26 February 2014

Bundesbank/Dombret: Statement on the occasion of the expert consultation of the German Bundestag’s Finance Committee

Dombret said he was in principle sympathetic to the Liikanen Report's plans to separate banking activities but said the proposal also had its disadvantages and created problems of its own.

As a result of the financial crisis, there is now a focus on the systemic importance of banks. It is now indisputable – at an international level as well – that financial institutions should not be "too big to fail" and that orderly insolvency must be possible without risking the stability of the financial system. It is therefore essential to ensure banks’ resolvability, and the report by Mr Liikanen’s Expert Group makes an important contribution to this necessary debate.

In our view, the general thrust of the Liikanen Report – the idea that the universal banking system should essentially be retained, but the resolution of banks should be made simpler – is correct. However, the fact that this debate is being conducted with reference to Glass-Steagall-type banking systems would appear to be a critical point. Neither the Liikanen Group’s proposal nor similar concepts associated with Paul Volcker and Sir John Vickers target a true separation of banking activities of the kind introduced in the United States in the 1930s by means of the Glass-Steagall Act. It concerns, instead, the legal, financial and organisational separation of particularly risk-intensive types of activity – hereinafter referred to as "functional separation".

In our opinion, the report accurately describes the existing problems in the European universal banking system. We share the findings resulting from the analyses in the three basic sections. The two detailed analytical sections on the development of the banking sector in the EU and the various business models provide a sound basis for the discussion of any structural reforms.

With its reform proposals in five separate areas, the Liikanen Group rightly adopts a holistic approach that explicitly builds on existing and/or future regulations. The central proposal that there be an obligation to separate trading has the potential to be a further useful element of the reform agenda, which should, overall, increase the stability of the financial system. In that regard, the Expert Group is right not to target the strict separation of banking activities – instead seeking, in principle, to retain the universal banking system, with the trading unit and the deposit-taking unit (albeit legally and financially separate) able to operate within the same holding company.

We are, in principle, sympathetic to the separation proposal made by the Liikanen Group. A functional separation can help to protect traditional banking operations – including payment transactions – conducted in deposit-taking credit institutions against risks stemming from speculative proprietary trading.

However, the separation proposal also has disadvantages and creates problems of its own. The activities that are to be separated must be clearly defined, as must any exceptions, in order to prevent the rules from being circumvented. The difficulties encountered with the regulatory implementation of the Volcker Rule in the United States are a warning in this regard. The Liikanen Group looked in detail at two options (termed "avenues") as regards functional separation. We believe that both options are practicable, but the lower degree of intervention involved in Avenue 1 needs to be weighed, from a policy perspective, against the superior predictability of Avenue 2. It is also questionable whether the stability benefits of functional separation are as large as the Liikanen Group assumes. There is further a danger of business activities drifting into the shadow banking system.

All in all, we should be aware that functional separation is just one element of a whole bundle of measures necessary in order to ensure financial stability. It is vital that capital and liquidity levels are appropriate, and that credible resolution arrangements are put in place which not only include liability for creditors, but also make an involuntary exit from the market a realistic scenario and thus a credible threat. 

However, before structural policy measures are taken, the costs of the proposals should be weighed against their benefits. First, the volume of the operations that are to be separated off should be ascertained. In particular, there are currently no data available on the volume of market-making operations. There would also be a need for further details regarding the functional separation before a final decision could be made.

Full statement

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