No big break-ups in reform of Europe's banks

BRUSSELS Mon Sep 10, 2012 10:46am EDT

BRUSSELS (Reuters) - The European Union will insist on higher reserves from banks and impose stricter oversight to protect taxpayers and savers from further bailouts caused by risk-taking, but will not break them up to separate investment banking from retail activities.

While there may be public backing for such a move, EU officials and banking experts said the splitting up of banks to lessen risks to the general public across the European Union would be too complex to achieve in the short term.

European banks, such as Barclays, Germany's Deutsche Bank or France's BNP Paribas, combine high street banking alongside that of riskier trading of stocks, debt and other securities. Royal Bank of Scotland's rush to extend its investment arm resulted in it seeking the largest state bail-out of the crisis in Europe.

EU finance ministers will meet in Cyprus on Friday to discuss the work of a panel of experts, led by Bank of Finland Governor Erkki Liikanen, charged with exploring possible reform of bank structures in the wake of the crisis that beset the world economy from 2007.

"The real question is how does the bank provide enough capital so that whatever happens, it doesn't crystallize in a loss for the taxpayer," said Graham Bishop, an EU policy consultant, commenting on the challenge to regulators.

"The first port of call is capital," he said, adding that shaking up the structure of banks could come later.

The European Union will use tighter capital rules and closer European Central Bank oversight to stop banks taking risks that imperil the financial system, the financial experts said.

STRONG MESSAGE EXPECTED

The group's report, which is due at the start of October, is expected to deliver a strong message to European policymakers to try to prevent further bailouts.

The report will examine an idea some experts believe could have softened the impact of the banking crisis - ring-fencing high-risk businesses such as trading from more stable activities such as retail banking.

Britain is already pursuing safeguards for depositors against fall-out from casino-style banking.

The United States, through the introduction of the Volcker rule, will curb so-called proprietary trading, where banks trade for their own benefit on their own account rather than for clients.

Paul Volcker, a former Federal Reserve chairman, argued against certain kinds of speculative investments that go against the interests of a bank's customers.

There have been strong arguments saying that legally separating investment banking operations would make it easier for the part of the bank that holds savers' deposits and lends to business to stay open in the event of a crisis, even if other parts of the group were to go bankrupt.

But EU officials believe using rules that dictate how much capital banks have to keep to cover the risk of losses or relying on new powers that are expected to be granted to the European Central Bank in the coming months will prove more useful in keeping banks in check in the short term.

Setting aside extra capital by holding back profits, for example, makes banks less risky for shareholders and their host countries although it dilutes returns for investors.

That view was reflected in the European Parliament, which has an equal say alongside EU countries in negotiating new rules to try to reform the banks and their activities.

"Establishing subsidiaries for banks' trading arms would be possible in EU law. But having subsidiaries is not on its own sufficient," said Sharon Bowles, who chairs the parliament's Economic and Monetary Affairs Committee.

"I believe that there should be more simplicity in the banking system. This could rather be introduced via capital rules," she said.

"A VERY PAINFUL WAY"

Britain has already set its course.

A panel of experts headed by John Vickers, a former chief economist at the Bank of England, recommended that the retail arms of banks be "ring-fenced" by a cushion of extra capital beyond the international norm and with an "independent governance to enforce an arm's length relationship".

The British government has said it will implement his recommendations.

Views at the European Commission, which writes the initial draft of laws governing banks across all 27 countries in the European Union, diverge.

"It would be a very painful way," said one EU official, commenting on the prospect of splitting up bank businesses. "You could not do it immediately."

These splits are evident in the Liikanen group of experts. "Nothing has been finalized," one of the members of the group told Reuters, speaking on condition of anonymity ahead of the Cyprus meeting.

Introducing rules to cut through the structure of banks in Europe would have to wait for the completion of a banking union reform, placing the European Central Bank at the head of the fragmented system of national regulators, reducing their role.

Under this proposal, the ECB could monitor banks' liquidity closely and demand higher requirements on banks to keep up their capital reserves.

"There is no need to break up universal banks," said Karel Lannoo, of the Centre for European Policy Studies, a Brussels-based think-tank.

"The most risky business models are the concentrated retail banks or the pure investment banks."

"With the new structure, you will have the ECB which is the more hands-on supervisor. It will have the power to impose additional capital on risky businesses."

(Reporting By John O'Donnell,; additional reporting by Philip Blenkinsop, editing by Alex Smith and Peter Millership)

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