The Bank Structural Reform must separate substantially all trading – including market making and derivatives – from deposit banking activities. BSR is strongly opposed by the banking lobby and by certain member states protecting national champion banks.
High bank interconnectedness poses a threat to financial stability: authorities will not want to risk a domino effect propagating one bank’s losses to the whole system. This casts doubt on the credibility of the rest of the crisis management framework: if taxpayers cannot be protected after a round of stress tests, how could they be protected when exposed to a real financial crisis?
FW argues that a structural reform of banks would reduce interconnectedness and improve the credibility of resolution. Separating trading from credit at such banks would cut this link and is a vital step in ending too-big-to-fail banking. It would help banks to focus more on serving the real economy and give credibility to the EU’s plans for dealing with large banks in trouble, reducing the chances of further taxpayer bail-outs. Existing measures such as CRD, SSM, BRRD and SRM, while positive, are not enough to protect taxpayers because they have a micro-prudential focus (they make individual institutions more robust) whereas BSR has more of a macro-prudential focus and concentrates on the systemic risks posed by large trading-oriented banks (risk of joint default, risk of contagion).
In our view, prevention is better than cure. To achieve its goals, we think BSR must separate substantially all trading – including market making and derivatives – from deposit banking activities. However, BSR is strongly opposed by the banking lobby and by certain member states protecting national champion banks.
A successful BSR would focus banks on serving the economy and help capital markets to be competitive and subsidy-free. This in turn should support the EU’s ambition for a genuine capital markets union.
Since the financial crisis started in 2008, European and national level initiatives have been presented to reform the structure of banks, including the possible separation of deposit-taking from trading activities.
On 29 January 2014, the Commission published two legislative proposals, one on structural measures to improve the resilience of EU credit institutions (Bank Structural Reform, or BSR) and one on securities financing transactions.
The January 2014 proposal applies only to the largest and most complex EU banks. It would 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) into separate legal trading entities within the group (“subsidiarisation”) from 1 January 2018.
On 19 June 2015, after several months of negotiations, the Council reached an agreement on its position. The position introduced important changes to the original Commission proposal. It softens the original proposal as proprietary trading is no longer prohibited, but separated from the core credit institution. The proposal also incorporates a more flexibility to the approach by allowing discretion of the competent authorities (toolkit of supervisory measures to address excessive risk taking in trading activates).
On 26 May 2015 the Parliament rejected the report. The report was supported by 29 MEPs, with 30 against and no abstentions, meaning that no agreement has been reached. ECON did not adopt some key compromises, including those on the negative scope (Art 4), metrics (Art 5), proprietary ban (Art 6), and the separation modalities (Art. 10). The vote showed a big discourse between political groups. Parliament will resume negotiations in September 2015. Only if the Parliament reaches the agreement, trialogues (negotiations between the Commission, the Council and the Parliament) will start in order to reach a final text.
FW argues that it is fundamental in order to strengthen the financial system. While introducing the January 2014 proposal, Michel Barnier, former Commissioner for internal market and services, said: “This legislation deals with the small number of very large banks which otherwise might still be too-big-to-fail, too-costly-to save, too-complex-to-resolve. The proposed measures will further strengthen financial stability and ensure taxpayers don’t end up paying for the mistakes of banks. Today’s 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 proposals are 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”.
We have published several papers regarding the Bank Structural Reform. In our short note “Separating fact and fiction”, we debunk a number of misleading claims about bank structure reform, and our Policy Brief “Separating universal banks from too-big-to-fail banks (TBTF)” illustrates the very different characteristics of Europe’s small, medium and large banks. Another publication, “Too-big-to-fail (tbtf) in the EU”, provides an overview of the EU financial regulations (passed or still in discussion) related to the too-big-to-fail issue and an assessment of what remains to be done.
There is also a detailed policy note on bank separation from April 2013 designed to be read by politicians and newcomers to the subject alike, and a technical factsheet on bank separation for journalists.
In September 2013, we have published a longer report on Banking Union, and why it won’t work unless large universal banks are restructured. Here are the key points in one page. We also spoke at a public hearing on the Structural Reform of Banks at the Parliament’s ECON Committee on 2 December.
We’ve made several webinars, one of which was specifically about the bank structural reform: Why separate banking activities? (February 2014) and another explained the mechanisms of functioning of investment banking: “What is investment banking?” (16 December)
Our multimedia dossier “Understanding Finance #1: Splitting megabanks?” gives a non-technical overview on the issue of bank separation and explains Finance Watch’s position on this crucial issue. Lastly, we published a cartoon that illustrates the problems of imbalance caused by banks which are too-big-to-fail.
The EU’s High Level Expert Group on structural aspects of the EU banking sector, led by Bank of Finland Governor Erkki Liikanen, was appointed by the European Commission to examine whether the current EU banking regulatory reform agenda should include structural reforms to increase stability and customer protection.
The conclusions of the HLEG were that no particular business model in the European banking sector did particularly well, or particularly poorly, in the financial crisis. Rather, the analysis by HLEG revealed excessive risk-taking – often in trading highly complex instruments or real estate related lending, and excessive reliance on short-term funding in the run-up to the financial crisis. The risk-taking was not matched with adequate capital protection, and strong linkages between financial institutions created high levels of systemic risk.
The HLEG gave five recommendations to European policymakers:
- Mandatory separation of proprietary trading and other high-risk trading activities,
- Possible additional separation of activities conditional on the recovery and resolution plan,
- Possible amendments to the use of bail-in instruments as a resolution tool,
- A review of capital requirements on trading assets and real estate related loans, and
- A strengthening of the governance and control of banks.
The European Commission used more than a year considering how to regulate in this area. On 29 January 2014, after several postponements, the Commission adopted the Regulation on structural measures to improve the resilience of the EU credit institutions. The proposal aims at further strengthening the stability and resilience of the EU banking system. It sets out rules on structural changes for “too-big-to-fail banks” (TBTF). It explicitly targets the largest and most complex EU banks with significant trading activities.
- New chance to get bank structure reform right (press release, 27 May 2015)
- Separating fact and fiction (Publication, 16 March 2015)
- Separating universal banks from too-big-to-fail banks (TBTF) (Policy Brief, 16 March 2015)
- Bank Structural Reform in danger (series of articles on bank structural reforms, 26 February 2015)
- Draft ECON report would make bank structure reform ineffective, says Finance Watch (press release, 8 January 2015)
- What is investment banking? (Webinar, 16 December 2014)
- ECB stress tests – why taxpayers are still at risk and what can be done to protect them (press release, 8 October 2014)
- Reforming the mega banks – two ways to deal with a tsunami (Blog, 25 July 2014)
- Understanding Finance #1 – Splitting megabanks? (Multimedia dossier with explanations, videos, cartoons etc, March 2014)
- The importance of being separated (Policy Note, 8 April 2013)
- Too-big-to-fail banks (Cartoon, April 2013)
- Parliament compromises on bank safety 21 June 2018
- Too-big-to-regulate: The EU’s bank structural reform proposal failed 25 October 2017
- Finance Watch publishes Annual Report 2016 18 April 2017