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Time to cut the umbilical cord between bank deposits and financial trading

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Comment on EC bank structure consultation

Brussels, 23 May 2013 – Financial trading should not benefit from public support, said Finance Watch, the public interest advocacy association.

It is time to cut the hidden “umbilical cord” by which public support for deposit banks is used to feed banks’ trading activities. This undeserved subsidy distorts the economy and endangers the financial system.

This will be a key message in Finance Watch’s response to the European Commission’s consultation “Reforming the structure of the EU banking sector”, which was announced last week and has a deadline of 3 July 2013.

The opening statement of the new EC consultation states the problem and solution very clearly. It confirms that structural reforms would directly address the problems identified in its analysis:

On the problem: “The way some large banking groups are structured… makes them too big, too important, too complex, and too interconnected to fail. Such banks benefit from a lower cost of funding, given that bank investors judge that their investments face a limited risk of default.

Risky trading activities can accordingly be undertaken on a larger scale than would have

been the case if the cost of funding reflected the risk of that particular activity only.

Arguably, as a consequence, economic resources are diverted from more socially useful

activities such as lending to the real sector of the economy, while banks also tend to

accumulate excessive risks.

On the solution: “Structural reforms of the banks that are too-big-to-fail would directly address intra-group complexity, intra-group subsidies, and excessive risk-taking incentives” (emphasis added, full text below)

Finance Watch shares the EC’s diagnosis of the problem and notes that the OECD, HLEG and ICB, among others, also share this diagnosis.

The consultation will help the EC to assess the costs and benefits of structural reforms. Finance Watch hopes that the EC’s Impact Assessment will take into account not only the financial stability effects of reform but also the economic effects of reducing unwarranted public support for risky trading activities and the associated miss-allocation of resources in the economy.

“The case for a strong reform of bank structure is now beyond doubt: structural measures will directly address many of the problems we face. This consultation is the opportunity for civil society to demand a strong legislative proposal from the Commission. Finance Watch will be responding to the consultation and urges others to do so too,” said Aline Fares, Advisor to the Secretary General of Finance Watch.

“The economy and financial system will benefit greatly if financial trading stands on its own feet. We hear many false arguments against bank separation and invite journalists to contact us to hear the other side of the story,” said Duncan Lindo, senior policy analyst at Finance Watch.

ENDS

For further information or to speak to one of the team, please contact:

Greg Ford, Head of Communications, on +322.401.8740 or +44 7703 219 222 or greg.ford@finance-watch.org (mailto:greg.ford@finance-watch.org)

Charlotte Geiger, Communications Officer, on +322.401.8741 or charlotte.geiger@finance-watch.org (mailto:charlotte.geiger@finance-watch.org)

NOTES

Opening Section from EC Consultation

“1. PROBLEM DRIVERS

In the run-up to and during the on-going crisis, some large and complex EU banking groups have faced problems of balance sheet expansion, high leverage, lack of market discipline, lack of bank resolvability, excessive risk-taking, trading and market-based activity, implicit bail-out expectations, competition distortions, and conflicts of interest.

Arguably, pre-crisis regulation and supervision have been inadequate. These intertwined problems have a clear link with the way some large banking groups are structured, which makes them too big, too important, too complex, and too interconnected to fail. As a result, such banks benefit from a lower cost of funding, given that bank investors judge that their investments face a limited risk of default. The implicit subsidy arising from the limited default risk is further strengthened by the presence of deposits backed by deposit guarantee schemes.

Furthermore, such banking groups that take deposits subject to government insurance are

(i) largely unrestricted in the type of activities they are undertaking, (ii) largely unrestricted in their intra-group legal structure, and (iii) restricted only in a limited way in terms of intra-group connectedness and interconnectedness with other financial institutions. As a result, the lower cost of funding benefits the group as a whole.

Accordingly, depositors effectively cross-subsidise other activities. Such activities, e.g. risky trading activities, can accordingly be undertaken on a larger scale than would have been the case if the cost of funding reflected the risk of that particular activity only.

Arguably, as a consequence, economic resources are diverted from more socially useful activities such as lending to the real sector of the economy, while banks also tend to accumulate excessive risks. Conversely, it may be argued that cross-subsidisation may also result into market financing of the economy through notably private equity and market making on corporate bonds.

Structural reforms of the banks that are too-big-to-fail would directly address intra-group complexity, intra-group subsidies, and excessive risk-taking incentives. Structural reforms may increase the credibility and effectiveness of the recovery and resolution process for large and complex banking groups, thereby lowering the ultimate taxpayer costs. Structural reforms also aim at a broader set of objectives, such as aligning the private incentives of banks with socially useful activities.”

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