14 November 2012

Finance Watch publishes response to High-Level Expert Group's report on reforming structure of EU banking sector

The Finance Watch consultation response concludes that the Liikanen proposals are the minimum needed, and that robust structural reform of banks would boost growth and stability in the EU.

In its key points, Finance Watch says that the report's analysis is sound and its recommendations should be strengthened; robust structural reform of banks would boost growth and stability in the EU; and that without structural reform of banks, the EU's plans for banking union could backfire.

Thierry Philipponnat, Secretary General of Finance Watch, said: “The Liikanen diagnosis is right but the medicine may not be strong enough. We applaud the High Level Expert Group for its comprehensive study of moral hazard in Europe’s banking system and the distortions this causes in the economy. But while we agree fully with the analysis, we fear that the recommendations will not meet the Group’s objective of delivering an efficient and stable banking system. It is essential that policymakers do not water down these proposals under pressure from the banking lobby. They must bring forward legislation that can accomplish the task set.”

In its consultation response, Finance Watch explains why the public interest arguments claimed by the banking industry in support of the so-called “universal banking model” are substantially incorrect. At the same time, it explains why separation would benefit both investors and the economy.

Finance Watch’s Aline Fares, author of the response, said: “Moral hazard distorts the very nature of banking away from economically useful activities. Investment banking and commercial banking are fundamentally different activities. When the money creation process inherent in commercial banking is allowed to be used for investment banking, it has the consequence of feeding large amounts of newly created money into speculative trading and asset bubbles. Put simply, the way banks are structured today is a handicap to the EU’s financial stability and growth.”

Finance Watch contrasts the EU’s various proposals for bank reform with the three-part bank reforms enacted in the US in the 1930s, which led to more than 60 years of financial stability and economic growth in the US.

Mr Philipponnat said: “Banking union will deliver only two out of the three elements of Glass-Steagall: a resolution authority and a single supervisor. Unless the third, structural reform of banks, is also enacted, the Banking Union proposals risk increasing the harm done by moral hazard in the EU’s banking system.”

The consultation response says, among other things:

• Additional measures are needed to prevent the leakage of risk between the trading and deposit taking parts of banks.
• The thresholds and boundaries proposed could be adjusted to increase their effectiveness.
• The analysis that capital adequacy requirements should be materially higher than under Basel III/CRD IV is correct and should be reflected in EU bank regulation.
• Bail-in bonds are a potentially powerful tool to remove moral hazard but must be implemented in a way that is realistic for the market.
• Proposed changes to bank remuneration and governance should be welcomed, including the idea of paying bank employees with bail-in bonds.

Reducing the dominance of subsidised incumbents would breathe new life into the EU’s banking sector by lowering barriers to entry and promoting diversity and competition.

It is clear from the High Level Expert Group’s own analysis, supported by that of the International Monetary Fund, the Bank for International Settlements, the Bank of England and others, that a more robust approach to the structural reform of banks would bring significant benefits to taxpayers, investors and the economy alike.

Press release

Consultation response

© Finance Watch