Bank structural reform hits the buffers, but probably not derailed | Wolters Kluwer Financial Services
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  • Bank structural reform hits the buffers, but probably not derailed

    By Michael Imeson

    Published June 30, 2015

    The European Commission’s plans for Bank Structural Reform have been severely criticised by the banking industry and held back in the European Parliament. However, they are still likely to come to fruition, even if delayed, as Michael Imeson reports.

    Among the many banking laws and regulations emanating from Brussels, perhaps the European Commission's proposal for a Regulation on Bank Structural Reform (BSR) is the most disliked and least necessary. The European Banking Federation, the Association of Financial Markets in Europe and many others have lined up to rail against the Regulation.

    Meanwhile, in the European Parliament, which should have adopted it earlier this year, MEPs in the Economic and Monetary Affairs Committee (ECON) who decide on the matter are split down the middle. Some want to dilute the proposal, others do not, and they are currently at an impasse.

    The proposed “Regulation of the European Parliament and of the Council on structural measures improving the resilience of EU credit institutions”, to give the BSR Regulation its full title, was announced in January 2014. It is intended to implement some of the recommendations of the 2012 Liikanen report, in two ways. First, Europe’s biggest banks (approximately the top 30) will be prohibited from engaging in the “risky activity” of proprietary trading, that is, trading on their own account for the sole purpose of making a profit for the bank. Second, supervisors will be given the power to require those banks to separate other potentially risky trading activities from their deposit-taking business if those activities threaten financial stability.

    The objective of the Regulation is to reduce the risk of the largest banks getting into difficulty as a result of over-reaching themselves in their financial markets trading operations. This, in turn, will reduce the risk of these banks damaging the rest of the financial sector.

    To stop banks from trying to get round the regulation by moving parts of their activities to the less-regulated shadow banking sector, the Commission has also proposed other measures to improve the transparency of shadow banking, in particular securities financing transactions (STFs) such as repos and securities lending.

    Action elsewhere

    A number of other countries, such as the UK, Belgium Germany, France and the US have already implemented structural banking reforms, and others, such as the Netherlands and Denmark, are considering them.

    For example, regulatory authorities in the US issued the Volcker Rule which prohibits proprietary trading by banks. It was published in 2014, phased in over the past year and will have to be fully complied with by 21 July 2015. It differs in some ways from the BSR regulation; for example, it applies to smaller banks as well as large; and it does not require the separation of a bank’s trading activities from the deposit-taking retail part of the bank.

    In the UK, the Prudential Regulation Authority (PRA) is preparing to implement “ring-fencing” rules that from 1 January 2019 will require large banks to separate their investment banking activities from their retail banking business. The rules stem from the Banking Reform Act 2013, which includes recommendations made in the Vickers report of 2011.

    The European Commission says that as “national reforms proliferate” it needs to create an EU-wide initiative “to preserve the smooth functioning of the single market”. The BSR Regulation will apply not only to EU banks, but to foreign banks operating in the EU “to ensure a level playing field and avoid circumvention by transferring potentially affected businesses outside the EU”.

    What the banks say

    The banking industry is firmly against the Regulation. A paper published by the European Banking Federation (EBF) in March, entitled The unintended consequences of structural reform in EU banking, explained how the reforms would damage banks and the wider economy and would be “at odds with the European growth and jobs agenda and the European Commission’s objective to revitalise long-term financing through Capital Markets Union”.

    Among the many criticisms leveled at the Regulation by the EBF is that it fails to take into consideration the “significant number of regulations” that have already been introduced to make the banking sector safer. Nor does it take into account the “associated de-leveraging and de-risking effects for banks which have already taken place”. By forcing further scaling back of bank activity, the Regulation would “handicap” the financing of European companies, “thus running counter to the European Union’s efforts to restore growth and improve employment”.

    Jacques de Larosière, an adviser to BNP Paribas, former President of the European Bank for Reconstruction and Development, and former Governor of the Bank of France, is also critical of the reforms. “The focus on bank structural reforms puzzles me somewhat,” he said in a speech at the London School of Economics in June. “Banking structures were not, per se, meaningful factors behind the [2008] crisis…all different structures participated in the disaster.

    “More important than structures were the exploding size of balance sheets (some banks’ assets climbed in a few years to five times their countries’ GDP), the concentration of risks as well as the reliance on wholesale liquidity.” Consequently, structural reforms are not the answer.

    Instead, the authorities should, he maintained, concentrate on two other aspects of the regulatory environment: first, reinforcing the capital base of banks, as Basel III does; and second, tightening risk-weighting methods. “With these two sets of actions (not to mention the resolution regulation and liquidity constraints) the banking system is becoming more resilient,” said Mr De Larosière. “And, as a result, the so called ‘structural vulnerabilities’ are being corrected, at least in the regulated sector.

    “There is no need for administrative structural reforms. Just let capital and risk weighting regulation do its job and contribute to the reshaping of the banking sector. It is better to let banks define their own business models within a sound regulatory framework, than for regulators to prescribe detailed structural rules.”

    The vote in the European Parliament

    The Economic and Monetary Affairs Committee (ECON) of the European Parliament drafted a law that watered down elements of the Commission’s Regulation. The MEP in charge of drafting the law, the “rapporteur”, was Gunnar Hökmark, the Swedish centre-right MEP, who was supported by other centre-right and liberal ECON MEPs. However, the centre-left ECON MEPs did not want to weaken the Regulation, and in a vote on 26 May the draft law was narrowly rejected by 30 votes to 29.

    If MEPs cannot agree on a compromise some bankers have speculated that the Commission will withdraw the proposal, though this is unlikely. “There remains the necessary political intention to make progress on bank structural reform, so the idea that this file will be withdrawn by the Commission is somewhat exaggerated,” writes Ashley Dorrington, Head of EU Affairs at the British Bankers’ Association, in an article on the association’s website. “The least disruptive path forward would be to allow the rapporteur some more time to reach a broader base of support for the compromise amendments, as per his stated intention after the vote.”

    The Association of Financial Markets in Europe (AFME) issued a statement after the vote saying it was concerned that structural reform of banking was still being considered without taking stock of the many regulations that have come into force in the aftermath of the financial crisis. “The failure to agree in the European Parliament on the BSR regulation highlights this is a divisive issue and we urge policymakers to consider the range of existing reforms and the need to develop Europe’s capital markets in adopting any new measures,” said AFME. “The scope of the proposed BSR Regulation and its detailed provisions generates uncertainty and could lead to regulatory duplication for banks and supervisors as they seek to implement ongoing and planned reforms.”

    The European Banking Federation took a similarly dim view. It said the outcome of the ECON vote “shows that there is no clear consensus on what is right for big universal banks in Europe”. It added: “The confusing vote is indicative of the uncertainty that the European banking sector faces at a moment when Europe needs to revitalise economic growth and create a genuine Capital Markets Union supported by liquid markets with banks active as market-makers.”

    The EBF urged legislators to rethink their priorities as the regulation “could lead to a loss in European investment capacity equal to 5%, representing a decline of almost €100 billion in capital expenditure” in the long term.

    A re-think is wishful thinking

    Hoping that EU legislators will scrap the proposal is wishful thinking, partly because there are few precedents for them backing down, partly because similar rules are already in force in the US, and partly because the UK’s ring-fencing plans are still on track. The most likely outcome is that the European Parliament will soon reach agreement and adopt the Regulation.

    The proprietary trading ban is supposed to apply from 1 January 2017 and the separation of trading activities from 1 July 2018. As the MEPs have missed their deadline for adoption by several months, those dates must now be in doubt. But if there is a delay, it is likely to be only a short one.

    About the author: Michael Imeson is a Contributing Editor of The Banker magazine; Senior Content Editor at Financial Times Live where his role is to chair events on financial services; and the owner of editorial services agency Financial & Business Publications. Michael is also a regular contributor to Wolters Kluwer Financial Services’ Compliance Resource Network.

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