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Monday, 15.09.2014, 07:03
The EU new plans for safer banks
The proposed reforms would ban around 30 of the EU’s largest banks from carrying out so-called proprietary trading, where banks use their own funds for investments to boost profits for their own gain. Although the practice can be highly profitable for banks, the European Commission says it entails many risks but no benefits for either banks’ clients or the wider economy.
Safe banking system
Strengthening the financial stability of the EU’s largest banks, those regarded to be “too big to fall” (that is, to be too large to be allowed to fail), will ensure taxpayers do not end up paying for the mistakes of banks. This happened during the financial crisis when publicly-funded bank bailouts swallowed around 13% of the EU’s gross domestic product.
The EU also wants to introduce measures to ring-fence banks' low-margin (though rather safe), retail operations from their potentially riskier investment divisions. This would ensure the safety of depositors’ savings and prevent the need for any further bank bailouts.
Under the plan, national supervisors would be given the power to transfer the high-risk trading activities of selected banks - such as market making, mortgage securitisation and investments in complex derivatives - to separate subsidiary companies.
Reducing excessive risk taking
The Commission’s proposal also calls for greater scrutiny of any attempts to switch newly-regulated activities to the “shadow banking” system - which is a less regulated sector of the financial services industry.
The Commission hopes the reforms will be the “final cog” in a complete regulatory overhaul of the European banking system which was prompted by the financial crisis. Earlier measures include the creation of larger capital cushions for banks, bonus caps for bankers and plans for a eurozone banking union.
The plans have to be approved by the European Parliament and individual countries and would likely start in 2017.
Based on national initiatives and increasing global debate on the needs for banks’ structural reform, European Commission (headed by M. Barnier) suggested in November 2011 the setting up of a High-level Expert Group ("HLEG") with a mandate to assess the need for structural reform of the EU banking sector. The expert group was chaired by Erkki Liikanen, Governor of the Bank of Finland.
The Group delivered its report in October 2012, recommending mandatory separation of certain high-risk trading activities for banks whose trading activities exceeded certain thresholds (see IP/12/1048).
As regards shadow banking, the Financial Stability Board proposed a series of recommendations in 2013 to regulate the sector. Those recommendations were endorsed at the St-Petersburg G-20 Summit in September 2013.
Structural reform in the banking sector
The European Commission’s new rules involve measures to stop the biggest and most complex banks from engaging in the risky activity of proprietary trading. The rules would also give European supervisory authority (e.g. the ECB) the power to require those banks to separate certain potentially risky trading activities from their deposit-taking business if the pursuit of such activities compromises financial stability.
Alongside this proposal, the Commission has adopted accompanying measures aimed at increasing transparency of certain transactions in the shadow banking sector. These measures complement the overarching reforms already undertaken to strengthen the EU financial sector.
In drafting its proposals, the Commission has taken into account the useful report by the High Level Group chaired by the Governor of the Bank of Finland, Erkki Liikanen (see IP/12/1048), as well as existing national rules in some member states, global thinking on the issue (e.g. Financial Stability Board principles) and developments in other jurisdictions.
Introducing the proposal, Michel Barnier, Commissioner for internal market and services underlined that the proposed measures were the final steps in the EU efforts to complete the regulatory overhaul of the European banking system.
Although the suggested financial legislation deals with the small number of very large banks which otherwise might still be too-big-to-fail, too-costly-to save and too-complex-to-resolve, it also would affect all other banks.
Besides, the proposed measures will further strengthen financial stability and ensure that taxpayers did not end up paying for the mistakes of banks.
The new set of proposals will
provide a common framework at EU level - necessary to ensure that divergent
national solutions do not create fault-lines in the Banking Union or undermine
the functioning of the single market.
The Commissioner underlined that new proposals were “carefully calibrated” to ensure a delicate balance between financial stability and creating the right conditions for lending to the real economy, particularly important for competitiveness and growth in the EU.
Stable path of reforms
Since the start of the financial crisis, the European Union and its Member States have engaged in a fundamental overhaul of bank regulation and supervision. The EU has introduced reforms to reduce the impact of potential bank failures with the objectives of creating a safer, sounder, more transparent and responsible financial system that works for the economy and for society as a whole.
To increase the resilience of banks and to reduce the impact of potential bank failures, new rules on capital requirements for banks (see MEMO/13/690) and bank recovery and resolution (see MEMO/13/1140) have been adopted.
Then, the Banking Union has been launched. Nevertheless, some EU banks may still remain too-big-to-fail, too-big-to-save and too-complex-to-resolve.
Hence, further measures are therefore needed in the EU, notably a structural separation of the risks associated with banks’ trading activities from its deposit-taking function.
The new proposal aims at strengthening the resilience of the EU banking sector while ensuring that banks continue to finance economic activity and growth.
The measures proposed
The proposal on structural reform of EU banks will apply mostly to the largest and most complex EU banks with significant trading activities.
The structural reform will, generally:
1. Ban proprietary trading in financial instruments and commodities, i.e. trading on own account for the sole purpose of making profit for the bank. This activity entails many risks but no tangible benefits for the bank's clients or the wider economy.
2. Grant supervisors the power and, in certain instances, the obligation to require the transfer of other high-risk trading activities (such as market-making, complex derivatives and securitisation operations) to separate legal trading entities within the group (“subsidiarisation”). This aims to avoid the risk that banks would get around the ban on the prohibition of certain trading activities by engaging in hidden proprietary trading activities which become too significant or highly leveraged and potentially put the whole bank and wider financial system at risk. Banks will have the possibility of not separating activities if they can show to the satisfaction of their supervisor that the risks generated are mitigated by other means.
3. Provide rules on the economic, legal, governance, and operational links between the separated trading entity and the rest of the banking group.
To prevent banks from attempting to circumvent these rules by shifting parts of their activities to the less-regulated shadow banking sector, structural separation measures must be accompanied by provisions improving the transparency of shadow banking.
The accompanying transparency proposal will therefore provide a set of measures aiming to enhance regulators’ and investors’ understanding of securities financing transactions (STFs). These transactions have been a source of contagion, leverage and pro-cyclicality during the financial crisis. A better monitoring of these transactions is necessary to prevent the systemic risk inherent to their use.
More information on:
= Commission’s website: Structural reform of the EU banking sector;
= European Commission - IP/14/85; 29/01/2014;