European banks won’t have to ring-fence their risky activities after all.
In October, an advisory group headed by the governor of the Bank of Finland, Erkki Liikanen, wrote a report for European Commissioner Michel Barnier. It recommended that lenders in Europe put firewalls between their retail banks and their investment bank trading activity, if the latter exceeded a certain size. Now Germany has said how it will respond.
On the surface, the German finance ministry’s draft law seems to stick with Mr. Liikanen’s original ideas. Any bank with so-called proprietary trading activities exceeding 100 billion euros, or 20 percent of its balance sheet, will have to put that business in a separate, capitalized subsidiary. But in reality, Germany has ignored the spirit of the Liikanen report. Simply cutting off proprietary trading, where banks play for their own profit instead of for clients, doesn’t take the risk out of investment banking.
For starters, pure prop trading caused only 4 ercent of credit crunch losses, according to consultancy Tricumen and the Bank of International Settlements. More important, prop and market making are hard to differentiate from a risk perspective â€" the viewpoint with which politicians and regulators should be most concerned.
Take Goldman Sachs. Market making accounted for a third of the Wall Street bank’s $34 billion revenue in 2012. But in order to make markets in products, Goldman stockpiles inventory in anticipation of client orders. That business carries the same kind of risk as prop trading.
The banks argue that the more present they are in markets, the more they are able to offer their clients better prices and larger deals. That clearly has benefits for the economy. With lenders still in recovery mode, that argument has won the day in France and now Germany.
But it also means European depositors are still exposed to major trading losses. One could argue that the scale of global investment banks means governments still c! annot let them fail, and the only solution is proper bail-inable debt (instruments that could be converted into equity in an emergency) and resolution plans. But in the continuing absence of these, ring-fencing at least offers a safety net. European taxpayers will just have to keep on living dangerously.
George Hay and Dominic Elliott are columnists at Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com.
