How to reform the banking system to avoid the subprime crisis of 2008, the "whales of London" (the JpMorgan derivatives scandal) and the manipulations of the Libor rate that have followed one another without stopping, bringing the flaws in the system to light? This is the question on which authorities, think tanks and experts have been racking their brains in recent years. For many there has been much discussion and little action. Last summer, for example, the economists Luciano Gallino and Luigi Zingales wrote, albeit from opposite sides of thought, that four years after the beginning of the crisis, world governments limited themselves to recommending, examining and reflecting on the reform of the financial system. While the European Union tries to bring the implementation of Basel 3 to a successful conclusion and relaunches the Banking Union aiming, as a first step, at a single European supervision entrusted to the ECB (which will have to be followed by a single guarantee of deposits and with municipality in the event of a crisis), The report drawn up by a group of experts led by Erkki Liikanen has arrived on the table in Brussels these days (October 2nd) (President of the Central Bank of Finland). The mandate had been entrusted by the same Commission in November 2011 to evaluate the opportunity for structural reforms of the European banking system in the light of the heated debate that had already developed in the USA and the United Kingdom (think of the Volcker rule, the Dodd-Frank Act and the report of the Independent Commission on Banking or “Vickers Report”).
The Liikanen report it stands here as a third way between the US and the English recipe by reviewing the architecture of the banks through five main recommendations:
1) the legal separation from the bank's activities of proprietary trading and other significant trading activities above a certain threshold;
2) the need for banks to design and maintain realistic and effective resolution plans (interventions for crisis management and the reorganization of bank assets, ed.), as proposed by the European Commission's Bank Resolution and Recovery Directive (BRR).
3) The report strongly supports the use of bail-in instruments (forced conversion of debt into capital ed). Banks should build up a sufficiently large and clearly defined amount of debt that can fit into the bail-in. This debt would have to be held outside the banking system and would increase overall loss-absorbing capacity, decrease incentives to take risks, and increase transparency and perceptions of risk (how it is priced).
4) the application of higher risk weights in determining the minimum capital and more consistent internal risk treatment models across European banks.
5) it is necessary to increase the existing reforms on corporate governance with specific measures in terms of: strengthening the board and management; promote the risk management function; closely monitor the compensation of banks' management and employees; increase risk disclosure; strengthen sanctioning powers.
THE SEPARATION OF TRADING AND THE UNIVERSAL BANK MODEL
“Banks are big, too many to fail and too similar to each other, commented Marco Mazzucchelli, a former Italian banker who is now senior adviser to Julius Baer bank and member of the Liikanen group who illustrated the proposals of the working group in a conference at Bocconi. Already because while the regulatory interventions currently in the pipeline act mainly on assets, liquidity and recovery resolution, the Liikanen group felt that something was missing on a more micro level. He thus proposed, beyond a certain threshold of activity, the mandatory separation into two legal entities of the trading activities from the rest of the banking activity. Separation would not be necessary when trading activities represent 15-25% of assets or do not exceed €100 billion, with depository banks being able to continue trading for their clients albeit within very narrow limits. Here the Liikanen proposal stands as a third way between the American recipe Volcker (who proposed to prohibit banks from speculating with their own funds) and the English Vickers (who suggested a clearer separation with the addition of capital) and arises from the difficulties of the US authorities in separating trading on own account from trading on behalf of customers.
But beware, this recommendation does not imply the cessation of universal banks. "It is a question of the separation of two legal entities which may however be within the same group - explains Mazzucchelli - I am not saying that universal banks must no longer exist for the global management of the customer". No mandatory dismantling of the universal bank in the proposal, therefore, just a legal separation: the bank will continue to have the ability to offer a wide range of financial services to its customers. But at the same time Mazzucchelli points out that "the best practice will be to not have the universal bank: these will continue to be discounted due to the perception of greater opacity". The reasons behind this position of legal separation? We wanted to give the banks two exclusive activities which are the collection of deposits and the provision of payment services with the aim of maintaining operational continuity in the event of problems, which means not having a rush to the branches and a payment system which continues to work. The two entities will have to be capitalized separately and the forms of transfers between them will only be possible if the individual capital requirements are met.
"In this way - Mazzucchelli points out - banks are safer, they have fewer incentives to take risks with deposits, they are simpler to monitor and manage, shadow banking is reduced (which has systematically securitized debts and credits ed) and c 'is more transparency about what the underlying group is doing.' However, it will be essential that, as recommendation 2 indicates, each bank presents a credible resolution plan. Otherwise, the regulator will have the power to make further asset segregations. “Had this been the case, together with the other measures in the pipeline, 2008 would not have happened, because balance sheets would have been smaller, trading balance sheets would not have reached this size and therefore neither would systemic risk. In this way in the future there will be many more operators, a greater diversity of participants and this will maintain the liquidity of the market”. In this picture it is also essential for Mazzucchelli the Banking Union, where banking supervision is an essential first step. Just as it is important Mifid II to regulate High frequency trading (Hft).
CAPITAL REQUIREMENTS AND GOVERNANCE
"The arbitrage of internal models must stop, it's a shame." For Mazzucchelli, an important part of the report, little underlined in the media these days, is the passage on capital requirements. In summary: in Europe, individual assets have very different risk weights which do not create a plain playing field. “This was allowed with Basel 2 – says Mazzucchelli – with internal rating systems that are so complicated that it is already a lot if a bank understands its own. The internal rating is fine but it has led us to lose sight of the absolute value of the positions". And real estate financing deserves a careful eye "which tends to have a lot of leverage - says Mazzucchelli - the banks are not able to discipline themselves on real estate financial exposure". It is no coincidence that in all crises there is a real estate component. Thus the report suggests that the treatment of real estate finance within capital requirements should be reconsidered and indicators such as maximum loan-to-value and/or loan-to-income should be included in tools for micro and macro supervision. In short, the theme of sovereign risk has been overcome, the real test is that of a real collapse of the real estate market.
And if the 2008 crisis wasn't enough to make us open our eyes to the flaws in the system, the scandals surrounding JpMorgan's derivatives and the manipulation of the Libor followed shortly after. “We were lucky – Mazzucchelli admitted with irony – during our work the JpMorgan and Libor scandals also arrived”. What to do at the governance level? In the first place it is unthinkable that the CEO is omnipotent but it must be included in a system of checks and balances and disclosure. And whoever makes a mistake has to pay.
BRUNI: THE PROBLEM IS NON-PERFORMING LOANS
PERFUME: BE CAREFUL NOT TO KILL SUPPLIERS OF LIQUIDITY
The "separation is proposed with measure and intelligence," he commented Franco Bruni, Bocconi professor of International Monetary Theory and Policy, who participated in the debate on the Liikanen report at Bocconi together with professor Francesco Saita, Mario Nava, director of the financial institutions area of the European Commission and Alessandro Profumo, president of MPS. But “I don't get too excited” about the separation of trading. For Bruni this was not the problem of the crisis, deposits were not affected and the fall in credit depended on other dynamics. “There is a worrying problem with non-performing loans which are the real reason for the fragility of the banking system. We need more attention in risk regulation and resolution systems”. However, separation is not an issue to be dismissed: "if moderate and intelligent, it can give results above all ex post in the resolution and evaluation of banks". But is it worth lowering it from top to bottom? “I see it as a spontaneous practice”, notes Bruni.
For the president of Mps Alessandro Profumo, former CEO of Unicredit, the separation between Investment Banking and Retail "on a dimensional basis" is more than acceptable. But, he warns, the main problem in the crisis has been the management of assets and liabilities ”. Many businesses have been classified as short-term when they weren't. Therefore, one must be careful not to kill the liquidity providers. Profumo then spoke in favor of the Banking Union, a fundamental step for the creation of a clear playing field, of the mechanism of a clear bail-in and in defense of Basel 2 which "represents a fundamental tool for growth in the management of risks of banks. Going back would be very dangerous”. In the context of governance measures, he then noted (“as I am no longer CEO, I can say it”, he began) that “bringing the chief risk officer to report to the board and not to the CEO would be disastrous because there would no longer be a hierarchy”.
THE IMPACT OF THE LIIKANEN REPORT ON ITALIAN BANKS
THE RECOMMENDATIONS IN CONSULTATION FOR SIX WEEKS
"I don't think there will be any impact for Italian banks because none reaches above 25%", notes Profumo, recalling that the reform provides for separation if trading activities exceed 25% of a bank's assets. But the reform process is also good for our institutions. “Everyone suffers from a reputation problem – he said – and everything that contributes to a better reputation of the system is fundamental”. For domestic institutions today, the main problem is the funding gap. “They ask me where the ECB's money has gone: they are financing the funding gap. Italian banks have a loan to deposit ratio significantly higher than 100, 128%, the excess is 28%, around 240 billion euro. Until recently it was covered by institutional investors who bought the liabilities of the Italian banking system. Now they don't do it anymore because we are a peripheral country. If this money is returned to the ECB in two years, a credit crunch will be created that we will dream of growth much later in time".
The Liikanen report presents no difficulties for Italian banks, not even for Bruni: "Italy has good supervision and a resolution rule as well, anything that happens in Europe that improves these things is only good for us, here we are free riders". Finally, for Mazzucchelli, it is a great opportunity for institutions to resume their past model. The 139-page report will remain in public consultation for six weeks and on various points it presents proposals on topics already under discussion at the European level. What reception will it have in Brussels? For now, Single Market Commissioner Michel Barnier hasn't gone too far, limiting himself to saying that he will study the report.
Attached is the Liikanen report
Attachments: Liikanen report.pdf
