ECB: Gertrude Tumpel-Gugerell: business models in banking – is there a best practice?
24 September 2009
It is important that the structure of banks’ liabilities is appropriate for the structure of the assets that they hold. In the past, banks have been excessively leveraged relative to the risks they were taking.
Her speech was focused on excessive risk-taking and banks’ creation of innovative financial products, which has led to the transformation of their business models.
To a large extent, this shift towards a new business model was based on innovation in the structured credit market, particularly in respect of securitisation instruments, such as credit default swaps, asset-backed securities and collateral debt obligations. A common feature of all these financial innovations is that they transform, transfer and trade credit risk. One of the main consequences of the use of such instruments is that large amounts of credit that were previously predominantly illiquid (such as bank loans) then became liquid and could potentially be traded in financial markets.
She highlighted different areas where banks have changed from their traditional business model:
· Banks’ funding sources. In particular, this refers to the shift in banks’ business models away from the traditional model of financing. In the traditional model, there was a heavy reliance on retail deposits, but this has been replaced by an increasing reliance on market-based sources of funding. The significant recourse to specific funding instruments, such as mortgage bonds and securitisation, has made banks increasingly dependent on capital markets, but at the same time, of course, less dependent on deposits, to expand their loan base.
· Securitisation activity did indeed increase substantially in the years prior to the financial crisis. Securitisation and financial innovation in credit markets have generated significant changes, particularly in the financial structure of banks, and, more generally, in financial market activity in the euro area.
She concluded by saying that “it is important that the structure of banks’ liabilities is appropriate for the structure of the assets that they hold. Banks have been excessively leveraged relative to the risks they were taking. We still know too little about why different banks hold different levels of equity. We do know, however, that, ultimately, equity is the only robust buffer against realising losses. Although holding equity is costly, bank capital regulation should also take into account the macroeconomic implications of bank capital requirements.”
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