The EU-led Liikanen banking review released this week has shifted the centre of regulatory gravity in favour of the hawks who want to break up lenders and separate retail deposit-taking units from risk-taking investment banking. Although it would preserve the universal banking model, the report’s other proposals – especially increased risk-weighting on trading books and real-estate lending – add to the regulatory momentum to curb systemic risk and in effect depress banks’ earnings.
However, the market reaction has been relatively muted – despite the media attention – given the uncertainty of implementation both in terms of substance and timing, as well as reform fatigue, more generally, amid the flurry of new rules this year: Vickers, a banking union, not to mention the implementation of Basel III.
The report’s most disruptive recommendation is the ring-fencing of banks’ retail and trading books. In a bid to ensnare capital markets-driven institutions and large universal banks, under the Liikanen proposal, a trading operation would need to constitute 15% to 25% of total assets or total more than €100 billion, before being reviewed for separation by supervisors.
What’s particularly onerous about the Liikanen review is that trading assets in the available-for-sale portfolio, rather than just those assets in the held-for-trading book, fall under the review, despite the fact these assets are likely to be held for liquidity purposes, rather than being actively traded.
The Liikanen report would capture the majority of the large banks in France, Germany and the UK – which are subject to the Vickers report – while Swiss institutions are outside the purview of the EU review.
The axe will fall on most of the large EU banks, with the exception of Austria’s RZB, Portuguese Commercial Bank (BCP) and Germany’s SHB Bank, which fall below the stated thresholds, according to CreditSights. The report is likely to embolden Crédit Agricole’s mission to downsize its trading activities since it “falls under its more generously capitalized mutual group”, according to CreditSights.
If ring-fencing were adopted, under Liikanen’s proposal, it could substantially hike the cost of financing for the trading bank, since it would be subject to onerous capital requirements. The Vickers report estimated a 100 basis point to 200bp increase in debt issuance costs for a given trading bank business over its retail bank.
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| Finnish central bank governor, Erkki Liikanen |
The jury is out on whether there is government appetite for ring-fencing in the near-term in France and Germany. Although German opposition leader Peer Steinbrück has called for ring-fencing and curbs on trading-related activities – leaving Deutsche Bank particularly exposed – the German government has yet to comment. However, the hawks now have the leverage, according to Deutsche Bank analysts: “We do not expect Liikanen’s proposals on ring-fencing to be implemented into EU law, because we see the regulatory pipeline as simply too full.
“[But with] the combination of the Steinbrück paper issued last week and this week’s Liikanen report, the debate has gained momentum in Germany. The government is likely to take up some elements of the banking separation proposal with a view to have them incorporated into banking legislation.”
The Vickers and Liikanen reports overlap on a combination of areas, including: loan-to-value limits for property funding and better comparability of internal risk models between banks, an increase in minimum risk-weights for trading assets, as well as enforcing a legal separation of investment banking and commercial banking, under a universal banking model. The idea of the reports is to ensure monoline banking arms of a holding firm can be unwound in the event of a crisis, without imperiling depositors.
French president François Hollande has pledged to separate retail and investment-banking operations at a time when French banks’ trading assets have expanded during the past year. According to Bloomberg data, the investment banking units of BNP Paribas, Société Générale, Crédit Agricole and Natixis combined equates to $2.64 trillion in trading assets, a 21% jump year-to-June, compared with France’s $2.77 trillion economy.
French banks’ trading assets have increased during the past year thanks to low interest rates that have boosted the value of interest-rate derivatives holdings. Nevertheless, under the Liikanen proposal, the deposit-funded banks would still be able to offer foreign-exchange and interest-rate hedging products for non-bank customers, while hedging these exposures on banks’ balance sheet.
Nevertheless, EU policymakers’ in-trays are crammed full of reforms: banking supervision and union; preserving a single financial market; a centralized fiscal union; a single bank resolution fund; not to mention direct recapitalization of banks.
The Liikanen report argues that the proposed reforms can help turbo-charge the establishment of the banking union. However, JPMorgan analysts reckon this proposal is bedeviled by competing objectives.
“The report is at pains to suggest that, while the proposals are designed ‘for the single market as a whole, [they] can also help the establishment of a banking union’.
“We are not sure what this means in practice, and think it reflects the confusion the region has about how these two concepts are to be stitched together. One (Liikanen) is about changing the rules of the game, the other (banking union) is about changing the referee – we think these could be sequenced more coherently.”
What's more, the Finnish banking blueprint conflicts with the UK regulatory agenda, says Credit Suisse analysts, further underscoring the challenge of creating a single global financial rulebook.
“It is unclear how the UK and EU processes will work from here,” they state. “We would hope for some harmonization, but there is a risk that we end up with multiple ring-fenced entities within banks based on region and assets/liabilities. Further, it is unclear to us how the European subsidiaries of foreign banks will be treated.”
Many a regulatory battle will be left to fight but it looks like the idea of European banks’ deploying holding company structures is here to stay.