Curbing risky banking activities, European Commission unveils proposals

The European Commission has unveiled some proposals aimed at curbing risky banking activities.

Banks would be banned from using their own funds for investing, a practice known as proprietary trading.

The Commission would also like to introduce measures that separate retail banking from investment divisions.

In the proposed new rules, supervisors would have the power to make banks separate certain trading activities from their deposit-taking business, if such activities risk undermining financial stability.

The Commission has also put forward measures aimed at improving transparency of some types of transactions in the shadow banking sector. “These measures complement the overarching reforms already undertaken to strengthen the EU financial sector,” the Commission wrote in an online communiqué.

Shadow banking refers to financial activities that are carried out by investment banks, hedge funds and other entities which do not take customer deposits, and are thus not regulated like mainstream banking is.

Curbing risky banking to protect taxpayers and the wider economy

Commissioner for internal market and services, Michel Barnier, said:

“Today’s proposals are the final cogs in the wheel to complete the regulatory overhaul of the European banking system. This legislation deals with the small number of very large banks which otherwise might still be too-big-to-fail, too-costly-to save, too-complex-to-resolve.”

“The proposed measures will further strengthen financial stability and ensure taxpayers don’t end up paying for the mistakes of banks. Today’s proposals will provide a common framework at EU level – necessary to ensure that divergent national solutions do not create fault-lines in the Banking Union or undermine the functioning of the single market. The proposals are carefully calibrated to ensure a delicate balance between financial stability and creating the right conditions for lending to the real economy, particularly important for competitiveness and growth.”

The structural reform proposal for European Union (EU) banks will only apply to the biggest and most complex banks in the EU, i.e. those with significant trading activities. The proposal will:

Ban proprietary trading in financial instruments and commodities – in other words, trading on your own account with the sole aim of making a profit for the bank. Proprietary trading entails several risks “but no tangible benefits for the banks’ clients or the wider economy.”

Grant supervisors power to ring-fence legal trading entities – known as subsidiarisation. Supervisors should have the power to make banks transfer other high-risk trading activities, such as complex derivatives and securitization operations to separate legal trading entities within the group.

The Commission says this second proposal “aims to avoid the risk that banks would get around the ban on the prohibition of certain trading activities by engaging in hidden proprietary trading activities which become too significant or highly leveraged and potentially put the whole bank and wider financial system at risk. Banks will have the possibility of not separating activities if they can show to the satisfaction of their supervisor that the risks generated are mitigated by other means.”

Set down regulations on the legal, economic, governance, and operational links between the ring-fenced trading entity and the rest of the financial group.

To stop banks from trying to bypass these regulations by moving parts of their activities to the shadow banking sector, which is less regulated, “structural separation measures must be accompanied by provisions improving the transparency of shadow banking.”

Critics say the Commission’s proposal is a watered down version of what had been advocated 15 months ago by an EU-appointed group of experts who recommended separating retail banks completely from investment banks.

The plan has to be approved by Member States and then ratified by the European Parliament, which will soon dissolve ahead elections in May.

Proposal attacked as either too soft or too tough on banks

The proposal has been attacked as too tough on banks by banking lobby groups, too soft by European policy-makers, and about just right by the UK Treasury.

Too late, say lawmakers – Chairwoman of the European Parliament’s Economic Affairs Committee, Sharon Bowles, said “It is certainly not satisfactory to bring something out when the last date for accepting legislation was last July.” Bowles added that during this Parliament nothing will happen.

Bankers did not like it – The European Banking Federation (EBF) says it is deeply concerned over the European Commission’s proposal and calls on policy-makers to consider its economic implications carefully. The proposal comes at a moment when Europe’s economy is slowly recovering and where European lawmakers “still need to understand the complete impact of the financial services regulatory reform agenda proposed under this Commission’s mandate.”

Mr Guido Ravoet, EBF Chief Executive, said:

“Europe’s banks are committed to ensure financing to the real economy and support the EU growth agenda, but they need to be left the room to do so. With the scope and separation requirements that the Commission proposes this will most definitely be a difficult task.”

Similar to our proposal – The UK Treasury said today’s proposals from the Commission “have much in common with the banking reforms the UK has pioneered and have been designed to allow the UK to go ahead with full implementation of its reforms. Indeed, the government’s Banking Reform Act already meets, and in some places exceeds, the proposed standards set out by the Commission, putting the UK at the forefront of European and global efforts to create safer banks without taxpayer subsidies that distort the European single market.”