of the European Union (EU).

This study makes sense of regulatory pressure as the circumstance around which profound institutional change can occur, as Scott (2001) argued. The study of Ang and Cummings (1997) on the effects of coercive isomorphism on strategic responses in US banks, underscores the relevance of institutional pressure on actors within an organizational field. By responding to these forces, organizations look for legitimacy which helps ensure their organizational survival (DiMaggio and Powell, 1983; Meyer and Rowan, 1977). We will therefore address the following research question:

“How have responses to managing legitimacy influenced institutional change that is brought about by coercive regulatory pressure in the EU financial organizational field?”

We build on institutional theory (Oliver, 1991; Scott, 2001; Suchman, 1995) to come up with a meaningful answer to this question. In methodological terms, this study relies on publicly available sources to reconstruct developments in the banking industry and understand how these impacted the wider EU financial organizational field. The variety of sources requires

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6 critical sorting, particularly in a context where all actors have an interest in legitimizing their own role. We use a longitudinal single embedded case study approach to analyze actors’ strategies and stages of institutional change within the EU financial organizational field in an effort to make sense of a complex set of circumstances over the last five years. We mobilize Suchman’s (1995) strategies for responding to legitimacy challenges to fulfill our purpose.

We proceed as follows. In section 2, I provide a basis for understanding the institutional context by providing the relevant theoretical background and concepts for this study. In section 3 and 4, I present the methodological framework which includes the research context where we formulate a set of propositions to guide our discussion, and the research design. Section 5 presents the results of the data analysis. Finally, section 6 and 7 interprets the major results of the study and draw conclusions, respectively.

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2. LITERATURE REVIEW

The literature review gives an account of what has been published on institutional theory and particular areas of the EU financial organizational field. The literature will be used as a foundation and as support for new insights that I contribute. The following sections will summarize and synthesize the core arguments and ideas of authors of relevant scholarly articles.

2.1 FOUNDATIONS OF INSTITUTIONAL THEORY

There is no single and universally agreed definition of an “institution”. However, most scholars conducting research in institutional theory and methodological principles take as a starting point Douglass North’s or William Richard Scott’s definition of institutions. Their contributions to the field transformed initial intuitions about institutions into a useful conceptual and analytical apparatus. North (1991, p. 97) defines institutions as “humanly devised constraints that structure political, economic and social interaction”. He distinguishes between formal constraints such as rules and regulations and informal constraints such as cultures and norms. These formal and informal institutional constraints form the “rules of the game” that shape the behavior of economic actors, create order and reduce uncertainty (North, 1991, p. 98). These constraints define the incentives that determine the choices that actors make that shape the performance of societies and economies over time (North, 1994). Scott (2001, p. 48) defined institutions as “social structures that have attained a high degree of resilience”. “It is the interaction between institutions and organizations that shapes the institutional evolution of an economy. If institutions are the rules of the game, organizations are the players” (North, 1994, p. 361). After institutions are established, they become authoritative guidelines for social behaviors and are taken for granted.

DiMaggio and Powell’s 1983 paper, the Iron Cage Revisited: Institutional Isomorphism

and Collective Rationality in Organizational Fields has been a major contributor to the

development of institutional concepts. It became an extensively influential piece of work and was at the forefront of development of institutional theory. Its influence continues, despite the shift of research focus towards other aspects of the institutional theory. DiMaggio and Powell introduced the concept of organizational field, focusing on a macro-level,

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8 interorganizational analysis. “The virtue of this unit of analysis is that it directs our attention (…) to the totality of relevant actors” (DiMaggio and Powell, 1983, p. 148). They emphasized that the organization exists in a wider context and this context extends beyond exogenous social forces. The organizational field could consist of the organization, its competitors, suppliers, and customers, regulatory agencies, and others with which there is a high degree of interaction or comparison. In practice, many scholars have equated the field to an industry. For example, Greenwood, Suddaby and Hinings (2002) conceptualized the professional services industry as an institutional field, giving “an account of how the boundaries of one community of organizations (…) within a field (professional business services) changed” (Greenwood et al., 2002, p. 58). The most common application of the organizational field concept has emphasized the constraining nature of the institutional environment through pressures that create tendencies for organizations to appear similar to one another (DiMaggio and Powell, 1983). The organizational fields perspective has been criticized for how it has neglected the actions of actors that change the structures of fields (Barley and Tolbert, 1997). Another contribution by DiMaggio and Powell (1983) has been their emphasis on institutional isomorphism. Institutional theorists have suggested that “in the initial stages of their life cycle, organizational fields display considerable diversity in approach and form. Once a field becomes well established (…) there is an inexorable push towards homogenization” (DiMaggio and Powell, 1983, p. 148). The authors posed the question: “What makes organizations so similar” DiMaggio and Powell, 1983, p. 147)? DiMaggio and Powell draw on the concept of institutional isomorphism, referring to the tendency of organizations within an organizational field to adopt similar practices leading to homogeneity of structure. A fundamental proposition of institutional theory is that institutional isomorphism increases organizational legitimacy (DiMaggio and Powell, 1983; Meyer and Rowan, 1977). Legitimacy is perhaps the most central concept in institutional research (Haveman and David, 2008). Suchman (1995) observed that existing literature provided “surprisingly fragile conceptual moorings. Many researchers employ the term legitimacy, but few define it. Further, most treatments cover only a limited aspect of the phenomenon (…)” (Suchman, 1995, p. 571). To remedy these weaknesses, Suchman presents an encompassing definition of legitimacy as “a generalized perception or assumption that the actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and

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9 definitions” (Suchman, 1995, p. 574). Almost five decades ago, Weber (1968) already identified legitimacy as an important condition for order and authority. Later scholars argued that legitimation efforts help explain organizational adjustment to the environment. Organizations that pursue isomorphic strategies are recognized as being more legitimate than those that deviate from accepted practices (Deephouse, 1996). “As an innovation spreads, a threshold is reached beyond which adoption provides legitimacy rather than improves performance” (DiMaggio and Powell, 1983, p. 148).

DiMaggio and Powell (1983) define three isomorphic mechanisms to increase legitimacy: coercive, mimetic, and normative. Mimetic isomorphism occurs if organizations are aspiring to imitate the practices and structures of other organizations. Normative isomorphism refers to organizational change driven by professional pressures, such as formal education and professional networks. Coercive isomorphism result from both formal and informal rules exerted by powerful entities, such as the state and regulatory agencies that organizations are dependent upon.A relevant finding from Deephouse (1996) is that coercive isomorphism increases organizational legitimacy, supporting the general proposition made by Meyer and Rowan (1977) and DiMaggio and Powell (1983). His study empirically demonstrates that firms conform to broad industry practices, not because they are efficient per se, but because they acquire legitimacy in the form of regulatory and public media endorsement (Deephouse, 1996).

Similar to DiMaggio and Powell’s (1983) conceptualization of isomorphic processes to increase legitimacy, Scott (2001) outlined three institutional pillars to illustrate different pressures of conformity to gain organizational legitimacy: regulative, normative, and cognitive. “These three bases of legitimacy map neatly onto the three processes driving isomorphism” (Haveman and David, 2008, p. 580). The regulative pillar corresponds to DiMaggio and Powell’s (1983) coercive isomorphism. Since the focal point of this study is on regulatory institutions, the emphasis is on the regulatory/coercive aspect of organizations. It is probably the most clear and most commonly studied because it describes explicit rules, laws, procedures, and regulations.

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2.2 INSTITUTIONAL CHANGE, INSTITUTIONALIZATION, AND DEINSTITUTIONALIZATION

Traditional approaches to institutional analysis have tended to focus on explaining how various coercive, mimetic, and normative pressures, embedded in the prevailing belief system, lead organizations to converge on a standard set of practices (Scott, 2001). As a result, organizational conformity and isomorphism have been emphasized over conflict, change, and practice variation (Lounsbury, 2002). Institutional theorists argued that it is reasonable to assume that organizational structures are subject to inertial forces and therefore it is difficult for organizations to make radical changes in strategy and structure (Hannan and Freeman, 1984), especially in those structures that have been “institutionalized” and legitimated (DiMaggio and Powell, 1983). Nevertheless, this does not suggest that institutional theory is incompatible with change processes. “On the contrary, many institutional accounts are about isomorphic convergence, which implies movement from one position to another” (Greenwood et al., 2002, p. 59). While earlier work by institutional theory scholars has viewed institutions as a source of stability and order, recent literature has considered how institutions change (Ingram and Silverman, 2002; Scott, 2001; Tolbert and Zucker, 1996; North, 1994; Oliver, 1992) and recognized different types of institutional change (Oliver, 1992). Institutions legitimize actions, and thus play an important role in generating the performance acceptable to others (Scott, 2001). When that performance falls short, pressures grow for institutional change.

The process of institutional change involves the deconstruction of an old order and the building up of a new set of institutional arrangements (Lounsbury, 2002). Greenwood, Suddaby, and Hinings’ (2002) model of institutional change is helpful in thinking about how and why institutionalized practices within an organizational field change. They suggest that institutional adjustment emerges from a process that begins with “jolts”, which may arise from social, technological and regulatory pressures, and subsequently passes through a series of stages of institutional change (Greenwood et al., 2002, p. 59). An important stage that follows directly from a precipitating jolt is deinstitutionalization. At this stage, emerging new actors play a part in disturbing the established institutional order. As a new belief or practice become widely accepted and adopted by actors, it gains legitimacy and becomes taken for granted as the most appropriate within that context (Greenwood et al., 2002). Hannan and Freeman’s (1977) are interested in how organizational interdependencies change in response

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11 to institutional change. Their framework of organizational ecology posit that organizational forms compete with each other in the sense that growth in the numbers of one form diminishes the number of a second form. Two central mechanisms in organizational interdependence are legitimation and competition.

The concept of institutionalization and deinstitutionalization are central to institutional change as they address the pace and direction of institutional change. Institutionalization is often described as a “social process by which individuals come to accept a shared definition of social reality” (Scott, 1987, p. 496), or the “process by which an organizational practice attains a stable and durable state or property” (Galliers and Currie, 2011, p. 139). In short, organizational forms and practices are institutionalized when they are adopted because actors take them for granted, independent of evidence that they “work (…)” (Davis et al., 1994, p. 550). Scholars have argued that through the process of institutionalization, institutions diffuse within organizations, industries, or organizational fields (Philips et al., 2004; Scott, 2001; Scott, 1987; Tolbert and Zucker, 1983; Zucker, 1977). This includes the diffusion of alternative ways of formal organization structure of state and for-profit corporations (Tolbert and Zucker, 1983). According to Meyer and Rowan (1977), regulation is a source of organizational practices in a field. New organizational practices come into being by virtue of economic requirements of the task. Once such practices gain legitimacy, they become institutionalized as others in the field uncritically accept their validity and value and adopt them.

But institutionalization is not a “once-and-for-all process” (Davis et al., 1994, p. 550). The growing body of literature on institutional change has so far mainly addressed the emergence of institutions. Institutional theory has been critiqued for its tendency to focus on processes of institutionalization, rather on what might be labelled “deinstitutionalization” (Greenwood et al., 2002; Oliver, 1992), or “the processes by which institutions weaken and disappear” (Scott, 2001, p. 182). The wider literature share a common view that deinstitutionalization involves a process that is distinct from that to create and maintain institutions (Lawrence and Suddaby, 2006; Oliver, 1992). According to Oliver (1992, p. 564) deinstitutionalization is “the process by which the legitimacy of an established or institutionalized organizational practice erodes or discontinues”. Just like the flipside of institutionalization is deinstitutionalization, the flipside of legitimation is delegitimation: reduced acceptance of activities or practices (Haveman and David, 2008). Prevailing

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12 institutions within organizational fields can become vulnerable, as some actors within them abandon them (Davis et al, 1994). Lounsbury, Ventresca and Hirsch (2003) suggest that the emergence of new structures and practices within industries requires the previous deinstitutionalization of existing dominant structures. The importance of deinstitutionalization has been emphasized (e.g. Oliver, 1992) with several such studies (following Scott, 2001, p. 184; e.g. Greenwood et al., 2002; Davis et al., 1994) stressing the importance of placing “deinstitutionalization in a broader context of institutional change, since the weakening and disappearance of one set of beliefs and practices is likely to be associated with the arrival of new beliefs and practices” (Scott, 2001, p. 184). Oliver (1992) provides essential background to the understanding of deinstitutionalization. He identifies three antecedents of deinstitutionalization that may put pressure on institutionalized norms or practices. Deinstitutionalization can be precipitated by political, functional, or social forces (Oliver, 1992). Oliver argues that “changing government regulations are most likely to deinstitutionalize past practices, given the strength of coercion that underpins the legal enforcement of government mandates” (Oliver, 1992, p. 584).

A number of studies examine processes of decline and erosion of legitimacy of previously institutionalized practices. For instance, Davis, Diekmann, and Tinsley (1994) investigated the decline and fall of the conglomerate firm, which they conceptualized as the deinstitutionalization of an organizational form. By 1990 the conglomerate form had become deinstitutionalized in the US. In its place emerged a new appropriate business practice which suggested “extreme specialization and contracting for any aspects of production outside the firm’s “core competence” (Davis et al., 1994, p. 563). In another study, Currie (2009) investigated the processes of deinstitutionalization of working practices in the UK health care sector as the organizational field of health care moved from professional dominance by medical practitioners to one based on market mechanisms.

Apart from intentional institutional change processes (for example, the top down, government-led IT innovation was an attempt to deinstitutionalize the entrenched working practices of medical practitioners in the UK healthcare sector (Currie, 2009)), there can be unanticipated consequences of unintentional, but purposive activities leading to new institutions (Hwang and Powell, 2005). Regulatory institutions sometimes produce outcomes that were not and perhaps could not have been foreseen (Walter, 2012;Hwang and Powell,

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13 2005). Thus the impacts of regulatory institutions vary depending on the rules enacted and enforced and on the way firms respond (Williamson, 1991).

2.3 MANAGING LEGITIMACY: STRATEGIC APPROACHES

One of the main theses of institutional theory is that organizations “require more than material resources and technical information if they are to survive and thrive in their social environments (Scott, 2001, p. 71)” – in short, they act to enhance their legitimacy (Suchman, 1995; DiMaggio and Powell, 1983). Meyer and Rowan (1977) were among the first to call to attention to the ways in which organizations seek legitimacy and support by adopting widely accepted practices or structures that are not immediately connected to any increase in efficiency. Suchman’s (1995) outlined three types of legitimacy: pragmatic, moral, and cognitive, which are broadly similar to Scott’s typology of legitimacy against the regulative, normative, and cognitive pillars of institutions. Pragmatic legitimacy rests on the self-interested calculations of corporate actors about the expectations of its surrounding environment. A crisis at the level of pragmatic legitimacy occurs when the output of practices which previously were beneficial have temporarily collapsed and positive outcomes to wider audiences in society and government are no longer being produced. Moral legitimacy rests on normative evaluation of whether the action of an organization is judged to be moral or “the right thing to do” (Suchman, 1995, p. 579). Cognitive legitimacy is produced when an organization pursues goals and activities that society values as appropriate, proper, and desirable.

Oliver (1991) noted that attention towards strategic behavior of organizations was lacking in institutional theory. A central concern for institutional scholars has been the degree of strategic choice organizations can exert in response to institutional pressures (Goodstein, 1994; Hannan and Freeman, 1977). Organizations were seemingly placed at the mercy of their institutional environment, or their “iron cages” (DiMaggio and Powell, 1983, p. 147). Over time, there has been a growing recognition among institutional scholars that “organizations may respond to institutional pressures in a variety of modes ranging from passive compliance with institutional norms to direct defiance of an institutional environment” (Goodstein, 1994, p. 351).

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14 Suchman provides the clearest range of strategies organizations may adopt for gaining, maintaining, or repairing legitimacy. Suchman (1995) argues that gaining legitimacy is a proactive enterprise where an organization can either conform to the environment, select among multiple environments, or manipulate the environmental structure. However, not all legitimation attempts are met with equal success (Suchman, 1995). Institutional changes can lead to the questioning or loss of legitimacy. In such cases, Suchman (1995) suggests three broad approaches that serve to repair legitimacy: offer normalizing accounts, restructure, and don’t panic. Then there are strategies for maintaining legitimacy which “fall into two groups – perceiving future changes and protecting past accomplishments” (Suchman, 1995, p. 594).

2.4 CONCEPTUALIZING THE EU FINANCIAL ORGANIZATIONAL FIELD

In this section we use the organizational field concept to specify at the field level the set of organizations involved with institutional change processes. In order to identify which actors are subject to which institutional pressures in the EU financial organizational field, a categorization needs to be established. We differentiate between field actors, who shape the field, and its institutions. Each key constituent of the EU financial organizational field within the context of this study will be briefly discussed here. Figure 1 portrays the EU financial organizational field, as it exists after the Basel III Accord.

 European Global banks

The first major constituent in the EU financial organizational field is the European banking sector, or more specifically the largest banks in the EU that operate globally. Banks are crucial to the European economy as the majority of small and medium-sized businesses, the cornerstone for Europe’s economic growth, are reliant on bank lending to finance their growth. Because of their crucial function and a “deep-seated concern that social and economic costs of financial crises are large” (Acharya, 2009, p. 225), banks in Europe operate in highly institutionalized environments.

 Shadow banks

The second major constituent is the shadow banking sector. The increase in the shadow banking industry has increased the complexity within the organizational field. In the last decade the EU financial organizational field has become more market oriented. Shadow banks

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15 face less restrictions because they operate beyond traditional regulatory institutions. The next section will shed more light on the emerging shadow banking sector.

 Regulatory agencies

The classic definition by DiMaggio and Powell’s (1983) of an organizational field included specific reference to regulatory agencies as constituents embedded in the field. The regulatory structures of an organizational field form one of the defining element of its institutional environment and guarantees its stability (Scott, 2001). “Banking is one of the most regulated industries in the world” (Chortareas et al., 2012, p. 292). The Basel Committee on Banking Supervision is the primary international standard-setting agency for the banking industry. National supervisors and regulators are the national competent authorities in charge of implementing key elements of the Basel regulatory framework in their country’s banking system.

= Actors in the EU financial organizational field

2.4.1 THE REGULATORY INSTITUTIONAL CONTEXT

Regulative institutions refer to rules and laws and are diffused through written documents and legislation, laws, codes, directives, and formal structures of control (Canning and O’Dwyer, 2013; Scott, 2001). Regulatory institutions are identified as highly important formal or informal pressures enforced by state agencies to regulate the activities of organizations (DiMaggio and Powell, 1983). This pressure is explicitly linked to DiMaggio and Powell’s (1983)

Traditional banking sector Figure 1 EU financial organizational field

Basel III regulatory framework

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16 coercive pressure, as well as Scott’s (2001) regulative pillar, in that organizations are forced to comply with both hard and soft regulations, laws, and externally codified rules and norms. In particular, Scott’s (2001) regulative pillar underscores the regulative aspects of institutions by giving prominence to explicit regulatory processes such as rule-setting, monitoring, and sanctioning activities. In this conception, regulatory processes constrain and influence future behavior of actors as they pursue their interests. Regulatory reform then, involves changing the rules of the game. The regulatory pillar provides a basis of legitimacy and emphasizes on conformity to rules: legitimate organizations are those established by and operating in accord with relevant laws and regulations. Balganesh (2008) argues that actors’ compliance and cooperation with regulatory requirements comes out of the belief in the legitimacy and fairness of legal authority rather than the fear of sanctions.

2.4.2 INITIATIVES TO BUILD TRANSNATIONAL REGULATIVE INSTITUTIONS

In recent years, scholars of global governance have devoted increased attention to institutions of transnational governance networks (Verdier, 2009). Many of the laws and regulations that govern the EU banking sector stem from transnational regulatory institutions. They aim to enhance the efficiency and effectiveness of the regulatory structure of the global financial market through formulating international agreements (like the Basel Accords) (Lee, 2014). Their functional purpose has become considerably greater in the post-financial crisis reform era. Internationally, the concerns regarding bank-specific governance, risk and compliance structure began with the Basel Committee on Banking Supervision (BCBS). “Born from the ashes of the Bretton Woods system, the BCBS has been working to develop international regulatory standards in banking since 1974” (Young, 2012, p. 664). During this period, the BCBS was established by a group of central bank governors from the G-10 countries and Switzerland (Young, 2012). The efforts of the BCBS achieved a critical milestone with the 1988 Basel Accord (Basel I) on bank capital adequacy (BCBS, 2010). The Basel Accord sets uniform capital requirements for international active banks and has been adopted by some 120 countries, including all EU member states (Verdier, 2009). The Basel Accord of 1988 has subsequently been amended by the Basel II (2004) and Basel III Accord (2010).

The European financial industry and its regulation constitutes what Quack (2009) refers to as a “transnational market” in the sense that it involves “regularized relationships of

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17 competition over exchange opportunities which interconnect a growing number of economic actors from multiple political jurisdictions across the world” (Quack, 2009, p. 131). Arguments concerning legitimacy have been generally developed in contexts where legitimacy issues are confined within national boundaries (Morgan, 2010). However, as Quack (2009, p. 9) points out, many markets are transnational in scope and populated by actors with heterogeneous institutional orientations. “As the rule-making process becomes more transnational, it becomes subject to multiple regimes of accountability, creating a system where multiple agencies and actors are competing for legitimacy” (Morgan, 2010, p. 20).

The BCBS is generally considered an important institution of transnational financial governance (Lee, 2014; Verdier, 2009; Young, 2012). The Basel Accord in particular operates through what Lee (2014, p. 604) calls a “transnational regulatory network” (TRN), a regulatory framework based on informal group consensus than a formal treaty and which comprises “central bankers, international policy makers, practitioners and industry leaders” (Lee, 2014, p. 607). “The theory of regulatory networks claims that TRNs illustrate a pivotal contemporary phenomenon: the disaggregation of the state in the conduct of its international relations” (Verdier, 2009, p. 113). “Transnational transactions are subject to overlapping and sometimes contradictory national laws. Likewise, national regulators, not global authorities, supervise internationally active banks” (Verdier, 2009, p. 114). Therefore, government agencies and actors interact directly with their foreign counterparts to exchange ideas, coordinate their enforcement efforts, and negotiate common standards relating to their areas of responsibility (Verdier, 2009). Barr and Miller (2006) argue that the transnational strategy inherent in the Basel process which involves interaction among international, transnational and domestic administrative procedures “generates norms of behavior and structures of practice that can help to promote accountability and legitimacy” for banking organizations (Barr and Miller, 2006, p. 20). One characteristic of TRNs is that they develop specific end products called “regulatory prototypes” (e.g. Basel III regulatory framework) that can be absorbed into national structures through domestic implementation efforts by national regulators to fulfil the goals of the framework (Lee, 2014). The implementation of the Basel Accords in the EU legal framework provides a good example of such. Within the universe of TRNs, the BCBS is “relatively formal, producing a steady and increasing output of readily available documents,

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18 holding frequent meetings, and publicizing their activities through the internet and in professional and academic circles” (Verdier, 2009, p. 131).

2.4.3 TOWARDS BASEL III

Basel III aims to prevent banks from taking the types of risks that precipitated the 2008 crisis. In the aftermath of the crisis, policymakers and regulators realized that the largest banks became progressively more exposed to risks. Their complexity and interconnectedness with the broader financial system meant that their collapse had resulted in high social cost. Therefore, Basel III imposes higher capital requirements on the biggest and most interconnected banks, also designated as “systemically important”, subjecting them to tougher regulation than non-systemic banks (BCBS, 2010). The role of capital for banks is a central element of Basel regulation. A bank’s capital position functions as protection for its depositors and ensures confidence and continuation of its operations (Barth et al., 2003). On the other hand, capital is a critical driver for business decisions. The more capital a bank is required to hold for each type of asset on its balance sheet, the lower the financial performance of those assets will be. Structurally, Basel III’s framework is built on three pillars: capital requirements (Pillar 1), supervisory review (Pillar 2), and market discipline (Pillar 3), which are aimed at improving banks’ risk management and governance. In Europe, the Basel III rules have been implemented across all EU member states by means of the so-called Capital Requirements Directive IV (CRD IV) package, which contains proposed legislation. Table 1 shows the policy items.

There have been a number of papers that analyze the impact of the Basel III capital regulation on bank behavior (Dermine, 2013). For example, Figuet, Humblot and Lahet (2015) examine the effects of Basel III increases in capital requirements on cross-border bank lending of European banking in a push and pull framework. They consider Basel III requirements as push factors and provide evidence that the new regulation will almost certainly reduce lending to emerging countries by 20%.

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19 Table 1 Basel III regulatory framework for banks

Source: Basel Committee on Banking Supervision, 2010

2.5 SHADOW BANKING

The term “shadow banking” appeared in headlines in the wake of the global financial crisis and provided a new narrative of the existence of a market-based financial system that has evolved in parallel to the regulated banking system (Nesvetailova, 2014; Rixen, 2013; Kessler and Wilhelm, 2013). Nesvetailova (2014) explains that the economist Paul McCulley first captured the unregulated industry of market finance by coining the term “shadow banking system” in 2007. Lysandrou and Nesvetailova (2014, p. 4) propose a definition of the shadow banking system: “the shadow banking system is a system of unregulated off-bank balance sheet credit intermediation and maturity and liquidity transformation activities conducted by

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20 bank owned or sponsored entities in the capital and money market domains for the primary purpose of expanding the rate of production of yield bearing debt securities required by the global investor community.” Unlike the traditional banking system, the shadow banking system operates outside the traditional regulatory institutions, as shadow banks are not being subject to the regulation of banks. This has enabled shadow banks to exploit arbitrage opportunities in regulatory systems in order to circumvent economic constraints that regulation subject banks to. “The arbitrage of capital requirements has become in particular an important feature of the banking industry since the implementation of the first Basel Accords” (Plantin, 2014, p. 3). This regulatory arbitrage and has been a central argument in explanations for the growth of shadow banking (Plantin, 2014; Lysandrou and Nesvetailova, 2014; Gorton and Metrick, 2010). Since the implementation of the Basel III, regulatory arbitrage has attracted a lot of renewed attention, especially in relation to shadow banking.

Shadow banking and traditional banking perform similar functions and assume similar risks associated with maturity, credit, and liquidity transformation. However, two major differences can be distinguished. Firstly, whereas credit intermediation at a bank is carried out in a single organization, the shadow banking system by contrast manages credit intermediation processes through a network of unregulated non-bank actors. Consequently, shadow banking entails activities that have been called off-balance sheet financing as the financial intermediation process is relatively opaque (Gordon and Metric, 2010). Secondly, while public deposits held by banks are partially insured by the state (Barth et al., 2003), the shadow banking system relies on the private sector for sufficient liquidity (Kessler and Wilhelm (2013).

From the literature two types of shadow banking can be distinguished. The “old” shadow banking encompassed a relatively selected group of non-bank financial intermediaries with its heavy interconnectedness with the traditional banking system. It expanded rapidly in the years before the financial crisis, but has since collapsed significantly in volume due to the combined effects of the crisis and the actions of regulators. Kodres (2013) observes that this type of shadow banks “first caught the attention of many market participants because of their growing role in turning home mortgages into securities”, a financial practice also called securitization. Given the constraints associated with regulatory requirements that put an upper bound on certain activities, commercial banks were encouraged to shift banking

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21 activities to lightly regulated securitization entities in the years leading up to the crisis. In its broadest definition, this type of shadow banking includes investment banks, money-market funds (MMFs), and mortgage brokers; contractual forms, such as sale-and-repurchase agreements (repos); and off-balance sheet instruments such as asset-backed securities (ABSs), collateralized debt obligations (CDOs), and asset-backed commercial paper (ABCP) (Gordon and Metric, 2010; Papanikolaou et al., 2010). The “new” shadow banking is mostly focused on direct lending and operates independently from the established banks. The emergence of new shadow banking channels has increased the diversity of the sector. The definition of shadow banking has therefore expanded to include a host of non-bank financiers which are not or only lightly governed by regulation. These can be asset managers, hedge funds, private equity, and innovative peer-to-peer lending platforms. Institutional investors, such as pension and sovereign funds, and insurance companies that have long-term capital at their disposal, usually invest in credit related products originated by non-bank financiers.

3. RESEARCH FRAMEWORK

Institutional theory has grown extensively since the works of Meyer and Rowan (1977), DiMaggio and Powell (1983) and Oliver (1992). Legitimacy has had a major impact on many organizational theories, including institutional theory. Some key observations can be derived from the literature review: (1) a substantial body of literature argues that legitimation processes are associated with both institutionalization and deinstitutionalization pressures, (2) although scholars recognize the importance of the processes of institutionalization and deinstitutionalization, most prior studies on institutional change focus on a single dimension, to the exclusion of the other, within the boundaries of studying institutional change, and (3) while there exists a broad literature that supports the notion that state pressures for isomorphic change and conformity to rules and regulations are powerful forces not only for institutionalization but also for the deinstitutionalization of prior organizational traditions (Oliver, 1992, p. 577), the role and impact of regulative coercion through explicit regulatory institutions as key factors perpetuating change is lacking.

To date, the three concepts – legitimacy, institutional change, and regulative pressure – have not been explicitly linked when studying institutional change. We believe that these

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22 links may form the basis of a conceptual framework which can indicate response strategies in relation to regulatory pressures. As such, this paper seeks to respond to this gap in the literature. Having noted that institutional change can occur over time, involving institutional decline and institutional emergence, my interest in a longitudinal perspective of institutional theory leads me to investigate the processes of institutionalization and deinstitutionalization of organizations within an institutionalized field, paying special attention to regulative pressures as an antecedent (Oliver, 1992). The research question is oriented towards a better understanding of the process of institutional change. The thesis aims at answering the following question:

“How have responses to managing legitimacy influenced institutional change that is brought about by coercive regulatory pressure in the EU financial organizational field?”

We take up this question by adopting an institutional perspective on banking regulation to explore not only how the institutional context is shaped by regulatory pressure, but also how that context shapes the strategic responses of actors in the field to manage the challenges to their legitimacy and drive deinstitutionalization and institutionalization processes.

We develop a set of propositions from the conceptual framework to guide further research. Theory suggests that “deinstitutionalization may be an important precondition for the development of new institutional initiatives” (Oliver, 1992, p. 583). We therefore expect that isomorphism and conformity in the banking industry due to regulatory coercive pressure, which is supposed to decrease risks in the financial system and leads to legitimacy (Meyer and Rowan, 1977; DiMaggio and Powell, 1983), encourages banks to become more similar leading to a process of drastic deinstitutionalization of European global banking. We formulate our first proposition: 1) coercive pressure of regulation results in increased isomorphic practices to

appear legitimate which then propagates deinstitutionalization in the organizational field. The

restructuring stage appears well underway with banking actors within the EU financial organizational field. As they restructure, they put down stakes in certain contested areas of finance, leaving certain markets underserved, and enhance the positions of other actors. We formulate our second proposition: 2) deinstitutionalization of one organizational form opens

up opportunities for gaining legitimacy of a competing organizational form within the same organizational field. Not all organizations within an organizational field are subject to the same

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23 governance structure not direct subject to regulatory structures is thriving in the EU financial organizational field through actions to realize its institutionalization and gain legitimacy.And this brings us to our last proposition: 3) new entrants to the organizational field are gradually

institutionalized to fill the institutional vacuum created by deinstitutionalization. We build on

Suchman’s (1995) framework of strategic responses for managing legitimacy, as well as other contributions to institutional theory. In doing so, we contribute to the literature on both institutional change and explicit regulatory change that impose institutional pressure upon an organization.

Based on the structure of the EU financial organizational field, we develop a conceptual framework (Fig. 2) to make sense of the data and help answer the central research question. It assumes that legitimacy is closely related to deinstitutionalization and institutionalization. The regulative pressures refers to rules and regulations channeled via legal documents based on the Basel III Accord. This study seeks to understand what strategies the relevant actors within the EU financial organizational field used to manage legitimacy over time.

Based on Suchman (1995) and Oliver (1992)

My investigation of institutional change in the EU financial organizational field is fuelled by three reasons. Firstly, the banking sector is a highly institutionalized environment that must adhere to government agencies’ set of rules and regulations (Deephouse, 1996; Fligstein, 1996). Regulatory institutions have largely reshaped the rules of the game in the EU financial organizational field. Secondly, against the backdrop of a deglobalizing banking sector in Figure 2 Conceptual framework

Institutional Level Organizational Level

Regulative Pressures Partial Isomorphism within EU Financial Organizational Field Basel III/CRD IV Deinstitutionalization Repairing Legitimacy Institutionalization Gaining Legitimacy Deinstitutionalization of European Global Banking Rise of Shadow Banking

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24 Europe, shadow banking as an alternative source of financing is gaining legitimacy. Thirdly, banking regulatory institutions as well as shadow banking are inherently a transnational phenomenon that challenges traditional ideas of jurisdiction (Fernandez, 2014; Lee, 2014). The Basel III reforms have arguably gained the greatest attention at the transnational level. This study proposes that a contemporary frontier for institutional research is to consider the transnational level of analysis (Djelic and Sahlin-Andersson, 2006).

4. RESEARCH METHODOLOGY

The research methodology is an elaboration on the methods used to answer the established research question. First, the research design for the data analysis is described and its strengths and limitations considered. Second, the rational for case selection is provided and finally, the methods of data collection and analysis approach are described.

4.1 RESEARCH DESIGN

This study is qualitative in nature and seeks to offer detailed descriptions of the phenomenon under study. The research has an exploratory nature and is performed in order to discover new insights which could contribute towards institutional theory (Saunders & Lewis, 2012; Searcy & Elkhawas, 2012; Strauss & Corbin, 1990). One approach for conducting qualitative studies is the case study. Yin (2003, p.13) defines a case study as “an empirical enquiry that investigates a contemporary phenomenon within its real-life context, especially when the boundaries between phenomenon and context are not clearly evident”. Since this thesis will solely focus on the EU financial organizational field as a single case, we perform a single embedded case study. The embedded unit of analysis enables the researcher to look at sub-units that are situated within a larger case (Yin, 2003), allowing for a more detailed level of inquiry and serves to better illuminate the case. Within the context of this study, these sub-units are European global banks and shadow banking actors. Likewise, this study adopts the banking actors, shadow banking actors, and regulatory institutions within the field as the primary subunits of analysis.

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4.2 RESEARCH STRENGTHS AND LIMITATIONS

Analyzing qualitative data comes with strengths and limitations. The strength of a qualitative approach is that the researcher is able to do a longitudinal study and it allows quick revision of the research framework as new information emerges. But, this method has limitations as well. According to Yin (2003), there are two important drawbacks associated with using case studies: validity and reliability. Validity determines whether the research truly measures that which it was intended to measure to perform the objective of the study. Reliability concerns whether the manner of data collection and analysis will consistently provide the same outcomes. Yin (2003) offers several solutions to overcome these drawbacks. Firstly, it is advised to use multiple sources of evidence to deal with the problem of validity. Triangulation is a powerful technique with the purpose to increase credibility and validation of data through cross verification from two or more sources. Secondly, since the application of qualitative research is associated with subjectivity, it can cause problems for the reliability of this study. With regard to enhancing reliability, Yin (1994) suggest developing and maintaining a case study database during the process.

4.3 CASE SELECTION

This section presents the cases selected for this study and describes the method of selecting them. Cases are selected because they are “particularly suitable for illuminating and extending relationships and logic among constructs” (Eisenhardt and Graebner, 2007, p.27), which constitute a theoretical framework. This study is interested in cases which reflect any of the different strategic responses to legitimacy challenges faced by industry actors because of new government regulations (see following section 4.5). From the literature review we identified the relevant key components in the EU financial organizational field: European global banks, shadow banks, regulatory institutions. As the investigation involves subunits of analysis, we focus on the strategic responses with respect to subunits, or focal industry actors, of which the main unit may be a company as a whole, or the smallest units may be departments or individuals, such as bank executives. I mobilize a case of realized deinstitutionalization process of European global banking, namely the retrenchment of British banking group Barclays from many businesses around the world. Subsequent attention is then given to a contemporary

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26 challenge of institutionalization and building legitimacy of shadow banking within the EU financial organizational field.

Barclays counts as a premier example among those global banking organizations that have stepped back from expansion to pursue a more conservative strategy, opting to become more national and less international as they face more regulation. Founded in 1690, Barclays established itself during the 20th century as a predominantly European banking organization. Leading up to the financial crisis of 2008, Barclays was a front-runner among European banks in the expansion of cross-border activities. At the height of the financial crisis it acquired the US investment banking business of troubled banking giant Lehman Brothers. The acquisition transformed Barclays into a global investment bank overnight and gave it the global push toward the rest of Europe and Asia it had sought. At this stage, the bank looked like one that emerged as a relative winner from the financial crisis. In the aftermath of the crisis, the banking industry has witnessed a flurry of regulatory activity. These regulations had severe impact on many aspects of Barclays’ businesses worldwide. Barclays’ investment banking division, which turned into its main profit driver in the years after the crisis but later became the bank’s biggest source of reputational and regulatory risk. Faced with pressure, Barclays changed its corporate strategy to become a more focused business, started dialogues with stakeholders and revised its corporate principles.

4.4 DATA COLLECTION

Once the research methodology is established, the focus shifts to the method of collecting data. This paper relies on publicly available sources to reconstruct the evolving debates on how to better regulate the banking industry in light of the financial crisis, and the growing shadow banking sector. These sources range from financial news articles and publications of financial companies and industry associations, to the publications produced by central banks and international regulatory bodies. This can be supplemented by the study of financial websites and blogs as well as insider accounts. These sources are critically examined to explore traditional banks’ and shadow banks’ initiatives and communications in response to regulatory pressures on the banking industry. The use of multiple data sources enhances data credibility (Yin, 2003). Table 2 gives an overview of the types of archival data used as input.

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27 Table 2 Secondary data collection

Type of data Data source

Newspaper Articles International: Financial Times, Bloomberg, WSJ, Reuters, The Economist

Local: NRC, FD

Bank Reports Annual Reports, Investor Reports Government Reports/

Publications by Regulatory Agencies, Lobby Groups

BIS, BSBC, EBA, Consultation Papers AIMA

Timeframe

As this is a longitudinal study, this research involves observations over long periods of time. According to Pettigrew (1990), time sets a reference for what changes can be seen and how those changes are explained. An archival study is made of the period ranging from 2010 to 2015. This timeframe was selected because it encompasses a period of unprecedented institutional change in the European financial organizational field. Regulatory institutions in the form of Basel III and CRD IV are gradually adopted from 2010 onward, imposing on international banks a vast array of regulations and creating pressures on European banks’ business. In parallel, the activities in the shadow banking sector have grown in size to rival traditional banking assets.

4.5 ANALYTICAL APPROACH

As qualitative data is usually compiled of words and images rather than statistical information, analysis needs to be undertaken to determine major themes (Bryman and Bell, 2007). This usually involves a thematic analysis to systematically identify and interpret any commonly expresses themes or perceptions by the participants (Bryman and Bell, 2007). The NVivo software program is used to analyze the archival data. NVivo is an example of computer-assisted qualitative data analysis software designed for thematic analysis of qualitative data, with theory-building capabilities (Mills, Durepos and Wiebe, 2010). The program allows

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28 researchers to collect, organize, and analyze a wide range of data sources. A systemic coding process is used for the interpretation of the data and preliminary coding categories emerge from the data. These categories help to organize the codes into meaningful themes. This approach generates variables that are valid. The data is used to develop a chronological list of events (Garud and Rappa, 1994). This allows us to develop a narrative account of the phenomenon we wish to investigate (Eisenhardt and Bourgeois, 1988). The multiple data sources helped us accomplish triangulation.

The analysis uses the coding taxonomies of response based on Suchman’s (1995) strategies with the exception of maintaining legitimacy. An initial analysis of the archival data identified two broad content themes that reflected the development of the issue. These themes are 1) repairing legitimacy, and 2) the gaining of legitimacy. These themes were determined based on a review of media coverage as well as Suchman’s (1995, p. 574) argument that “legitimacy is dependent on a history of events”. In the literature review, we covered Suchman’s three primary forms of legitimacy: pragmatic, cognitive, and moral. Among these three categories, pragmatic legitimacy is the primary reason why organizations conform to coercive pressures such as regulation (Haveman and David, 2008). For this reason, pragmatic legitimacy is particularly relevant to this study. However, the other two categories play a role too. For example, the cognitive basis may also be challenged as actors rethink their assumptions, and a discourse may become moralized, a question of good and wrong. We use Suchman’s (1995) framework to operationalize definitions for actors’ responses. Coding descriptions are detailed in table 3 below.

Table 3 Coding matrix for legitimation strategies

Gain Repair Pragmatic • Conform to demands - Respond to needs - Co-opt constituents - Build reputation • Deny • Select markets

- Locate friendly audiences - Recruit friendly co-optees

• Create monitors

• Advertise

- Advertise product - Advertise image

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Moral

• Conform to ideals

- Produce proper institutions - Embed in institutions - Offer symbolic displays

• Excuse/Justify • Select domain - Define goals • Disassociate - Replace personnel - Revise practices - Reconfigure • Persuade - Demonstrate success - Proselytize Cognitive • Conform to models - Mimic standards - Formalize operations - Professionalize operations • Explain • Select labels - Seek certifications • Institutionalize - Persist

- Popularize new models - Standardize new models

Source: Suchman, 1995

5. FINDINGS

5.1 PERFORMANCE CRISIS IN EUROPEAN GLOBAL BANKING

The globalization of finance and subsequent international expansion of banks gave rise to an optimistic vision of global banking during the 1990s and in the mid-2000’s (Goddard et al., 2013; Calzolari and Loranth, 2011; Loranth and Morrison, 2007; Garret, 2000). And European financial conglomerates, such as UBS, Barclays, and Deutsche Bank were well positioned to seek out new sources of profit internationally. Before the financial crisis the expansionist strategy of the banking industry was seen as legitimacy and successful. Governments saw the supply of credit to all levels in society as an important contributor to robust economist growth. However, the financial crisis of 2008 brought a sudden stop to the banking globalization era and caused a collapse of core assumptions underpinning the industry. How the public from then on perceived banks and their conduct – as not honest and trustworthy – was an indication of how badly the crisis had affected their legitimacy. The values they serve were at

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30 issue; banks and their bonus culture became vulnerable to claims that they are irrational or unnecessary (Suchman, 1995). They were perceived by relevant stakeholders (e.g. investors, regulators) as having failed to carry out the purpose for which they were chartered and claimed support. It was not long before the focus had shifted to the structure of the wider financial organizational field in Europe.

The radical regulatory reform initiatives proposed by the Basel Committee for Banking Supervision in 2010 posed significant strategic and operational challenges for internationally active banks, while they tried to appease regulators and investors that they were not “too big to regulate” or “too big to manage” (The Guardian, 2014).

5.2 ISOMORPHIC PRESSURE OF REGULATION LEADING TO DEINSTITUTIONALIZATION

As a highly institutionalized field, the European banking industry has witnessed isomorphic change over long periods of time where coercive pressures have resulted in stable and enduring structures and organizational practices (Oliver, 1992; DiMaggio and Powell, 1983). Turning to the structure of banking governance, the most obvious outcome of the financial crisis was the shift towards stringent regulation and a new assertiveness of the government and government agencies. Through Basel III, government authorities imposed banks to adopt certain practices and procedures that were appropriate for ensuring financial stability. Compliance with Basel III regulation thus acted as a building block to legitimacy for banks (Deephouse, 1996). As banks conformed to these rules meant to safeguard the consumers, they signaled an increased focus on accountability towards clients, and services geared to the long term and characterized by discipline and prudence. The underlying relationship was a strong driver of isomorphism in the banking sector, even though they were coerced by national regulators. In this sense, the institutional context played a distinct role and the introduction of the Basel III rules was itself an institutional pressure that intended to standardize bank management practices.

Internationally active banks thus raised their status by conforming to industry regulation. This isomorphic behavior among the banking industry was viewed positively by stakeholders. For example, banking organizations were aiming to comply with the minimum

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31 Common Equity Tier (CET1) ratio of 6 percent under Basel III, or even exceed it to appear stronger relative to their peers:

“Strengthening our capital base was our top priority. At the beginning of 2012, we were well behind our peers with a pro forma Basel 3 Core Tier 1 capital ratio of less than 6 percent. It was imperative to catch up.” (Jürgen Fitschen, Deutsche Bank Annual General Meeting, 2013)

In another example, in terms of risk measurement practices at banks the BCBS supported the adaption of the most sophisticated approach as stipulated in Basel III. They argued that this would help banks to better manage their capital to cover against risk exposures. Despite being more complicated and costly to implement, the more sophisticated approach was strongly supported by the managers in banks despite of their personal disaccord with these rules. Therefore, the managers prioritized the legitimacy benefits that the favored approach could bring.

However, Basel III regulation impeded expansionist strategies as the increased sophistication in procedures and higher capital requirements necessarily led to the viability of certain business areas and activities being challenged and a process of deinstitutionalization of global banking to occur with respect to the European banking groups. The strong pressures for coercive isomorphism caused by the introduction of a new regulatory institution had altered a previously stable institutional setting. The changes were focused on the attainment of legitimation based on banks’ conformity with the institutionalized rules laid down by the government which enforced homogeneity in the banking industry (Scott, 2001).

5.3 OFFERING NORMALIZING ACCOUNTS TO REPAIR LEGITIMACY

Opposition to institutional change is generally expected to come from those actors likely to be adversely affected. The Basel III rules were considered by managers in banks as too aggressive, but effective opposition was relatively subdued because the financial industry itself was seen as the culprit. Industry leaders were firm in their belief that even where they did not agree with all the proposed regulatory measures, they were willing to take the hit if that was the cost of winning back public acceptance of their right to operate. Their efforts to restore their own legitimacy involved claiming to the wider audiences in society and

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32 government that what was occurring in bank regulation was acceptable and legitimate (Suchman, 1995), a message which was stronger where the outcome of the measures appeared beneficial. For example, in 2010, John Varley, chief executive of UK bank Barclays at that time justified the tough new capital rules, which he regarded as fair:

“The recommendation that will be put in front of the G20 (...) by the Basel authorities is very clearly sensitized to the obligation that the banks have over the course of the coming years to facilitate economic growth.” (FT, 2010)

His successor Anthony Jenkings, explained the bank’s strategy in response to increased regulation:

“More capital is required by banks, and we have put in place a strategy that will allow us to meet the regulations." (Institutional Investors, 2014)

Anshu Jain, co-CEO of Germany’s Deutsche Bank also justified the necessity of higher capital levels by stating:

"Our shareholders understand that strengthening our equity capital and liquidity is an absolute top priority and that there are no viable alternatives to this approach. We intend to meet the regulators' more stringent requirements on our own." (Annual Report, 2011)

Stephen Hestor, CEO of UK-based Royal Bank of Scotland, justified the regulatory discussion by stating:

"We support the revolution in regulatory standards that, when complete, and coupled with the dramatic industry changes taking place, will make for a safer financial services industry for everyone." (Annual Report, 2010)

5.4 RESTRUCTURING TO REPAIR LEGITIMACY

National regulators are an important stakeholder, and their norms and values are important criteria for evaluating legitimacy. The introduction of Basel III rules in 2010 meant banks received particularly close scrutiny from regulators concerning the evaluation of their capital adequacy. For banks with weak capital positions, regulators increased their supervision which included restricting banks’ fundamental business decisions, such as borrowing and lending, by applying harsher rules. As a legitimacy challenge, it limited unconstrained behavior and could

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33 lead to retraction of a bank license and enforced closure by central authorities’ coercive power. As such, European global banks initiated comprehensive restructuring programs to shed capital-intensive operations built or acquired in the boom years before the financial crisis. Compliance costs associated with the new Basel III rules were a highly significant push factor (Figuet et al., 2015). Operating certain risky activities outside the core business were made far less appealing because they required a higher level of capital under Basel III rules. The desired outcomes enabled them to compete more profitably in fewer markets and strengthen their capital position, so they could be seen as acceptable by regulators. McKinsey published a research which showed that European banks were considering the sale of up to 725 business lines across various business areas and geographies in 2013 (fig. 3).

Figure 2 European banks undergoing restructuring

How Deinstitutionalization influences institutionalization of alternative actors : a legitimacy-based perspective on global banking and shadow banking actors in the EU financial organizational field