Liikanen’s EU Ring-Fence Plans For Banks Come Under Attack

Terry Flanagan

Plans to ring-fence retail operations from investment banking in Europe may yet be watered down after a U.K. parliament commission earlier this week questioned the validity of the proposals, although the architect of the potential Europe-wide proposals is adamant that the reforms, if implemented, will be a success.

“There has been excessive risk-taking, excessive leverage, excessive complexity and inadequate capital,” Erkki Liikanen told a Centre for European Policy Studies meeting in Brussels yesterday.

Liikanen, the governor of Finland’s central bank, was last year tasked by the European Commission to issue independent advice on structural reforms to make banks safer, and earlier this month came up with his review to split the region’s banks along Glass-Steagall lines.

However, he was earlier this week grilled by the Parliamentary Commission on Banking Standards over his proposals, which are similar in essence to recommendations made by the U.K.’s Vickers Commission in September 2011.

Lord Nigel Lawson, the former U.K. Chancellor of the Exchequer, expressed the strongest opposition against Liikanen’s ring-fencing plan, which could, if adopted by the Commission, be rolled out across the whole of the European Union. The Commission is currently seeking public comment on the Liikanen recommendations before deciding how to proceed.

Lawson said the Liikanen idea was “not really relevant to this country” as the U.K. did not have a “universal banking” culture. Universal banking, more common in countries such as France, Germany and Switzerland, allows banks to provide commercial and investment services within the same structure.

The French Banking Federation, an industry group, has also come out against the Liikanen proposals. It says the universal banking model currently used in France is “effective in serving clients”.

“The Liikanen report, which recommends isolating ‘high-risk’ market activities while ruling out separation as defined by the Glass-Steagall Act, leaves many questions unanswered that should be studied within the framework of the consultation launched by the European Commission,” it said in a statement.

“In particular, it would be wise to ensure that the basic purpose of financing the economy is respected, as well as comprehensive client service. Measures that would result in a disproportionate cost increase, or even the disappearance of certain market activities that are useful to the economy, must be avoided. They would destroy the European economy’s competitiveness and, as a result, its growth and employment levels.”

In June, George Osborne, the current Chancellor of the Exchequer, looked to water down some of the Vickers proposals, including the ring-fencing plans, after submitting a U.K. white paper on banking reform.

Lawson, too, attacked Liikanen’s reading of the financial crisis, saying that both the banks and the ‘shadow banking’ sector—which includes entities such as hedge funds, money market funds and structured investment vehicles—had escaped regulatory oversight.

“That is manifestly incorrect,” said Lawson. “With respect, that is totally the reverse of the truth. The banks which were ostensibly heavily regulated [failed].”

Earlier this month, former U.S. Federal Reserve chairman Paul Volcker, whose rule in the U.S. aims to limit risky behavior within banks, told the same U.K. parliamentary commission that the idea of ring-fencing retail operations from investment banking was “full of holes that were likely to get bigger over time” and that “it would be difficult to sustain”.

Liikanen, though, believes that his plans will work, as they differ slightly from both the U.S. and U.K. proposals. Liikanen says that if “the share of proprietary trading, market making and certain other securities-related businesses in the balance sheet exceeds a given threshold, banking groups must organize these businesses to a separate legal entity”.

He added that a “trading entity must be separately capitalized and must not be funded by insured deposits” and that “deposit-taking part of the banking group is not allowed under any circumstances to support the trading entity either directly or indirectly by making transfers or commitments to the extent that its capital adequacy including capital buffer requirements would be endangered or that the general limits on large exposures would be violated”. His only real fear for his recommendations are that the reforms could push more activity to the less-regulated shadow banking sector.

The proposals by Liikanen, Vickers and Volcker all stem from the need to better regulate the global banking system following the financial crisis.

“There was clearly the lack of a sufficient, systemic (macro-prudential) aspect to banking supervision and regulation prior to the crisis,” said Liikanen. “In the absence of substitutive regulatory and supervisory measures, systemic risks built up in the form of ever larger, more complex and more leveraged financial institutions.”

The Glass-Steagall Act of 1933, which separated retail and investment banking in the U.S., was introduced to control speculation following the Great Depression of 1929. It was repealed in 1999 and some commentators have blamed this as an important cause of the late-2000s financial crisis.

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