AN EXPERT group chaired by Finnish central bank chief Erkki Liikanen has called for the mandatory separation of risky bank trading activities from core deposit-taking operations.
The proposed reform was among five produced by the group, which was set up by the European Commission to develop suggestions for measures not already under way in the drive to prevent any rerun of the financial crisis.
The group stressed the need for banks to draw up and maintain “realistic” recovery and resolution plans which would minimise the need for taxpayer support at a time of crisis.
It called for greater use of bail-in instruments, in which creditors contribute to a rescue operation, and said risk-weighting should be more robust. It also called for further governance reforms to strengthen boards and rein-in the bonus culture.
“The group’s conclusion is that it is necessary to require legal separation of certain particularly risky financial activities from deposit-taking banks within a banking group,” said Mr Liikanen.
“The central objectives of the separation are to make banking groups, especially their socially most vital parts (mainly deposit-taking and providing financial services to the non-financial sectors in the economy), safer and less connected to high-risk trading activities and to limit the implicit or explicit stake of taxpayers in the trading parts of banking groups.
“The group’s recommendations regarding separation concern businesses which are considered to represent the riskiest parts of trading activities and where risk positions can change most rapidly.”
The group said a future resolution authority should request a wider separation of activities “if this is deemed necessary to ensure resolvability and operational continuity of critical functions”.
The report was published in Brussels by EU internal markets commissioner Michel Barnier, who is advancing a huge swathe of legislation to reform the financial system. “This report will feed our reflections on the need for further action,” he said.
The report comes as the commission tries to expedite the adoption of contentious new laws to create a European “banking union”, an initiative likely to overshadow the Liikanen recommendations for the foreseeable future.
The proposals met with a frosty response in the banking sector. The European Banking Federation, an umbrella body to which the main Irish bank lobby is affiliated, said the recommendations may weaken banks’ ability to fund the real economy.
“We are worried that the benefits of the diversified banking approach reflected in Europe’s universal banking model may not be preserved for all banks and we are concerned over the proposal to ring-fence trading activities of the bigger banks into a separate part of the banking structure,” said EBF chief Guido Ravoet.
The group said banks should build up a sufficiently large layer of “bail in-able” debt that should be clearly defined, so its position in the hierarchy of debt commitments is clear and investors understand the eventual treatment in case of resolution.
“The debt (or an equivalent amount of equity) would increase overall loss absorptive capacity, decrease risk-taking incentives, and improve transparency and pricing of risk.”
