Brussels pushes full separation of banking units

By bne IntelliNews October 3, 2012

bne -

Retail banks in the EU should be forcibly ring-fenced from risky trading operations, a high-level report on reform of the European banking sector released on October 2 insists, creating consensus with US and UK proposals.

While the report, one of several in Europe and around the world put together to review ongoing regulatory reform, is happy with raised capital ratios and liquidity requirements, it adds that it has "concluded that it is necessary to require legal separation of certain particularly risky financial activities from deposit-taking banks."

The call brings Brussels into line with both Washington and London, which have both also made proposals to restructure the industry along the same lines. However, the group behind the EU report goes further, suggesting deeper separation than previously seen may be necessary to avoid further crises in the future.

"This idea clearly draws from the Vickers proposals in the UK for ring-fencing retail banking," points out Michael Symonds at Daiwa Capital, "and would represent the greatest challenge for large capital-markets focused institutions such as Barclays, BNP Paribas, Deutsche Bank, Royal Bank of Scotland and Societe Generale (notwithstanding the existing de-risking initiatives of all of these banking groups)."

Speaking to the BBC, Bank of Finland Governor Erkki Liikanen, who led the group, said banks could be forced to go further than the "moderate" directive of making them different parts of the same banking group. "[Banks] must present a plan that they are able to unwind their activities without harming the broader economy. If they fail to do this because their structures are too complex or too difficult to manage, then the regulator can ask for deeper separation," Liikanen said.

The report also calls for higher capital requirements on trading assets and real estate related loans; a designated layer of "bail-in" debt incorporated into capital structures, but to be held outside the banking system (i.e by investment funds and life insurance companies); and for government and regulators to step up oversight, particularly concerning risk management and compensation.

While noting that the report represents no more than a set of high-level recommendations at this stage and there's a long and rocky route through all member states, Symonds says that the major points are set to act as cornerstones for the inevitable reform of EU banking when it does arrive.

"As with Volcker in the US and Vickers in the UK, structural banking reforms across the EU are an inevitable outcome of the crisis, and the Liikanen recommendations will no doubt set the foundation for future legislation," he states, before pointing out that the creation of an EU banking union will take precedence.

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