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On both sides of the Atlantic, much more needs to be done on a fundamental issue – the structure of banking entities. This is crucial for three reasons.
First, having a clear sense of who is in charge of what is vital when it comes to management and supervision, especially in times of stress. Structural reform and “living wills” can be used to help clarify lines of authority, align business risk with organisational form and simplify structures of complex financial institutions.
Second, structural reform can help bolster “horizontal buffers”, which can help stop crises spreading. Limits on the activities of retail deposit banks, restrictions on transactions between retail banks and their affiliates, independent capital and caps on counterparty credit exposures can help minimise contagion. The core banking services upon which everyday economic life depends would be better protected.
Third, paying attention to structure would help resolve companies when they get into distress. In the US, the Federal Deposit Insurance Corporation is developing a “single point of entry” model for resolution that would allow it to wind down a complex financial conglomerate by separating it into a holding company with “resolution-ready” capital and equity, and solvent subsidiaries permitted to continue to operate. Similar approaches are being pursued in Europe. Structural reform will make it much more likely that such resolution plans would work in a crisis. Indeed, it is hard to see how complex financial companies can be credibly resolved without prior measures of structural reform...
So structural reforms need to be part of a broader change in supervision and capital requirements, including resolution procedures for large financial companies regardless of their corporate form, and much-needed reforms to derivatives markets.
Ringfencing is no excuse to avoid regulating non-bank firms and markets that can pose a risk the financial system. At the same time, Europe should embrace structural reform as an essential feature of banking reform. And the prospect of eurozone banking union makes this all the more important.
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