Banking experts propose EU-wide separation of high-risk trading from retail banking

The findings (153-page / 2.1MB PDF) of the panel, led by Bank of Finland Governor Erkki Liikanen, have been presented to Internal Market and Services Commissioner Michel Barnier for consideration by the European Commission. The panel's recommendation that banks should establish a separate trading "entity" reflects proposals currently being taken forward in the UK as a result of the recommendations of Sir John Vickers' Independent Commission on Banking, and the 'Volcker Rule' under the Dodd-Frank Act in the US.

"The report underlines the excessive risks taken by banks in the past, and makes important recommendations to make sure that banks work in the interest of their customers," Barnier said. "I will now consider the next steps, in which the Commission will look at the impact of these recommendations both on growth and on the safety and integrity of financial services. We need to look at these questions in light of the financial reforms that I have already put on the table of the European Parliament and the Council."

In November 2011 Barnier announced that Liikanen, himself a former European Commissioner, would lead a review to consider the need for structural reform as a means of improving financial stability. Any recommendations made by the panel would be considered alongside, and in addition to, the capital adequacy and liquidity requirements to be implemented by the Basel III international banking agreement and the Commission's own proposals for recovery and resolution.

Alongside the general separation of banks' trading and retail activities, the report also suggested that bank recovery and resolution plans could call for the separation of additional activities, at the discretion of the European Banking Authority (EBA). It also called for stronger governance arrangements, possible amendments to the use of bail-in instruments as a tool for bank resolution and the possibility of stricter capital requirements on riskier products, such as trading assets and lending related to real estate.

In a statement, Liikanen explained that the separation would prevent customer's deposits, with "the explicit and implicit guarantee they carry", from directly supporting banks' risky trading activities. The split would apply if those activities amounted to a "significant share" of a bank's business and were above a certain threshold.

"The huge cost of the financial crisis, both in terms of direct public support to banks and lost economic output has sadly fallen to tax payers, causing an understandable and justified public outcry," he said. "Trust needs to be rebuilt between banks and the general public, and the role of internationally co-ordinated regulatory reforms is central in this process. Also in banking not only gains but also losses must fall on the risk-takers."

The British Banking Association (BBA) said that it would await further details of the proposed ring fence which would, it said, "require changes in the way banks structure their activities". "The UK's major banks are already preparing for significant structural changes to their businesses," the body said in a statement.

"Customers expect and deserve banks which unfailingly put them first, which are stable and reliable, and which never again have to appeal for taxpayer support," it said. "The banks are committed to meeting these expectations, and are working with the national and international authorities to do so."

The UK Government's White Paper on Banking Reform (86-page / 878KB PDF), published in June, proposed 'ring fencing' the "critical banking services" of major high street banks from their riskier investment activities in order to protect retail banking from wider economic shocks. It also set out proposals to make banks more resilient in the event of failure. Draft legislation is due to be published this autumn with a view to completing the arrangements by the end of the current Parliament in May 2015; although banks will have until 2019 to comply with the new rules.