Too-big-to-regulate: The EU’s bank structural reform proposal failed
Brussels, 25 October 2017 – Finance Watch, the independent organisation that defends the public interest in financial reform, deplores the European Commission’s decision to withdraw its legislative proposal for Bank Structural Reform (BSR), as announced yesterday in its 2018 Working Programme.
Separating systemically important banks' retail and commercial banking from their investment banking activities should be a necessary element of overall financial regulation to address systemic risk and reduce the probability of another financial crisis.
The failure of BSR now places the burden of responsibility squarely on the shoulders of supervisors and resolution authorities. It will be up to them, first and foremost, to ensure that systemically important banks are, at the very least, resolvable, i.e. they can be wound down in a crisis in an orderly manner and without triggering contagion.
In theory, recent legislation, notably the bank recovery and resolution directive (BRRD), has provided authorities with sweeping new powers to force banks into adopting structural changes, if necessary, to ensure that they can be resolved safely.
In practice, however, it remains to be seen if any of these new powers are exercised, let alone enforced, in the face of relentless resistance by the industry and rapidly declining political support.
Christian Stiefmueller, Senior Policy Analyst at Finance Watch, commented:
“The demise of the bill is as regrettable as it was – by now – predictable. The fact that not even Vice-President Dombrovskis' intervention one year ago succeeded in reviving the effort is testimony to the iron grip the financial industry's lobby still exerts on governments and legislators.
“Bank Structural Reform would have gone a long way towards solving the "too big to fail" problem. Instead of taking preventive action to contain systemic risk and ward off future crises, we have, it appears, chosen to ‘chance it’. A great opportunity to make the financial system more resilient has been missed.”
So far, most of the post-crisis regulatory agenda has focused on improving the micro-prudential framework. While higher capital requirements (CRR/CRD IV) and a new recovery and resolution framework (BRRD), among others, have contributed to improving the resilience of individual banks, comparatively little progress has been made in addressing the systemic risk posed by the size, complexity and interconnectedness of the very largest, systemically important banks.
Benoît Lallemand, Secretary General of Finance Watch, said:
“Ten years after the global financial crisis started, the EU’s banking system is unfortunately still not resilient. We still cannot afford to let the regulatory pendulum swing back. Unfortunately, this seems to be precisely what is happening now.”
Separating market-related activities (also known as investment banking) from the traditional lending activities (deposits, loans and payment system) of the largest European banks would:
- focus large banks on serving the economy again and help capital markets to be competitive and subsidy-free. This, in turn, would have supported the EU’s ambition for a genuine capital markets union;
- cut the hidden “umbilical cord” by which public support for deposit banks is used to feed banks’ trading activities. This implicit subsidy unduly encouraged banks' excessive growth;
- separate two very different cultures: long-term versus short-term. It would in fact avoid a situation where the short-term oriented, deal- based, investment banking culture can negatively influence the long-term, relationship-based culture of commercial banking;
- bring financial stability and prevent contagion between banks and make resolution possible for all banks – even the very largest. This greatly decreases the risk that taxpayers will once again have to bail out banks;
- avoid the economy seizing up if one investment bank fails. Separating all trading activities (not just proprietary trading) from commercial banking activities would make it easier for investment banks to fail safely.
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In November 2011, Commissioner Michel Barnier announced his intention to set up a High-level Expert Group (HLEG) to consider deeply the need for possible reforms to the structure of the EU banking sector, chaired by Erkki Liikanen. The HLEG final report was published on 2 October 2012 and recommended among other things that banks’ proprietary trading and other significant trading activities should be placed in a separate legal entity (although this can remain part of a banking group) if above a given threshold. On 14 November 2012, Finance Watch published a response to the Liikanen Report.
On 29 January 2014, the Commission published its legislative proposal for a regulation on structural measures improving the resilience of EU credit institutions (COM/2014/43 final 2014/0020/COD). While introducing the January 2014 proposal, Michel Barnier, former Commissioner for internal market and services, said: “This legislation deals with the small number of very large banks which otherwise might still be too-big-to-fail, too-costly-to save, too-complex-to-resolve. The proposed measures will further strengthen financial stability and ensure taxpayers don't end up paying for the mistakes of banks. Today's proposals will provide a common framework at EU level - necessary to ensure that divergent national solutions do not create fault-lines in the Banking Union or undermine the functioning of the single market. The proposals are carefully calibrated to ensure a delicate balance between financial stability and creating the right conditions for lending to the real economy, particularly important for competitiveness and growth".
On 19 June 2015, after several months of negotiations, the Council reached an agreement on its position. The position introduced important changes to the original Commission proposal. It softens the original proposal as proprietary trading is no longer prohibited, but separated from the core credit institution. The proposal also incorporates more flexibility to the approach by allowing discretion of the competent authorities (toolkit of supervisory measures to address excessive risk taking in trading activates).
On 26 May 2015 the Parliament rejected the Hökmark report. The report was supported by 29 MEPs, with 30 against and no abstentions, meaning that no agreement has been reached on how to take the Commission's proposal forward. ECON did not adopt some key compromises, including those on the negative scope (Art 4), metrics (Art 5), proprietary ban (Art 6), and the separation modalities (Art. 10). The vote showed a big discourse between political groups. Parliament had planned to resume negotiations in September 2015. As the Parliament did not reach an agreement, trialogues (negotiations between the Commission, the Council and the Parliament) never started in order to reach a final text.
In September 2016, Vice-President Valdis Dombrovskis met with the European Parliament’s negotiating team to kick-start the stalled bill by offering his help to facilitate an agreement without any success.
The withdrawal was publicly announced on 24 October 2017 in the European Commission's Communication on its 2018 work programme “An agenda for a more united, stronger and more democratic Europe”. In Annex 4 to this communication it stated the following reasons for the BSR withdrawal: “No foreseeable agreement. The file has not progressed since 2015. In addition, the main financial stability rationale of the proposal has in the meantime been addressed by other regulatory measures in the banking sector and most notably the entry into force of the Banking Union's supervisory and resolution arms.”
Finance Watch materials on BSR:
- On the 2017 Banking Package: “One step forward, two steps back”, June 2017
- On the differences between TBTF and other universal banks: Separating universal banks from too-big-to-fail banks (March 2015)
- On debunking the arguments used by opponents of BSR: Separating fact and fiction (March 2015)
- On EU legislation tackling too-big-to-fail: TBTF in the EU, an assessment of EU 2009-2014 legislative work on banking (September 2014)
- On why the cost of credit and other banking services to the real economy would decrease following structural separation: Structural reform to refocus banks on the real economy (July 2014)
- On why BSR is needed for Banking Union to be credible: Europe’s banking trilemma (September 2013)
- On making the public interest sovereign over banks: The importance of being separated (Spring 2013)