EU Group Calls for Firewall on Risky Investment Banking

Say retail banking should be protected from hazards to shield depositors

A group of European Union advisors said that the risks of investment banking should be separated from retail banking activities as a means of protecting depositors and taxpayers.

Reuters reported Tuesday that the advisory group, set up by the European Commission (EC) and led by Bank of Finland Governor Erkki Liikanen, examined bank structures. In addition to calling for division between retail and investment banking operations, the group also pointed out the risks of property lending, adding that such activities should be shored up with higher capital reserves.

"The group has concluded that it is necessary to require legal separation of certain particularly risky financial activities from deposit taking banks within the banking group," said the group in its report. It continued, "The activities to be separated would include proprietary trading of securities and derivatives, and certain other activities closely linked with securities and derivatives markets."

The recommendation to wall off investment banking from retail banking has done some borrowing from British policies already being put into effect in the wake of the Royal Bank of Scotland (RBS) debacle, and also from U.S. efforts to control proprietary trading at banks. The group also advanced the concept of bail-in debt, which would be a means of compelling bondholders to take losses in the event of a bank collapse or bailout. The group also suggested that bankers should be given such bonds as part of their bonuses.

While the notion of ring-fencing investment banking is sure to cause considerable debate in the already incendiary discussion about banking reform in Europe, it is unlikely to result in new regulation from the EC any time soon. Currently the major issue under scrutiny is the concept of a banking union with the European Central Bank (ECB) in charge of supervision for all eurozone lenders—a sore spot with non-eurozone banks, which fear favoritism and the surrender of control.

However, keeping investment banking separated from retail banking makes it easier for the retail side to continue to function without the loss of depositors’ funds and with the continued ability to make retail loans, even if something drastic shuts down the investment banking side.

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