The Great Bank Debate

Structural reform of banks does not solve all problems, but, at least for the UK and the rest of Europe, it is a key part of the overall reform package for the financial sector. Now, five years on from the start of the crisis, the debate about how to achieve a more stable, loss-absorbent banking system has finally begun.

OXFORD – Christine Lagarde, the International Monetary Fund’s managing director, recently said of the unfinished agenda for global financial-sector reform: “To start, we need concrete progress with the too-important-to-fail conundrum. We need a global-level discussion of the pros and cons of direct restrictions on business models.” Five years on from the start of the crisis, with the publication of the Liikanen report on European Union banking reform, that debate has finally begun.

The Liikanen proposals have much in common with those made in 2011 by the United Kingdom’s Independent Commission on Banking (ICB), which I chaired. Both sets of recommendations stress the importance of an interlocking package of measures that combine much greater loss-absorbency with structural reform. And both make the same economic case for such reforms: to insulate basic banking services from investment banking risks; to make resolution easier and thus more credible; to shield taxpayers from risks that belong in the private sector; and hence to ensure that banks’ risk-taking is subject to adequate market discipline.

Moreover, both Liikanen and the ICB favor structured universal banking – legally separate entities with separate capital, management, and so forth – rather than calling for its demise, as urged by those who want to split commercial from investment banking fully. For large banks, Liikanen would separate trading from deposit banking, while the ICB’s proposals, which are now incorporated in draft legislation in Britain, would ring-fence retail banking.