Towards a separation of deposit and investment banking activities

44 Pages·2013·0.28 MB·English

Towards a separa3on of deposit and
investment banking ac3vi3es

Jan Pieter Krahnen
Center for Financial Studies at Goethe University
SAFE, CEPR
18 April 2013
Towards the Banking Union: Open Issues
Roundtable at College of Europe, Bruges
Agenda
I.  LIIKANEN PROPOSAL
II.  BACKGROUND ON SEPARATION
-  Trading, banking, and risk taking.
-  Market making and banking.
III.  ALTERNATIVE MODELS OF SEPARATION
-  Comparing Volcker, Vickers, Liikanen.
IV.  ISSUES FOR DISCUSSION AND RESEARCH
2
Proposals need a narra6ve
Crisis narra3ve
§  Consistent economic explana3on of why the crisis happened, and how it
progressed.
§  Based on available academic and policy research,
§  As well as expert interviews on European bank business models.

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Proposals and their narra6ves
US (Volcker): Excessive risk
taking (through propietary
trading)
à Spin off prop trading from
UK (Vickers): Excessive risk taking (through deposit taking
investment or commercial banking) affects
economy‘s core financial services.
à Ring-fence core services & allow other
banking ac3vi3es to default (eliminate TBTF for
ring-fenced ins3tu3ons).
EU (Liikanen):
•  Systemic risk as the key challenge for preven3on and
interven3on.
•  Overcoming too-big-to-fail (TBTF)
à  Two main sugges3ons:
-  Enabling Resolvability (despite complexity)
-  Revitalizing Market Discipline via true Private Liability
(i.e. equity and debt) 4
Liikanen Proposal: basic approach
Objec3ve
No recourse to taxpayers’ money
(pushing systemic risk back to tail of
distribu3on)
Strategy
Facilita3ng resolvability of banking
ins3tu3ons
Instruments
Mandatory issuance of junior
Separa3on of trading ac3vi3es
bank debt, held outside banking
from universal banking
system (First-in-line debt)
Result
Re-introducing market
discipline into banking system
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A common misunderstanding
§  Instruments to be bailed-in
•  Cocos, Debt write-down, With pre-determined trigger, With pre-
determined conversion formula, respec3ng seniority
§  By some commentators, “bail-in bonds” were misread:
•  It has been insinuated that newly created „bail-in bonds“ is the one
and only instrument to be bailed-in by the supervisor.
•  All other debt instruments, in this interpreta3on, would con3nue to
benefit from a governmenbt guarantee.
•  Needless to say, this puts our proposal upside down.
§  ALL DEBT IS BAIL-IN-ABLE, subject to seniority, and regardless of its
label.
§  Change label now: à First-in-line bonds
à Anchor bonds
à No-mercy bonds
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Liikanen Report: proposals
1)  Mandatory separaon of proprietary and significant other trading
ac3vi3es
§  Addi3onal separa3on of other ac3vi3es condi3onal on recovery and
resolu3on plan.
2)  Amendments to the use of bail-in instruments as a resolu3on tool.
3)  Review of capital requirements on trading assets and real estate
finance (increasing risk weights).
4)  Strengthen banks’ governance and control (aligning incenves).

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First-in-line/Bail-in-ability
All banks: Mandatory issuance of designated May be subs3tuted by
all-equity. Does not
first-in-line debt.
imply other debt to be
bail-out debt.
Loss absorp6on First-in-line bonds are Or conversion into
equity (coco bonds), the
available for write-down (long-term investors
Swiss example.
Ensuring bank can distribute bail-in losses over many
resolvability periods).
without
Incidence: First-in-line bonds are priced First-in-line layer
recourse to may have
accordingly (high coupon compensates for
tranches of
TPM high expected loss).
different
seniority.
Credibility: First-in-line bond investors must May be
subs3tuted
be non-banks, limi3ng contagion risk
by a 1250%
(eliminates the rescue impera3ve for the risk weight.
state).
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Agenda
I.  LIIKANEN PROPOSAL
II.  BACKGROUND ON SEPARATION
-  Trading, banking, and risk taking.
-  Market making and banking.
III.  ALTERNATIVE MODELS OF SEPARATION
-  Comparing Volcker, Vickers, Liikanen.
IV.  ISSUES FOR DISCUSSION AND RESEARCH
9
Theore6cal perspec6ve on banking and trading

Banking Trading
§  Rela3onship business §  Transac3onal business
§  Not scalable §  Scalable, with decreasing
§  Safe, if lending book is returns to scale.
large and diversified. §  High risk-return strategy

§  Franchise value via long possible.
term pricing. §  No franchise value.

Possible problems of banking and trading interac6on
§  Time inconsistency
Banks may allocate too many resources to trading,

undermining rela3onship business.

§  Risk shi#ing
Trading may be used to increase risk, to the benefit
of shareholders.

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Boot/Ratnovs ky 2012