Split banks into retail and high-risk units, report urges

Banks should be dividedinto high-street deposit-taking banks for ordinary customers and separately capitalised institutions that carry out high-risk trading to reduce the possibility of taxpayers paying for reckless behaviour by bankers.

The report for the European Commission from a group of 10 led by Bank of Finland governor Erkki Liikanen wants more action to prevent the kind of housing bubbles that brought Ireland to its knees, tighter controls over staff bonuses and tests for bank management and board members.

Mr Liikanen said the aim of the proposals was to “get rid of a system where profits are private and costs are public”. But the report was criticised by some as not giving European banks the kind of radical overhaul they need while others praised it for suggesting the next steps towards getting them firmly under control.

The Commission hopes the proposals will give impetus to the banking union which Germany, in particular, has become reluctant to push through quickly and which would open the EU’s bailout fund, the ESM, to lend directly to troubled banks.

The document comes out strongly in favour of one of the planks for banking union, the Bank Recovery and Resolution Directive that would see cross-border deposit guarantees — another element Germany is reluctant to adopt.

In its analyses it said the banking debacle could not be blamed on any one business model. Instead it was down to the behaviour of people in the institutions where they took excessive risks in trading highly complex instruments or real estate-related lending.

These risks were not offset by adequate capital and the strong links between financial institutions meant the risks spread quickly from one to another.

The criteria for legally splitting a bank should be if its assets for trading and sale exceed 15-20% of the bank’s assets, or €100bn.

If so, then supervisors would decide on the share of assets to be separated based on a threshold to be calibrated by the Commission. The report advises that different bases for measuring trading activity, including revenue data, should be included.

There should be a transition period while the smallest banks would be fully excluded from the need to have two separate entities. High-risk activities would include unsecured loans to hedge funds and private equity investments and could not fund its activities through government guaranteed deposits.

Deposit banks would lend to SME, trade finance, consumer, mortgage and interbank lending, participate in loan syndications, private wealth and asset management and exposures to regulated money market (UCITS) funds.

The report also called for changes to recently published Commission proposals to force creditors to share the cost of stabilising institutions by issuing bail-in debt that stipulates when losses may be imposed.

The EBA and the new single euro area supervisory authority — the ECB — should ensure sufficient safeguards against substantial property market stress and there should be a cap on loan-to-value and/or loan-to-income.

Banks’ pay schemes should be proportionate to long-term sustainable performance while a share of any bonus should be in the form of bail-in bonds.

Supervisors much have sufficient powers to sanction wrongdoing, including imposing a lifetime professional ban and clawback on deferred compensation from executives. Candidates for jobs in management and boards should have to take a fit-and-proper test.

The European Commission, led by Internal Market Commissioner Michel Barnier, will decide what action to take.