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In his speech held at the 16th Banking Symposium of the European Centre for Financial Services: “Profile and profitability – Are banks’ business models in transition?”, Dombret addressed the individual elements of the build-up of risk and some elements of the associated financial innovations – key components of a bank’s business model. This he said was a vital aid in better understanding another debate: that on universal banking systems and specialised banking systems.
Specialised banking versus universal banks: missing the point
In terms of financial stability, a much more serious issue is at stake. One of the proposals for a specialised banking system currently on the table – the Vickers blueprint – would distinctly reduce interlinkages, which is welcome as far as its effects on financial stability are concerned. However, that would probably not close off every possible contagion channel. Banks are interlinked through all sorts of other channels. Not least, during the financial crisis, in order to prevent contagion, in particular, governments also gave support and assistance to many investment banks or – as I would call them – quasi-investment banks.
Not everything is rosy even in classical banking business. The very large banks – those deemed “too big to fail” – are not the sole sources of systemic risk. The Spanish case has made this abundantly clear. Here, banks were destabilised by their exposure to the real estate market. These vulnerabilities were created in traditional lending business.
Proponents of specialised banking systems believe this will produce a better solution to the “too big to fail” problem. And, the wisdom of introducing a system of specialised banks has to be judged in terms of whether it makes it easier to supervise large, complex financial institutions. Even more important, as I see it, is whether such banks can, in a crisis, be more easily resolved if they do not have an investment banking arm. After all, a break-up leads to the creation of smaller banks.
This much I believe: the best regulatory solution for the “too big to fail” problem is the credible threat of an institution’s orderly market exit. This is well within the tradition of standard insolvency law, if you will. And in cases where standard insolvency or bankruptcy proceedings cannot be applied precisely because of this “too big to fail” problem, other resolution regimes – and credible regimes at that – are needed. Developing cross-border, harmonised resolution regimes is therefore also at the core of international reform efforts.
The decisive factor – as always when it comes to money and finances – is credibility. Is it possible to introduce a credible resolution regime with the existing structures? Or are these structures too complex for a realistic market exit? The TBTF problem desperately requires a solution. If a solution can be found through credible resolution regimes, the advantages of universal banking do not need to be sacrificed. Let me repeat: credible resolution systems are the much better option for regulatory purposes.
I do see where the proponents of specialised banking are coming from. However, do not be fooled: simply ring-fencing investment banking from banks’ core business will not be enough to prevent future systemic crises. We therefore need to focus more strongly on the underlying sources of systemic risk in banks’ business models and then effectively mitigate them. This will involve subjecting activities such as banks’ proprietary trading to critical examination.
I am fully in agreement with Mr Schmitz, President of the Association of German banks, when he says that “the decisive factor is that the risk incurred is commensurate with risk buffers. To that extent, imposing greater restrictions on some areas of proprietary trading than existed before the crisis makes sense and is the right move.”
Conclusion
Dombret concluded his speech by summarising his thoughts as four basic propositions: