05 September 2013

Finance Watch: Europe's banking trilemma - A report on Banking Union and bank structure reform

Key points from the report include:

• The expectation of bail-out means that banks receive a funding subsidy via government guarantees.
• There is no reason to subsidise trading activities, in fact this increases systemic risk.
• In the last 25 years, our largest banks have evolved into "flow monsters" with balance sheets dominated by subsidised trading assets and inter-connected via the derivatives markets.
• In today's environment, it is difficult for highly inter-connected banks to undergo "creditor bail-in" without spreading danger throughout the financial system, which undermines the credibility of the bail-in mechanisms proposed.
• The proposed Resolution Fund and the European Stability Mechanism are too small to withstand a systemic banking crisis on their own.
• Without structural reforms and credible loss-absorbency mechanisms on banks' liabilities, Banking Union risks becoming a paper tiger: a mechanism that appears to help but which delays meaningful bank reform and lacks teeth when the next systemic crisis strikes.

Policy recommendations in the report include:

• A strong legislative proposal in the current European Commission mandate to separate commercial banking from investment banking and trading activities, including market making, as recommended by the High-level Expert Group led by Erkki Liikanen.
• Significantly higher loss-absorbing capacity for banks, including equity requirements through the adoption of strict leverage caps by 2015.
• Stronger powers for supervisors to intervene to ensure that recovery and resolution plans are realistic.

Full report

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