The Liikanen Committee has today
revealed its recommendations for how Europe's banking structure
The High-level Expert Group,
chaired by Bank of Finland governor Erkki Liikanen, was set up
by European Commissioner Michel Barnier in November 2011 to
assess the need for bank structural reforms.
In a statement released this
morning, a European Commission (EC) spokesperson said the
analysis revealed excessive risk taking often in trading
highly complex instruments or real estate-related lending
and excessive reliance on short-term funding in the
run-up to the financial crisis.
"The risk taking was not matched
with adequate capital protection and high level of systemic
risk was caused by strong linkages between financial
institutions," the statement read.
To counteract this, the
suggested changes include a mandatory separation of proprietary
trading and other high-risk trading activities, and a possible
additional separation of activities conditional on the recovery
and resolution plan.
A review of capital requirements
on trading assets and real estate related loans, and a
strengthening of the governance and control of banks have also
been proposed. There is also potential for amendments to the
use of bail-in instruments as a resolution tool.
It is understood that the
mandatory separation of proprietary trading aims to improve the
risk sensitivity of trading operations funding costs. At
the same time, the recommendations would maintain banks
ability to efficiently provide a wide range of financial
services to their customers.
"Banking groups would have fewer
reasons to take excessive risk with insured deposits," the
Group said in today's statement. "It would also make them
simpler and more transparent, which would facilitate market
discipline, supervision, and resolution."
"It would make deposit banks
less exposed to trading activities, notably preventing deposit
banks from covering losses in the trading entity," he said. "It
would reduce interconnectedness between banks and shadow
The structural reform proposed
by the High-level Expert Group is a complement, not a
substitute, to the other areas of bank regulation and does not
represent and end to the universal banking model.
The changes in
It is understood the scope of
activities to be included within the mandatory separation of
proprietary trading will be: proprietary trading;
market-making; loans and unsecured credit exposures to hedge
funds; structured investment vehicles; and private equity
Client-driven transactions that
fall within narrow risk position limits and securities
underwriting would not have to be separated.
Separation would only be
mandatory if the relevant activities amount to a significant
share of a banks business. The legally separate deposit
bank and trading entity could operate within a bank holding
structure. While the trading entity could do more activities
than the ones outlined above, it would not be able to be funded
by insured deposits.
The deposit bank and the trading
entity would need to be funded and capitalised separately.
Accordingly, transfer of risks or funds between the deposit
bank and trading entity within the same group should be done on
market-based terms. At the same time, transfers of risks or
funds from the deposit bank to the trading entity either
directly or indirectly would not be allowed if its
capital adequacy (including additional capital buffer
requirements on top of the minimum capital requirements) would
In terms of the possible
additional separation of activities conditional on the recovery
and resolution plan, the recovery and resolution planning
foreseen in the Commission's proposals on Bank Recovery and
Resolution is important.
Producing an effective and
credible resolution plan may require the scope of separated
activities to be wider. That judgement is left to supervisors,
but the EC statement said the Europeans Banking Authority (EBA)
would play an important role in harmonising recovery and
resolution plans and their assessment.
It went on to say that the EBA
could develop standards for triggering additional separation
based on the complexity of the trading instrument, the
complexity of the organisation and the absolute and relative
size of risk positions.
Moreover, given the potential
funding and liquidity implications, transaction service
continuity should be subject to particular attention in the
recovery and resolution planning process.
Possible amendments to the use
of bail-in instruments as a resolution tool would include
building on the bail-in regime contained in the bank recovery
and resolution proposal. The Liikanen Group recommends certain
amendments that, in its view, would make it more practical.
In particular, it recommends
that the bail-in requirement be used explicitly in relation to
a certain category of clearly defined debt instruments, and
that those instruments should not be held within the banking
sector. This is to limit interconnectedness and increase the
likelihood that the authorities are eventually able to apply
the bail-in requirements in the event of a systemic crisis.
In relation to the review of
capital requirements on trading assets and real estate related
loans, at a general level the Group calls for strong and
coordinated actions to improve the consistency of internal
models across banks.
As regards the trading entity,
the Group recommends that the Commission assesses whether the
future result of the Basel Committee on Banking Supervision's
trading book review is sufficient to cover risks of every type
of EU bank. With as regards the deposit bank, the Group
recommends that supervisors make sure that capital requirements
include sufficient safeguards against substantial property
market stress and that strict loan-to-value and/or
loan-to-income caps are part of the macro-prudential toolbox in
all member states.
Finally, the Group recommends a
number of measures to strengthen the governance and control of
banks. These include 'fit and proper' tests to ensure
management's ability to run large and complex banks, risk and
control management should report both to the chairman and to
the CEO, tighter measures related to remuneration of bank
management and staff. And as regards risk disclosure, more
detailed financial reporting by banks for each legal entity and
main business lines in an easily understandable, accessible,
meaningful and comparable format.
In a press release circulated
today, governor Erkki Liikanen said he believed that the
Group's recommendations would, if implemented, provide for a
safer, more stable and efficient banking system serving the
needs of citizens, the EU economy, and the internal market.
The Group's report contains
recommendations to the EC. On this basis, the Commission will
now undertake further analysis and consultations so as to
determine the appropriate course of action. Any legislative
proposals would be accompanied by an impact assessment by the
For more of IFLR's Liikanen coverage
' Why EU banks need limited liability'
'Liikenan poll: Volcker/Vickers hybrid wrong for Europe's