Structural reform of EU banking sector: improving the resilience of credit institutions

The Council is currently working on a draft regulation on structural measures improving the resilience of EU credit institutions. The regulation aims to prevent systemic risks to the EU's financial system that could be caused by the failure of large, highly complex and interconnected credit institutions.

The new rules would reduce such risks by introducing compulsory separation of a bank's high-risk activities, primarily proprietary trading, from its 'core' business, such as deposit-taking or retail payment services. The 'core' banking activities are of vital importance for the real economy and therefore merit special protection.

Expected benefits

increased stability in the financial markets
increased protection for taxpayers' money, as smaller failing banks can be resolved without recourse to public money
reduced moral hazard, as the possibility for large banking groups to rely on implicit subsidies by the government would be eliminated
increased consistency of rules for credit institutions across the EU member states, which should ensure a level playing field across the internal market and reduce the possibilities of circumventing regulation (or of seeking 'regulatory arbitrage')
reduced distortion of competition among banks

In the Council

June 2015: the Council agreed its position at first reading (known as 'general approach') on the draft regulation. This document will serve as the Council Presidency's negotiating mandate in the negotiations with the European Parliament on the final version of the regulation.

2014, 2nd semester: analysis of the proposal at the Council's Working Party on Financial Services.

January 2014: the Council received the European Commission's proposal for a regulation on structural measures improving the resilience of EU credit institutions.

Council's position: key points

Mandatory separation of proprietary trading

Proprietary trading is high-risk trading when a bank trades various financial instruments using its own funds, not the depositors' money, with the aim of earning profit for itself. If such activity constitutes a large part of the bank's activities, the losses would be detrimental to the bank's 'core' business, for example, deposit-taking. This is particularly important in the case of 'too-big-to-fail' banks, which may undertake such high-risk activities on the assumption that their size and importance would secure them the government's support in the event of failure.

The Commission's proposal envisaged a ban on proprietary trading. The Council considered that it would be better to regulate proprietary trading in a stricter way rather than to prohibit it, as a ban could be excessively detrimental to the diversification of a bank's revenue sources and could also be eluded by having certain activities performed by less or non-regulated entities. Therefore, the Council proposes a mandatory separation of proprietary trading from the 'core' activities of a credit institution.

The decision on separation would be taken by national competent authorities (e.g. banking supervision authorities) following an in-depth risk analysis according to an established set of criteria. The banks to which such decisions would apply would have sufficient time to reorganise their activities.

If, however, a bank were able to prove to its supervisor that the risks it takes are mitigated by other means, it would be exempt from the separation requirement.

Separation of other high-risk trading activities

National competent authorities would also carry out risk assessment of large banks' trading activities other than proprietary trading, such as market-making, risky derivatives and complex securitisation. If a competent authority finds excessive risks, it could:

require those trading activities to be separated from the 'core' credit institution
require that the core credit institution's own funds be increased, or
impose other prudential measures

The separated trading entities would not be allowed to take retail deposits that were eligible for protection under the deposit guarantee schemes, nor would they be allowed to provide related retail payment services.

Accommodation of existing national law

In the wake of the recent financial crisis member states have implemented a number of measures in their own national law to address the exposed weaknesses in their banking systems.

To accommodate these existing national rules and to avoid unnecessary overlapping, the Council proposes that the member states address excessive risk-taking in banks' trading activities in one of the following two ways:

1) either through national legislation that would require large banks to ring fence their core activities, or

2) through measures that would be imposed by competent authorities in accordance with the regulation

Scope of the regulation

Having analysed the Commission's proposal, the Council proposed that the regulation apply to:

global systemically important institutions
credit institutions with total assets of at least €30 billion over three consecutive years and with trading activities of at least €70 billion or 10% of their total assets

Global systemically important institutions are defined according to Article 131 of the directive on capital requirements (Directive 2013/36/EU) and are identified according to the specific methodology defined by the European Banking Authority. The criteria include, among other things, the bank's size, cross-border activities and interconnectedness.

The member states would be able to decide to apply these rules to smaller credit institutions if they so wished.

EBA technical standards on the methodology for the identification of global systemically important institutions

As for geographical scope, these rules would apply to:

all banks established in the EU and their branches wherever they are located
groups of credit institutions, if at least one of their entities is established in the EU
branches and subsidiaries established in the Union, whose 'parent' institutions are established outside the EU

The broad geographical scope should ensure a level playing field and prevent banks from circumventing these rules by, for example, transferring potentially affected activities outside the EU.

The supervisory authorities would be able to exempt from separation requirements any foreign subsidiaries of those banking groups that have geographically decentralised structures that work as a network of independent entities which can be easily resolved in the case of failure.

Exceptions

The Council proposes that the regulation should not apply to credit institutions whose:

total deposits falling under the protection provided by the EU directive on deposit guarantee schemes are less than 3% of their total assets
total eligible retail deposits amount to less than €35 billion

The Commission proposed that the regulation should not apply to sovereign debt instruments. The Council proposes a clause which would enable the Commission to review this exemption, taking into account developments at European and international level.

Other rules

The draft regulation also establishes the coordination rules between different national banking supervisory authorities for decisions related to the separation of high-risk banking activities, particularly in the case of cross-border banking groups.

Why is banking structural reform regulation necessary?

Reducing risks

The EU has recently undertaken a number of reforms to improve the resilience of its banking systems and to protect taxpayers' money in the event of bank failures.

However, some significant risks in the EU's banking sector remain, mainly due to the large size and complexity of some of its credit institutions and excessive risk-taking, especially in trading in highly complex financial instruments. These institutions remain too-big-to-fail and too-complex-to-resolve in the case of failure.

Protecting taxpayers' money

Because they are so important to the financial system, these institutions tend to rely on inherent guarantees by governments - which, in the event of failure of large banks, would have to use public funds to support them. According to the European Commission, taxpayer support for bank recapitalisation, guarantees, asset relief measures and similar solutions in 2014 amounted to approximately €1.6 trillion or 13% of EU GDP.

Some of the EU's largest banks have assets amounting to almost as much as the GDP of their home countries, with 10 of the largest banking groups each having total assets of between €1 000 billion and €2 000 billion.

The notional value of derivatives has increased from 3.5 times world GDP in 1998 to 12 times world GDP in 2014.

According to the European Commission, in 2014 the European Union's banking sector represented around €42.9 trillion and almost 350% of EU's GDP.

Background

Liikanen report

In 2011 the European Commission established a high-level group of experts to assess the situation in the EU banking sector and to identify areas where structural reforms were needed. The group was established by the European Commission and chaired by Erkki Liikanen,Governor of the Bank of Finland.

The expert group held wide consultations with the banking sector and the public. The ensuing report recommended that proprietary trading and other high-risk activities by large banks should be carried out by separate legal entities within that banking group in order to mitigate risks. The Commission examined the report and its proposals and issued the current proposal for a regulation on the banking structural reform.

Next steps

The negotiations between the Council and the European Parliament on the draft regulation are expected to begin as soon as the EP will have adopted its position.