Arlene McCarthy, MEP, is preparing a parliamentary report, with a committee vote on compromise amendments planned for 28 May, in advance of the European Commission's publication of legislative proposals in September 2013. The report aims to set out Parliament's position on bank structure reforms, likely adopting a "principles-based" approach, particularly regarding the issue of separating retail activities from investment banking.
The Liikanen Report
Meanwhile, the European Commission published in May its Consultation on the Liikanen bank structural reforms, calling for banks to separate out their trading activities. The Consultation has a deadline of 7 July and large EU banking groups are being asked to provide data to assess impact under two scenarios:
- Separation of prop trading, Private Equity/hedge fund exposures and market making (in line with Volcker, and France and Germany's national proposals)
- Separation of all investment banking activities (effectively like the UK ICB proposals)
Notwithstanding the Liikanen report, other European countries, such as France, the UK and Germany, are taking matters into their own hands and developing their own bank structure laws. Belgium, Italy and the Netherlands have also discussed potential national measures. There is a real danger that we will end up with a patchwork solution that will not work in the context of the single market.
Bank for International Settlements working paper
The Bank for International Settlements (BIS) has also published a working paper (PDF 317 KB)on structural separation in banks.
The paper provides a review of the academic literature on diversification and scale economies – the research results are mixed, but the general conclusion is that both diversification and economies of scale only bring benefits up to a point, after which the benefits fade away. Moreover, diversification benefits are stronger for geographical and loan portfolio diversification than for diversification across investment and retail banking. And the 'tipping point' for economies of scale is difficult to identify – for example, some apparent economies of scale may only have reflected the cheaper cost of funding for "too big to fail" banks.
The paper also provides a list of the growing range of benefits of structural separation – shielding protected activities from losses incurred elsewhere, preventing subsidies on protected activities from extending to other activities, reducing size and complexity, and reducing the cross-contamination of culture from investment banking to retail banking.
Implications for firms
In practice, the effectiveness of structural separation will be challenging, because:
- Structural separation may be of only limited value once higher capital requirements and resolution planning are in place; and
- Investment banking will continue to carry systemic risk, even if it is isolated from retail banking – indeed it could become even riskier if it has to rely on less stable funding;
Any ring-fencing proposals to come from the EU will have significant implications for European banks, in particular, those in Spain, Italy, France, the Netherlands, Germany and the UK. Crossover or convergence between EU-level and national proposals could further complicate the already difficult regulatory landscape for banks.
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