During the global financial catastrophe of 2008, financial services organizations went bankrupt partly due to ineffective and insufficient regulations, corporate mismanagement, and reckless risk taking. More recent scams such as Libor and J.P Morgan's trading loss, and the involvement of major banks in money laundering scandals have encouraged policy makers, governments, and industry leaders in various parts of the world to call for regulatory and compliance reforms.
Many attempts have been made to change the industry structure to provide more transparency and consumer protection and reduce bank's risk appetite by separating its trading activities from deposits. Three of these models are Volcker's rule for U.S. banks, Vickers ring-fencing aimed at banks in the U.K., and the Liikanen EU bank report.
Volcker's Rule
Volker's Rule bans financial institutions from proprietary trading. Experts view this rule as a modern version of the Glass-Steagall Act. The Volcker reform restructures the U.S. financial regulatory system to restore public confidence and states that banks must make decisions regarding their corporate structures and their activities including how to deal with their existing investments in equity and hedge funds.
Many financial organizations state that the new regulations will have serious economic shocks as it will result declining market liquidity and impede the ability to raise capital and manage risk. In addition, it will increase investor costs and hurt U.S. banks' competitiveness with foreign banks. Although the objective is to make banks safer, critics suggest that Volcker's rule will abolish investment risk without considering the risk level and the institution's capacity to handle the risk. It also does not address bank capital requirements.
Vickers Ring-Fence:
In the U.K., Sir John Vickers proposes placing retail and small and mid-sized enterprise (SME) deposits in ring-fenced subsidiaries and riskier trading business outside the fence. The reform gives bank's flexibility in deciding which part of the business should be ring-fenced and operate as a separate entity.
Angela Knight, the former Chief Executive of the British Bankers' Association (BBA), is critical that ring-fencing the retail portion of banking has a number of loopholes and makes it difficult for a bank to provide its business customers with a full range of services.
Some critics believe that Vickers' proposal still does not guarantee that tax payer monies will not be used to save ailing banks, particularly U.K. retail banks experiencing liquidity problems due to mortgages they provided to home owners who could not service their debts. Critics believe that ring-fencing will encourage high street banks to engage in more risky activities such as corporate and personal loans.
Paul Volcker, the former Federal Reserve Chairman, opines that the Vickers proposal only works in "fair-weather" and not when banks are under pressure. Further, he questions how different subsidiaries of a single commercial organization can maintain independence.
Liikanen:
The Liikanen report recommends that EU banks' trading businesses be placed in separate subsidiaries, fencing off the risky trading arm of the bank. It also requires banks to hold more capital against riskier businesses and to hold debt that could be turned into equity to recapitalize an ailing bank. The report includes recommendations that a portion of bankers' compensation is in the form of "bail-in" debt issued.
Industry experts note that fencing off trading is too difficult for banks with considerable investment operations such as Deutsche, BNP Paribas, and Societe Generale and will result in increased higher funding costs for the segregated trading entities. The report also fails to recognize risks inherent in the retail bank.
Conclusion:
As the these proposed solutions are debated, it's worth noting that there is no guideline that defines the risk of bailout promises guaranteed by national governments. It will be intriguing to see in the coming years which of these proposed reforms will actually succeed in making the global banking industry more competitive, transparent and safe.
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