Market Users Fenced In By Proposed Banking Reforms

Terry Flanagan

Plans afoot to radically reform the banking model in Europe and the U.S. have been met with growing skepticism from the industry.

Proposed structural changes if implemented, in the form of the European Union-wide Liikanen report and the U.K.’s Vickers reforms, which involve similar but differently defined ‘ring-fences’ of retail and investment banking operations, will likely bring about changes to the banking sector not seen since the U.S. Glass-Steagall Act.

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and investment banking in the U.S. to control speculation following the Great Depression of 1929, although it was later repealed in 1999.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

The U.S. is also looking to implement its own measures to curb risk-taking within banks following the financial crisis, with its Volcker rule—a cornerstone of the 2010 Dodd-Frank financial regulatory overhaul—which, although narrower than Glass-Steagall, aims to restrict proprietary trading by banks.

While in Europe, the chorus of disapproval to the Liikanen report, in particular, is mounting. Erkki 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 last month unveiled his proposals.

The European Commission is currently seeking public comment on the Liikanen recommendations before deciding on how to proceed and, if adopted, the proposals would be rolled out across the whole of the European Union.

“We urge the Liikanen Group to conduct a thorough impact study to assess the costs and benefits of their recommendations and strongly encourage efficient co‐ordination of regulatory initiatives to ensure the goal of reducing risk in the banking sector is achieved without harming global financial markets,” said George Handjinicolaou, deputy chief executive and head of Europe for the International Swaps and Derivatives Association, a trade body.

The proposals by Liikanen, Vickers and Volcker all stem from the need to better regulate the global banking system following the financial crisis, but there is a real fear from many market participants that these proposals will just kick into touch any potential green shoots of an economic recovery.

Simon Lewis, chief executive of the Association for Financial Markets in Europe, a sell-side industry body, said: “AFME agrees with the core objectives of the Liikanen group’s work, particularly the goal of reducing risk in the banking system, promoting competition and maintaining the integrity of the single market.

“However, if the Liikanen proposals are implemented as they stand there is a serious risk that the capital markets will be unable to meet Europe’s financing needs at this time of very subdued bank lending. The impact of these structural separation recommendations needs to be assessed, particularly regarding any potential systemic and operational consequences.”

The mandatory separation of trading activities from the deposit taking activities of Europe’s bigger banks under the Liikanen review seems, according to market participants, also to not fully acknowledge the major regulatory changes already put in place and those still forthcoming to reduce risk—as well as potentially creating another layer of banking structure.

“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 Guido Ravoet, chief executive of the European Banking Federation, a trade body.

Others are worried that the final versions of Liikanen, Vickers and Volcker may also not be in tune with one and other and could cause future regulatory extraterritoriality.

“Inevitably there are elements of overlap amongst these initiatives and there is a risk that any final proposals which do emerge may not necessarily all fit neatly together, either with respect to their content and/or timing,” said David Hiscock, senior director, market practice and regulatory policy at the International Capital Markets Association, a global capital markets self-regulatory organization, in a November 13 letter addressed to the European Commission.

“It is in everyone’s best interests to sustain on-going dialogues that necessary issues are adequately addressed, whilst at the same time avoiding any unnecessary adverse implications for the international capital market.”

However, there are others that say the Liikanen review does not go far enough.

“The Liikanen diagnosis is right but the medicine may not be strong enough,” said Thierry Philipponnat, secretary-general of Finance Watch, a Brussels-based group that aims to serve as a counterweight to the financial industry

“We applaud the [Liikanen] group for its comprehensive study of moral hazard in Europe’s banking system and the distortions this causes in the economy. But while we agree fully with the analysis, we fear that the recommendations will not meet the group’s objective of delivering an efficient and stable banking system. It is essential that policymakers do not water down these proposals under pressure from the banking lobby. They must bring forward legislation that can accomplish the task set.”

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