Liikanen report on the structure of EU banks

04 Oct 2012

The Liikanen expert group (see Daily New 24 February 2012 has published its report on structural change in the EU banking sector. The main recommendations are:

• Mandatory separation of proprietary trading and other high-risk trading activities. Proprietary trading and all assets and derivatives positions incurred in market-making (subject to certain exceptions) must be held in a separate legal entity from a bank that takes insured deposits, although these entities may exist within the same corporate group. Loans and unsecured exposures to hedge funds (including prime brokerage), SIVs and similar entities, and private equity investments, should also only be held in the trading entity. But mandatory separation would only be required if certain thresholds are met – an absolute threshold of €100 billion of trading assets, or trading assets exceeding a threshold of 15-25 per cent of total assets (or an alternative threshold to be set by the European Commission). This would be combined with a non-risk-weighted capital buffer for trading book assets.
• Possible separation of activities conditional on the recovery and resolution plan. An alternative to the separation referred to above was favoured by some of the Liikanen expert group (although the group as a whole preferred the above approach). The alternative is that mandatory separation would be required only if the bank’s supervisor considers it necessary in order to ensure that the bank is resolvable, based on clear EU-wide criteria. This would be coupled with a non-risk-weighted capital buffer for trading book assets.
• Possible amendments to the use of bail-in instruments as a resolution tool. The bail-in proposals in the draft Recovery and Resolution Directive should be amended to improve predictability. The categories of debt instrument subject to bail-in should be expressly defined and the bail-in requirement should be phased in over an extended period of time. Banks should be allowed to meet a requirement to issue bail-inable debt by issuing equity instead. Bail-inable debt should not be held within the banking sector.
• A review of capital requirements on trading assets and real estate related loans. Trading book capital requirements for both the deposit bank and the trading entity should be strengthened by setting an additional capital buffer and/or a robust floor for these assets. Current capital levels for real estate lending are quite low and should be strengthened, e.g. by imposing robust floors on the requirements resulting from internal models. Strict maximum loan-to-value and loan-to-income ratios should be established in all Member States.
• A strengthening of the governance and control of banks. More attention should be paid to governance and controls. Capital Requirements Directive level 2 measures should spell out risk management requirements in much greater detail. Risk disclosure should be enhanced and include detailed reporting for each entity and main business line.
• Remuneration. A share of variable remuneration should be in the form of bail-in bonds. Consideration should be given to further restrictions on the level of variable to fixed remuneration (e.g. 50 per cent), and to preventing total bonuses from exceeding dividends. Supervisory sanctions against executives should include power to impose a lifetime ban and to claw back deferred compensation.

Michel Barnier is now going away to think about these recommendations and next steps.

Copies　of the report; press release; and related webpage　are available.