Market casts doubt on Liikanen reforms

A report released last week that recommends ring-fencing banks’ deposit taking activities from trading operations, may not go far enough in protecting investors, market participants have suggested.

A report released last week that recommends ring-fencing banks’ deposit taking activities from trading operations in Europe, may not go far enough in protecting investors, market participants have suggested.

A core tenet of the report, authored by the Liikanen Group, headed by Finnish central Bank governor Erkki Liikanen, recommends that banks with trading assets exceeding €100 billion, or 15-25% of total assets, should protect retail banking from the risk associated with trading activity by separating the two.

The Liikanen proposals bear similarity to new UK laws that were recently adopted, based on a report from Sir John Vickers. The Vickers report suggested the separation of retail trading operations from investment banking. Meantime, the US’ Volcker rule, will ban deposit taking institutions from engaging in proprietary trading.

Other recommendations in the Liikanen report include establishing ‘bail-in bonds’ to add a layer of protection for banks in the event they fold, to ensure they rely on creditors rather than the state, addressing the so-called too-big-to-fail issue.

Andrew Gowers, director of external relations for broking trade body the Association of Financial Markets in Europe (AFME), said Liikanen and the regulatory backlash in Europe from the financial crisis verge on going too far.

“We question whether an additional layer of structural regulation is needed at all. There is regulation underway now dealing with many of the issues listed in the Liikanen report,” Gowers said, adding that despite the fact the proposed ring fence may only net around six of Europe’s banks, it “still create another speed bump for economic growth in Europe”.

AFME will release a report next month going into the report’s finer details and make a submission to the European Commission as part of the consultation process.

Discovering value 

Andrew Haldane, executive director for financial stability at the Bank of England, wrote a recent article published in the Financial Times arguing that Liikanen doesn’t go far enough in solving banks’ valuation issues, a vital aspect in strengthening investor confidence.

Haldane contends that forbearance on past loans and global accounting rules have led to the overvaluation of legacy assets, which makes the banks less attractive for investors.

“Many large universal banks are a complex portfolio of franchises. It is very difficult to value any individual component of that portfolio in the current environment. And it is almost impossible to value the portfolio as a whole,” Haldane wrote, adding that present valuations suggest banks’ value is skewed.

“Market prices suggest the banking whole may be worth less – in some cases much less – than the sum of its parts,” Haldane wrote.

Haldane believes the regulatory changes must focus on their original mandate of forcing banks to insulate themselves from both relying on the state and adversely affecting the market should they fail.

“Despite the alarm some have expressed, if implemented faithfully and simply such structural solutions ought to help solve the too-complex-to-price problem, to say nothing of too-big-to-fail,” Haldane wrote.

Other key proposals in the Liikanen report include pushing for stronger corporate governance procedures and paying executive bonuses in bail-in debts. Also, updating the processes for calculating capital to hold against trading positions was recommended, which Basel III is currently investigating.

The European Commission established the Liikanen Group last year to advice on banks’ structural reform, and recommendations will assist the Commission in deciding whether to enhance current regulation or draft new proposals.