Memorandum

Restructuring the EU banking system

Memorandum

9 April 2013, Brussels Memorandum Restructuring the EU banking system

function well and efficiently and have the necessary stability.

Ms McCarthy sees the structural reform of the banking system as complementary to all other new regulations coming up. It is much more fundamental than simply changing the rules of operation. She believes that they are in Arlene McCarthy agreement in the ECON Member of the European committee on a number of core Parliament, rapporteur on issues and that is that we have to reforming the structure of the make sure that in any reform we undertake a first line of protection EU banking sector that must be put in place to The culture has not changed. We protect depositors and savers. continue to see crises and There is nothing wrong with taking scandals like Libor and misselling. risks, that is what generates We have not gotten away from profits and returns, but excessive banking . We have seen risk is not good and it has led to situations in the Netherlands in some of the problems in the which a bank had to be bailed out recent crisis and the taxpayers are very recently and we have seen still paying for that. Another issue the emergence of a banking crisis on which ECON members seem in Cyprus. to agree is that it is wrong that depositors and savers should Ms McCarthy is reluctant to take bear the cost for banks failing due anything definitive from that crisis to reckless activities. because the Cypriot case is a unique one. Nevertheless, a ECON members wish to put in conclusion to be drawn is that place measures that prevent banks are still . The banks from being too big to fail. EU banking sector amounts to They also want to look at the 375 per cent of the EU’s GDP. So long-term sustainability and health this is a very important sector. of the sector. Some members do That is why we have to get it to not believe that there should be a Memorandum Restructuring the EU banking system distortion in the banking sector, Do we need a separation or unlike in other industries where should we have a ring-fence? To there is an implicit guarantee and we need a full separation or funding subsidy. Of course they should we be banning certain also want to reduce to probability activities? In any case, this will of bank failures and the likelihood happen. We will get a proposal and cost of government from the Commission and there interventions. will be a reform. What we now are seeing is that in the absence One of the arguments used by the of such a reform, the individual banking industry as to why we member states are taking actions should not have a separation or on their own. ring-fencing between retail and investment activities is that the If the industry does not want help cost would be too high, but Ms find a constructive approach, it is McCarthy would say that those going to happen in any case. So banks do not seem to have a the way to lobby is not to lobby problem with the cost taxpayers against it. have to bear when things go ______wrong.

One of the reasons why we need a structural reform is that we have a fundamental problem with public trust and confidence, which does not go away. What do we want our banking system to do? What structure do we need so that the banking system can do that? We want a more stable and competitive banking system that Mario Nava can contribute to growth. Directorate H – Financial Institutions, DG MARKT, We need to reduce the European Commission interconnectivity between the risky elements of banks and the Mr Nava started by underlining shadow banking system. Of what Ms McCarthy had said will course there are many questions. happen, that there will be a Memorandum Restructuring the EU banking system reform. He gave three probability and the cost of a bureaucratic reasons showing default. Here, the new capital how serious the Commission is requirement rules do part of the about this. First, they have put job. However, the fact that there together a high-level expert group, are intragroup subsidies and at i.e. the one led by Erkki Liikanen. the same time as there are basic Second, they have set up a new banking activities with deposits unit, which always should be and other riskier activities does taken as an important sign. The not create the right incentives. third sign is that the European Parliament is putting forward an There is a third reason which own-initiative report. should not be underestimated, and that is that a number of The co-legislators have to prove countries both within and outside the complementarity of this reform the EU have already taken actions to all other measures being taken. towards a structural reform of the There are three types of banking system. Most of the measures. First, there are banks are international and hence prudential rules and regulations it does not make sense to have such as CRD IV. Second, a lot several different national rules. has been done in the area of supervision. Finally, there are Those jurisdictions that already resolution measures, where there have taken action have chosen is a proposal out on crisis different approaches. First of all, management. However, as stated does one put the fence around in the Liikanen report, the current the retail activities or does one put reform agenda does not fully the fence around the investment correct incentives for excessive activities? The second question is risk taking, complexity and intra- what type of fence we should use. group subsidies. Hence, we need Should we have a high fence, i.e. to make sure that we create the full separation? Or should we right incentives for banks to go have a lower fence meaning just back to basic and start serving functional separation but not strict the real economy. legal separation? Finally there is The second point concerns the issue of defining investment financial stability and the activities and trading. ______

Memorandum Restructuring the EU banking system

organisations he supports the idea that diversification is in itself a risk mitigant. A separation will lead to narrower business models. Banks may be smaller by definition, but not necessarily less risky, neither individually, nor collectively. Furthermore, having separated them, we may actually encourage what is perceived to Iain Cummings be low-risk businesses to take Partner, , more risk. KPMG, UK Another dynamic that we see Mr Cummings started with the within the financial sector is first discussion point on the progressive localisation. Arguably agenda: are the proposals in the there are moves to address this, Liikanen report the right way because it fundamentally comes forward? If the aim is to make from a lack of cross-border banks smaller, if the aim is to resolution measures. This has led support ex-ante resolution politicians and regulators to take measures and if the aim is to action in order to protect their prevent banks from using own reputation by dealing with guaranteed retail deposits to fund what they actually can deal with risky trading activities, then the within their own local system. Mr answer probably has to be yes. It Cummings fears, however, that by is by no means the only option, or moving trading businesses that indeed, the best. It is also one are inherently more international that has been tried at least twice away from the business perceived in history before and subsequently be more domestic, we have there have been periods of further incentive towards this stability. However, if we go down dynamic. The 1930s trade wars it this route we have to accept all of were driven by a failure to realise the consequences. It is by no that what looks sensible on a means a nirvana. In general, when country by country basis was not Mr Cummings looks at banking actually for a greater good. Memorandum Restructuring the EU banking system

Having said all of this, one of the problems, retail distribution and most compelling arguments for sales culture without focus on risk Liikanen actually goes against was actually the issue. localisation. We have proposals from the US, from the UK, from There is a need for enhanced risk and last week from governance in most organisations. Germany. Having different kinds of It is a process that most financial rules in different countries can services businesses are going only lead to huge inefficiencies. through. This is included as one of We need to have clarity about the recommendations in the where the dividing lines are. Liikanen report. We should not Liikanen has the advantage of lose sight of this, regardless of setting clarity across the whether we choose separation or marketplace within the EU about not. Whatever the size and shape what the rules are. There should of banks, it is essential that it be also be clarity about the definition clear to all stakeholders the risk and the application of those rules that those organisations are to ensure that we have a level taking. Poor governance and the playing field. “tone from the top” have

Banks have realised that the contributed to all failures. As culture that permeated them, and Citigroup’s Chuck Prince said, “as still does after the crisis, needs to long as the music is playing, change. Most financial services you’ve got to get up and dance”. organisations that Mr Cummings We do however need to become talks with are going through that. better at understanding when the Culture, however, is not music might stop, and ensuring something you can change by a that, when it does, there are flick of a switch. We are talking sufficient chairs for everybody. about changing behaviours in very ______large organisation, which may take a decade.

Mr Cummings does not believe that it is only culture that can pose problems here. Looking at some of the banks that got themselves into Memorandum Restructuring the EU banking system

money in order to invest. Therefore, how the Cyprus crisis has been handled sends out entirely wrong signals. Deposits are protected up to 100 000 euros. Imagine that you just have sold your house and have just received the money on your account—money that you plan to use to buy a new home. If the Monique Goyens bank goes bankrupt at that Director General, BEUC and moment you lose almost Member of the European everything. This example Commission's High-level Expert demonstrates that it is not only Group on reforming the rich consumers who are affected. structure of the EU banking Therefore, if you wish to restore sector consumer trust and if you wish to prevent a bank run you need to send out better signals and you Bank resolution rules are currently need to deliver a safer system. a priority for BEUC. Banks are the Structural separation is one of the only example in which the clients, tools that can be used in order to i.e. the depositors, have to pay provide consumers and tax when a company fails. The money payers with a safer system. Over in your bank account is your the years the banking system has money and you are told that it grown too complex and too should be safe there. It is not opaque. reasonable that you should lose your money just because As a consumer organisation, someone has mismanaged risk. BEUC welcomes the Liikanen Depositors do not have any report. We would even like to go possibility to influence the bank’s further. The deposit-taking bank risk taking. We need consumer should only take very limited risk trust and we need depositor’s while the risk-taking bank may Memorandum Restructuring the EU banking system take risks; there is no problem with that, but they will also be the ones to bear the risk. The risk- taking bank should be allowed to fail. That is a consequence of the separation. The deposit-taking bank is the one that should be saved but as there are no risky activities there should not be any needed. The risk-taking activities are the responsibility of Paul Chisnall those engaging in risk-taking, not Executive Director, BBA - the bank’s client. British Bankers' Association

There are five sets of Mr Chisnall has no in-principle recommendations in the Liikanen objections to the own-initiative report but only two are about report because what it largely sets separation. Another issue is about out is rather consistent with the risk governance. Remuneration Vickers ring-fencing approach in and incentive schemes should be the UK. What usually happens much more linked to the risk- when the EU is looking for a taking through for example blueprint for a new regulation is deferred bonuses bail-in that representatives around the instruments and clawbacks. There European policy table usually find was also a recommendation that for very good reasons they regarding banks mortgage decide to support their own lending, which must be more national approaches. Mr Chisnall responsible. The fifth does not necessarily advocate recommendation also includes the that Vickers should be mandated issue of sanctions for excessive across the entire EU but it risk taking. arguably makes it easier to sort ______out both the ring-fenced and non ring-fenced part of a bank in the event that they get into difficulty without taxpayers’ funded support. Memorandum Restructuring the EU banking system

It certainly insulates vital banking the financial crisis was not even services on which SMEs and about investment banking. The others are dependent and can be same is true for other EU member said to curtail the implicit states where the root was not government guarantee through investment banking, it was bad which large too-big-too-fail retail and commercial banking organisations benefit from cheap decisions, principally real estate. funding. What Mr Chisnall is unsure about though, is whether Mr Chisnall is unaware of any ring fencing is necessarily evidence that the universal appropriate as an EU-wide banking model contributed to the measure to be mandatory across financial crisis. Certainly that was all 27 member states. There is a the view when the ECB looked at question whether others it back in 2010. Looking at necessarily view the implicit structural separation in terms of guarantee in the same cultural purpose, the question is what way that they do in the UK. does it give us that other measures if finalised and applied Mr Chisnall’s doubt concerns both consistently across the EU will not diagnosis and purpose. First of all give us. The answer to what was in terms of diagnosis, the political needed lies in measures already debate in the UK which is taking taken and in some of the place against the backdrop that measures that are on the way. we must protect ourselves against “casino banking”. Yet in the UK There are new capital requirements and strengthened supervision. Most important according to Mr Chisnall is the resolution regime, which is on the way. If we achieve all this, the question is whether a mandatory structural separation really adds a great deal. The Commission should consider whether the Memorandum Restructuring the EU banking system

perceived added benefit from a UK on issues which have proven structural reform outweighs any more complex than they first negative or unintended appeared. For instance, how do consequences for long-term we make sure that ring-fenced economic growth. If however, we banks can actually deliver what do conclude that there is SMEs need in the support of their something to be gained from important exports? The US Volker structural separation, then we rule on the other hand is not as should look at Vickers, but in the easy to put in place as one first process learn from detailed might think. discussions they have had in the ______