While the bank crisis continues, banking reform remains weak and slow

By Myriam Vander Stichele, SOMO
with contributions from Aldo Calieri (CoC), Markus Henn (WEED), Gildas Jossec (AITEC), Lydia Prieg (NEF) and Rens van Tilburg (SOMO)

It has become more and more clear that the Euro crisis and the sovereign debt crisis and the heavy strain from the markets, which has brought Spain and its banks in severe crisis (see article about Eurocrisis), are caused by serious continuous bank crises. Banks had taken too many risks, after which the crisis in 2008 erupted. Now it is clear that banks – including those from Germany and other countries – lent too easily and with sloppy risk management to governments and business or real estate in Spain, Greece, Ireland, etc. Nevertheless, bank reforms at the EU level have been moving only slowly and in watered down form, without much public debate, even though there is much public anger about the bank bail outs, bonuses of bank bosses and the austerity measures after cuts in public money that was used to save the banks.

As explained in previous Newsletters, the internationally agreed Basel III standards are now being integrated at the EU level as a directive and a regulation (CRD 4 / CRR) on capital requirements, availability of cash (liquidity ratio), borrowing levels (leverage ratio), risk management requirements for banks and investment firms (for more explanation see also Finance Watch, ‘Basel 3 in 5 questions’: keys to understand Basel 3, May 2012). The European Commission (EC) had already published its text to apply Basel III in the EU on 20 July 2011. A major issue of contention that delayed decisions at the European Parliament (EP) and the Council of Finance Ministers was whether countries with banks that have balance sheets that are 3 to 5 times larger than the annual GDP of a country (UK, Sweden, Netherlands) would be able to set higher capital requirements. While Basel III agreements were about ‘minimum requirements’ for capital reserves, the EC had turned them into a fixed percentage which was more or less the maximum, so as to avoid too much lack of ‘harmonisation’ between different countries in the ‘Single European Market’.

On 14 May 2012, the Economic and Monetary Committee (ECON) of the European Parliament (EP) voted on 2,195 amendments to the draft EP report that amends the EC text. Apart from voting for the proposed capital requirements, the MEPS voted amongst others for:

• sufficient flexibility for countries with very large banks to set higher capital requirements; to protect themselves against harmful bank collapses;
• better treatment of how banks can finance exports and other trade; 
• basic aspects of resolving a bank crisis;
• reporting on lending of securities;
• variable remuneration awarded to bankers not to exceed their fixed pay (which is considered controversial and not in the EC text); and
• benchmarking banking models in order to get a better understanding of how bank models compare.

On 15 May 2012, the Finance Ministers (ECOFIN) of all the EU countries agreed on the compromise proposals by the Danish Presidency for CRD 4/CRR after an extraordinary Council meeting on 2-3 May 2012. These very lengthy Council texts on CRD4 and CRR were published a week later.


Important compromises reached by the Ministers were:

• In addition to Basel III requirements on capital reserves and buffers (for more details see explanations by the Council) each member state would be allowed to impose an additional ‘systemic risk buffer’, with only prior Commission authorisation needed if set at high levels (at more than 3% or more of each banks’ global assets, adjusted for risk);
• the EC has the possibility to impose for one year stricter prudential requirements on all member states;
• the opportunity for member states to impose, for up to two years (extendable), stricter prudential requirements for domestically authorized financial institutions;
• liquidity reserve requirements (liquidity ration) to be introduced at national level from 2013, and at EU level from 2015 onwards;
• requirements for guaranteeing longer term funding and for a limit to borrowing (leverage ratio) would be introduced only after agreements reached in respectively 2016 and 2018. 

For more details, see amongst others the Council’s press release and its annexes.

The Council’s proposals are considered by some member states to be weaker than Basel III since they address ‘certain European specificities’ based on the fact that CRD 4/CRR would be applied to all of the EU's approx. 8,300 banks. The EC argued these specificities did not go against the Basel regime overall. For instance the possibility for banks to include holdings in insurance companies (in the same financial conglomerate) as own funds is seen as watering down the capital reserve requirements. The UK lambasted the compromise text as not as tough as Basel III, and that this was happening specifically to assist struggling German and French banks. However, the introduction of a ‘systemic risk buffer’ was a response to its demands for higher capital requirements.

The fact that no fixed liquidity ratio and limit to borrowing (leverage ratio) has been introduced, has been the consequence of heavy lobbying by the banking industry, as analysed by Corporate Europe Observatory in its May 2012 publication ‘Addicted to risk’. The European banking lobby with strong influence of Deutsche Bank was already successful in avoiding strict banking reforms when Basel III was being decided (e.g. banks can continue to rely on, and manipulate, their own risk management models) and when the EC made its CRD 4/CRR text (e.g. the EC proposal to have the same level of maximum capital requirements rather than minimum requirements, an issue of major contention that delayed the decision making). After the Council’s decision, the European bank lobby already wrote a letter to the Council of Ministers on 23 May 2012 to ask the Council to adopt the more lenient rules for financing trade as agreed by the ECON committee of the EP (see above).

After the ECON and the ECOFIN had agreed on their own texts, the EP and the Council have started behind-close-doors discussions to come to a common text, if possible by June 2012. The new compromise text could then be voted on in EP plenary on in July or September 2012 (for an update on the vote date, see here. 

MORE STRUCTURAL BANK REFORMS DISCUSSED BUT NOT YET DECIDED

The CRD 4/CRR does not solve many fundamental and structural problems, such as moral hazard and too big to fail banks, as many critics have pointed out (see for instance a new publication by Finance Watch). Given the continuous dire state of the European banking system, some more banking reforms are being discussed and are expected to be proposed, amongst others the EU bank deposit guarantee system that would avoid that national governments have to guarantee deposits at banks headquartered in their country but operating in other EU countries.

• Dealing with banks in crisis: A legislative initiative at the EU level on a framework on how banks should recover or be dissolved during a bank crisis (‘bank recovery and resolution framework’ as explained in Newsletter nr. 6) is expected before mid June 2012.
• Dealing with banks that are too big to fail: In France, it remains to be seen how the new president will follow up his promises during his electoral campaign to separate the activities of banks that are useful for investment and employment, from their speculative activities. Francois Hollande wanted to forbid French banks to engage in tax havens, and to end toxic financial products that enrich speculators and threaten the economy. He also wanted to increase tax on bank profits by 15%. In the UK, the Vickers Commission had proposed in 2011 bank reforms to avoid that too big to fail banks would need to be rescued by tax payers’ money, including by ringfencing retail banking away from investment banking. The proposals have continued to stir up debate in the UK and the banks are maintaining pressure on the government to relax the proposed ringfence. Greater technical detail about the reforms is due to be released by the government in June 2012, followed by draft legislation in the autumn. At international level, the G-20 follows the work by the Financial Stability Board to extend their new additional requirements for banks that can wreck the financial system (SIFIs) to domestic systemically important banks (D-SIBs) by November 2012.
• Reducing the risks of banks that are trading securities: The Basel Committee of Banking Supervision published a consultation on 3 May 2012 to review the risk models of banks who trade in securities: they could so be required to hold more and better capital reserves. The proposals, that would complement Basel III and other post-crisis reforms, would make it harder for banks to switch capital between their balance sheets and trading books, would restrict trading and reduce profitability. 
• Volcker rule discussed in the US and EU: The US Dodd-Frank Act contained the so-called ‘Volcker rule’ that prohibits banks that receive public guarantees from trading at their own account (‘proprietary trading’) and financing or having hedge funds or private equity funds. But many exceptions were allowed to the rule due to financial industry lobbying as Aldo Calieri explains in his article. After JP Morgan lost $2 bn or more in May 2012, some politicians and the US Administration started showing a stronger resolve for enforcement. But enforcement of the Volcker rule would most likely not have prevented JP Morgan’s behaviour. Nevertheless, the Volcker rule and the prohibition of propriety trading at EU level was being discussed at a public hearing at the European Parliament on 25 May 2012.
• Better supervision and regulation of shadow banking: At the request of the G-20, the Financial Stability Board’s report points out how to monitor and address risks posed by the shadow banking system. The FSB is working on two main initiatives: First, an annual global data to monitor shadow banking activity. Second, there will be regulatory recommendations on how to mitigate spill-over effects between regular and shadow banking system and other types of related risks. The FSB plans to issue the full set of recommendations by end-2012.