European Union banks would be forced to push much of their trading activities into separately capitalized units and face extra bonus rules under plans proposed by an EU-mandated working group.
The group, led by European Central Bank Governing Council member Erkki Liikanen, also calls for a toughening of Basel bank capital rules and for lenders to issue debt designed to be written down in crises. The non-binding recommendations are part of a detailed blueprint to protect taxpayers from bailouts.
“This report will be the cornerstone of our work” on bank structure, Michel Barnier, the EU’s financial services chief, told reporters in Brussels today. The European Commission “will look at the impact of these recommendations both on growth and on the safety and integrity” of lenders, he said.
U.S. and British regulators have also proposed structural changes to banks in a bid to curtail risks. U.K. Chancellor of the Exchequer George Osborne plans to force large lenders to separate their consumer and investment banking operations in an overhaul that the Treasury estimates may cost as much as 7 billion pounds ($11.3 billion) a year.
The U.K. plans, drafted by a panel led by former Bank of England Chief Economist John Vickers, won’t clash with any EU follow-up to the Liikanen group’s recommendations, according to an EU official.
U.K. Labour Party leader Ed Miliband said Sept. 30 that he may go further than Vickers and break up banks if he wins the nation’s 2015 general election.
Barnier said the commission would seek public comment on the Liikanen group’s proposals for the next six weeks before deciding how to proceed. Any steps to implement parts of the report would be proposed “before summer” 2013, Barnier told reporters at a joint briefing with Liikanen.
“Don’t ask me today to tell you what lies at the end of the road,” he said.
Under the Liikanen group’s plan, lenders would transfer trading they conduct on their own behalf and other “high risk” activities to a separately capitalized unit, according to the report.
This so-called trading entity would have to be “legally separate” from other parts of the bank. It also wouldn’t be allowed to finance its activities through deposits covered by government guarantees, according to the report. It would be allowed to be part of the same holding company as the rest of the business.
The high-risk activities would include, among others, unsecured loans to hedge funds and private equity investments, according to the report.
Activities that could remain outside the trading unit would include interbank lending, mortgages and small business loans, as well as some hedging activities for non-bank clients.
The separation rule would apply to banks with available-for-sale assets worth more than 100 billion euros ($129 billion) or amount to more than 15 percent to 25 percent of a lender’s total assets, according to the report. Supervisors would also carry out other assessments before applying the measure, while the “smallest banks” would be exempt.
“The review creates even more uncertainty for U.K. banks,” Jeremy Jennings-Mares, capital markets partner at law firm, Morrison and Foerster LLP, said in an e-mail before the Liikanen-group report was published.
“What banks need more than anything now is certainty and a realistic timetable to be able to properly plan for the effect the proposals will have on their business in the long term,” he said.
On pay, regulators should consider setting “absolute levels to overall compensation,” including banning bonus pots that exceed fixed dividends, according to the report.
The group also called for a share of bonus awards to be in debt that can be written down if a lender gets into difficulties.
Consideration should be given to plans by the European Parliament to set limits on how far bonuses can exceed fixed pay, according to the report.
Such a cap would “substantially ease the task of the supervisory authorities in screening out undesirable remuneration policies,” according to the report.
Barnier set up Liikanen group earlier this year to examine possible rules on bank structure. Its 11 members included Jan Vanhevel, the former chief executive officer of KBC Group, and Zdenek Tuma, a former governor of the Czech National Bank.
Banks would need a “period of transition” to implement the separation measures, Liikanen said. The commission needs to “assess the costs and decide whether this leads to a proposal or not.”
Other parts of the report call for a toughening of international capital rules set by the Basel Committee on Banking Supervision, notably those for assets that lenders intend to trade and for real-estate lending.
Options include bolstering a so-called leverage ratio drawn up by the Basel group, which is intended to limit how much a bank can finance its activities through debt, or toughening rules on how much business a lender can do with a single counterparty.
“Supervisors’ ability to monitor banks has proven inadequate,” according to the documents. “The financial crisis has clearly highlighted that the governance and control mechanisms of banks failed to rein in excessive risk taking.”
The group also called for changes to plans published by Barnier in June to force creditors to share the cost of stabilizing failing lenders.
Banks should be required to issue so-called bail-in debt that stipulates, in its contractual terms, when losses may be imposed on the bearer, according to the report.
“Detailing the characteristics of the bail-in instruments in this way would greatly increase marketability” of bank debt and “facilitate the valuation and pricing of these instruments,” according to the report.