A year after the European Commissions Michel Barnier instructed an expert group to look at whether there is a need for structural reforms of the EU banking sector, the commission has today published the so-called High Level Expert Groups (HLEG) findings and proposals for consultation.
In a nutshell, the group has concluded that it is necessary to require legal separation of particularly risky financial activities from deposit taking banks within the banking group in order to protect the consumer and ensure the resumption of the critical functions of deposit taking entities. The activities to be separated would include proprietary trading of securities and derivatives, and certain other activities closely linked with securities and derivatives markets. Stronger capital requirements, in general, will enhance the resilience of banks; correct, to some extent, the incentives of owners and managers; and, will also help reduce the expected liability of taxpayers in the event of adverse shocks to bank solvency, said the HLEG in its executive summary. Separation of these activities into separate legal entities is the most direct way of tackling banks complexity and interconnectedness, it added.
The HLEG, led by Bank of Finland governor Erkki Liikanen, noted the Commissions initiatives that have already taken place, including the implementation of the new Capital Requirement Regulation and Directive (CRR/CRDIV).
Of particular importance, the Group recommends:
– Imposing a non-risk weighted capital buffer for trading activities of banks and a separation of activities conditional on supervisory approval of a recovery resolution plan (RRP).
– On bail-in requirements for debt instruments used by banks and the RRP proposed by the Commission in June 2012, the group recommends that producing an effective and credible RRP may require the scope of the separable activities to be wider than under the mandatory separation.
– More robust risk management frameworks are required and more consistent treatment of the risks in certain activities and instruments is required. We need consistent treatment of real estate and loan to value ratios and hence a review of the capital requirements on trading assets and real estate related loans, said the group.
The group questions whether the outcome of the Basel Committees review, as to whether the proposed amendments to the trading-book capital requirements would be sufficient to cover the risks of both deposit banks and trading entities. The Group suggests that the Commission should consider further measures regarding the treatment of real estate-related lending within the capital requirement framework. As a direct measure to limit the risks stemming from real estate markets, the European Systemic Risk Board recommends that loan-to-value (LTV) and/or loan-to-income (LTI) caps are included in the macro-prudential toolbox. The HLEG supports this recommendation- It is also necessary to reform the corporate governance framework, improve risk management and strengthening sanctioning powers.
The group believes a clear definition would clarify the position of bail-in instruments within the hierarchy of debt commitments in a banks balance sheet, and allow investors to know the eventual treatment of the respective instruments in case of resolution.
In order to improve the standing and authority of the risk management function within all banks, so as to strengthen the control mechanism within the group and to establish a risk culture at all levels of financial institutions, legislators and supervisors should fully implement the CRD III and CRD IV proposals. In addition, there should be a clear requirement for Risk and Control Management to report to Risk and Audit Committees in parallel to the Chief Executive Officer (CEO).
The HLEGs report will be consulted on over the coming weeks, with the European Commission due to make an assessment of whether to legislate on the proposals.
We want to compliment what is already taking shape in the European Commission, said Liikanen in a press conference in Brussels. For example, with respect to risk weighting, the Basel Committee is sitting on various issues we say there is a need for reform but we want the Commission to consider this independently. There is too much heterogony today and bank-based international models have been so different.
Barnier added: In 2010 I committed myself towards intelligent supervision for financial services and looked at the prevention and resolution of the banking crisis. On banking union the first stage of work commenced on June 29 this year and our teams have made proposals in nine weeks.
On the HLEGs report, Barnier said: Were working towards a date leading towards December for the results of the consultation. Then there will be guidance and then the time for legislative proposals will come but if we make legislation from it I dont think we would wait until the end of next summer (September 2013).
Barnier recognized that while the European Commission is moving towards a single market act for banking and financial services, individual countries in Europe are also working on a single rule book. A differentiation of risks is a key thing in terms of the robustness of the banking sector going forward and this has been worked on in individual countries e.g. in the UK with the John Vickers report, he said. France and Germany also recognize a separation of the risks and a single rule book is needed. A year ago I asked the group to make proposals since I wanted a common framework and we want coherence. Were going as quickly as possible with these proposals because my concern is that we need a stable framework.
The Liikanen report and what we do with it in in terms of legislation will be part of a framework for single rule book for single markets like other frameworks on derivatives and capital requirements for MiFID.
Commenting on the HLEGs recommendations, Simon Lewis, chief executive of the Association for Financial Markets in Europe, said: AFME supports the regulatory reform program and the authorities aim of restoring confidence in the European financial system. But we do not believe that further changes to the structure of the banking industry are necessary or will contribute to Europes economic growth.
(JDC)