Of Special Interest


[x] [x]

5th October 2012

The Liikanen banking reform proposals

Erkki Liikanen produced his proposals for reforming the European Union major banks. The most single important reform is that universal banks with very large trading arms either in absolute terms (over €100bn-£80bn-$130bn-¥10.2tr-Y821bn) or in proportion to the rest of the bank (greater than 15%-25%) should be forced to hold separate capital for its trading operations. Underneath the headline proposal is the suggestion that regulators should have powers to include other aspects of investment banking they deem of high risk to be included in the separate capital calculation alongside trading.

More bail-in capital is also recommended. Existing European proposals are somewhat confused on this matter. Essentially any capital that is not directly secured (bonds or loans) should be made 'bailinable'. This would include many forms of bonds and similar as well as long-term management bonuses.

There are a number of proposals connected with risk and governance. Many faults were found and the point was made that lessons from the 2008 financial crisis have not yet been put into effect, for example the treatment of loans for property. The fact a particular reason for borrowing had proved a good risk in the past was not necessarily a reason to think it will always remain so. Lending for real estate being the obvious example. The text referred to 'micro and Macro prudential supervision', at its crudest this could be interpreted as looking for bubbles in asset pricing or other loan and product excesses. Capital for trading risks was also identified as needing comprehensive overhaul.

The report identified the need to radically strengthen the knowledge on bank boards. The role of risk management, and where it reports to needing upgrading and the need for better risk disclosure were identified as in urgent need of improvement. At a more individual level, strengthening sanctioning powers and curbing bank bonuses was also proposed.

There are few who can find fault with the general proposals at a rationale level. That is very different from saying that the proposals will have a smooth ride to implementation, and perhaps they may not all be ever implemented. Almost all countries have banks considered as national champions and many of these are universal banks that will have to find yet more capital as a result of these proposals. Some countries may also see this as weakening the competitiveness of their national champions compared with banks in non-European countries. BNP Paribas and Deutsche Bank have been widely cited as national champions likely to be significantly affected should the proposals be implemented.

From a British prospective the proposals have similarities with the British Vickers report which the UK government has committed to implementing. In some respects it offers a route that could be easier to implement in the UK than Vickers also. Rationally, the differences should be capable of bridging through negotiation so that the UK can fully implement the same common European banking policy. UK banks have said they would prefer one Europe-wide regime and a number of European politicians have expressed this wish. Politics are not rationale however. The Conservative Party, the largest party in the governing coalition has many members that dislike anything connected with the European Union irrespective of rational considerations and would like to exit from the EU. The same group dislike the party's chosen leader and Prime Minister, David Cameron, believing him to be secretly in league with the European Union and thus risking the destruction of British independence. It will therefore be difficult for Cameron to agree to changes in the Vickers report without facing a revolt from his party, regardless of whether it makes Europe-wide banking stability sense.