With a cumulative balance sheet nearly as big as the GDP of the EU-27 (94% as of 2015), the failure of one of the 12 systemically important European banks would be a financial cataclysm that no European economy can afford. Should such an event occur, national authorities cannot but save their domestic economies, at any cost. But a bail-out at this scale would be a catastrophe for the entire EU and would rob another generation of EU citizens of any hope of support from an indebted and impoverished state. This systemic financial risk is admittedly at the root cause of the 2008 financial crisis and is referred to in a quick way as “Too Big To Fail“.
Since the European institutions gave up on the idea of splitting these mega-banks in the face of fierce lobbying from the banks concerned, the corresponding policy (Bank Structural Reform, BSR) has been officially withdrawn from the European Commission work program last October. EU’s only hope of tackling the Too-Big-To-Fail problem remains the Bank Recovery and Resolution Directive (BRRD). This directive gives regulators new powers to ensure that banks can be resolved safely when they fail. Among these powers, the supervisory authorities could demand banks to make “structural changes” if that is needed to make them safely “resolvable”. In other words: the authorities could decide to force banks to split up their business pre-emptively, for prudential reasons.
So far, however, this tool has never been used. The ECB’s recent announcement asking Deutsche Bank to run a stress-test that would test the bank’s capacity to withstand the separation and resolution of its capital markets activities (which have been performing poorly for some time) has got some observers to suggest that regulators could be getting ready for a test run. But it is a long way, of course, between running a one-off stress-test on Deutsche Bank and actually imposing structural changes on G-SIBs.
Quite possibly, this step may be a “shot across the bows” of G-SIB management, just reminding them that regulators have this tool in their back pocket, even if they may be decidedly not keen to ever use it. Contrast that with the UK where the largest banks, are as we speak, finalising the separation of their retail and investment banking operations (because they were told some years ago, in no uncertain words, that they had to “ring fence” the systemically important parts of their business) and you may begin to see why it is more effective, sometimes, to have the courage for one big legislative “shove” instead of any number of small regulatory “nudges”.
Which brings us back to the beginning: The best, easiest and probably only way for the EU to reliably protect citizens from another series of massive bank bailouts is to go back to their first idea and implement bank structural reform.