‘Ring-fencing’, or the separation of trading activities from more traditional retail lending and deposit-taking activities, has enjoyed considerable focus as part of the regulatory responses to the financial crisis. Arguably inspired by the 1933 US Glass-Steagall Act that separated commercial and investment banking, ring-fencing ostensibly prevents national governments being once again responsible for bailing out the widest range of national and international banking activities, regardless of their importance to national economies or their ‘social utility’.
Proposals from Volcker, Vickers and Liikanen have addressed ring-fencing from slightly different perspectives, respectively recommending a ban on proprietary trading activity, the separation of ‘traditional’ banking from other activities, and the separation of proprietary trading and market making from other activities. The proposals vary both in their scope – what is being separated – and strength, or the degree of separation, but the implicit underlying message is clear: some banking activities are seen by governments as essential to national economies, and are likely to receive future support if necessary, but much of what banks were doing pre-crisis is not essential and should not expect such support.
This then is the hope, but inevitably the devil is in the details. The Volcker proposals quickly became mired in these details, leading to complex legislation whose impact may well be limited. Given the limited role of proprietary trading per se in the financial crisis, Volcker may well have been far too narrowly focused in the first place, and the UK’s Vickers and the EU’s Liikanen reports appeared more ambitious. The Commission’s response to Liikanen saw it move from the position generally ascribed to it, of the chief promulgator of market-freeing initiatives, to push for relatively stringent ring-fencing regulation. Given the costs national governments have faced as the result of their banks’ failings, we might expect the national-level response to these proposals to be positive. Our research has focused on the fact that, in the case of France and Germany, the opposite has been the case. Both French and German governments have sought to undermine the EU-level constraints on their large banks. They have done so by introducing their own national-level ring-fencing regulations, which, while claimed to be in line with the EU proposals, actually undermine them.
In the final analysis, the purpose of the EU and French and German national reforms are at odds: the EU seeks to promote more substantive change in banking structures, but national authorities are using their reforms to protect the status quo. The initial political rhetoric in both countries (largely in the context of elections) called for substantial reform in response to the perceived failures of the respective banking systems. However, the need for a national political response to the banking crisis did not determine the strength of that response. As the ring-fence debate unfolded, weak French and German reforms emerged, and the timing of these national laws – as part of a coordinated response by the two governments – sought to forestall emerging EU legislation. While claiming to separate ‘speculative’ activities from those central to the financing of the real economy, national authorities are using the national laws to protect structural aspects of their domestic banking systems. The Liikanen report recognised the potential for ring-fencing to undermine the European universal banking model, but in the subsequent debate two facets of universal banking have become conflated. Liikanen sought to protect a benign facet – the ability to act as a ‘one stop shop’ for banking services. Large banks have focused on protecting the more malign facet – their trading activities. The trading activities affected by the French and German proposals are as a result minimal. Banks and policymakers claim that a tougher ring-fence would harm domestic lending. Our research suggests that there is little evidence to support such a claim. However, we suggest that something else was at stake; namely the defense of national champions in investment banking in France and Germany. The bottom line is that – despite the unwelcome costs and risks associated with Too-Big-To-Fail banks – French and German governments still consider their largest banks too important to separate.