How EU Liikanen will change global banking

Author: Gemma Varriale | Published: 15 Oct 2012
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The Bank of Finland governor, Erkki Liikanen, this month announced his flagship report for reshaping European banks. Here’s how these proposals could impact global banking and how European banks can continue to work within the new framework.

Liikanen’s central proposal is a trading ring-fence for Europe’s major banks. This would force banks to detach their risky trading activities from their retail operations to protect taxpayers from having to bail them out in a crisis.

The proposals will provide the basis for structural reform of Europe’s banking sector. Lawyers expect Liikanen will replace the UK Vickers and prompt a spate of mergers between Europe’s second-tier and shrinking top-tier investment banks as a strategy to create economies of scale.

But one senior in-house counsel warned they could also promote an environment in which trading is no longer profitable, thanks in part to conceptual differences with existing regulatory reforms.

Vickers versus Liikanen

The risks banks were allowed to take under the Liikanen proposals remain a critical uncertainty, the counsel said. Vickers tries to create no risk to make deposit-takers into a utility. Under Liikanen, however, banks are expected to take a lot of the typical lending risk but not trading risk.

Indeed, Liikanen’s proposals go further than many in the industry expected. The UK’s Independent Commission on Banking (ICB) proposed building a firewall around banks’ retail activities from their wholesale operations. But Liikanen recommends ringfencing banks’ more risky trading operations, including proprietary trading and derivatives businesses above a certain size.

Some of Europe’s biggest banks could therefore face the expense of almost completely ringfencing their trading activities. What’s more, the two structures proposed in Liikanen and Vickers could force some of the UK’s top banks to construct two ringfences: one around the retail arm and one around trading.

The in-house counsel said in such a climate hedge funds would play a key role in providing markets for large corporates.

The lawyer believed any large-scale EU banking sector restructuring was dependent on how US regulatory developments, however, and more specifically on how the US Securities and Exchange Commission (SEC) implements Basel III.

If SEC-regulated investment bankers get out of a lot of the Basel III  issues, the US could become a lot more attractive  ” the counsel told IFLR. “We could see a situation where SEC-regulated investment banks have a drastically lower cost base than their counterparts in Europe and the US.”

The split between Dodd-Frank and SEC regulation would also impact the way that global markets develop, he said. “The rules under Dodd Frank are so completely different that we could see competition and different markets developing in future,” he said.

More EU banking reform to come

Baker & McKenzie’s Paris-based European head of banking and finance, Michael Foundethakis,warned that Europe was self-flagellating to a greater extent than banking systems elsewhere.

What’s more he expected more regulation to come for the European banking sector. “Liikanen sets the minimum standard,” he said. “Individual jurisdictions may choose to tweak it further.”

Even so, he believed regulation was important. But he stressed it was also important for Europe to avoid knee-jerk reactions. “We need to first clear up the mess from the crisis and then implement appropriate regulation - not put the cart before the horse,” he said.

“It’s not a simple question of ringfencing the retail from the trading arm,” said Foundethakis. “The EU plans might not be enough and in the mean-time they would make European banks less competitive. They will squeeze liquidity from the market and prolong this crisis.”

“We are in a double-dip recession because not enough is being done to stimulate the economy and right now we are simply stifling it further,” he added.

See also:

  ‘How Liikanen will impact Vickers implementation’

‘European bank reform: Liikanen report revealed’

‘Liikanen Report: market concerns’

‘Why an EU banking union poses an existential threat to the UK – opinion’