Ring fence risky trading activities of European banks says report

A committee led by the Governor of Bank of Finland, Erkki Liikanen, has produced a report to ensure that taxpayers do not have to foot the bill for risks undertaken by banks.

The report comes in the wake of the economic crisis, which was due to a large failure of banks to have due diligence on securities they were backing.  As a result, many of the European banks have had to write off bad debts due to toxic real estate loans and assets.

In many cases, such as Ireland, Spain and Britain, taxpayers have had to rescue banks to protect depositors and ensure the financial system did not fully collapse.

The Liikanen report suggests four major recommendations focusing on ring fencing risky trading activities and proposed bank executives must bear losses if banks fail. In effect, the report calls for remuneration and interest of bank executives must be aligned with the interest of creditors instead of shareholders.

There must be better due diligence and better assessment of risks especially when it comes to real estate loans and trading assets. The European authorities should consider imposing an additional capital buffer for these activities specifically, the report said.

The recommendations are not far off from the Independent Commission on Banking’s proposals in the UK. However, the details are bit different – where the Vickers report in the UK calls for “ringfencing” retail activities the Liikanen report calls for “ring fencing” of trading activities.

But in essence both reports say that banks should not be allowed to gamble with insure deposits. "In Europe, banking is critical," Liikanen told reporters. "It's more important in the European economy than any other area in the world."

The European Commissioner for Internal Markets Michel Barnier has welcomed the report and said the Commission will consider its proposals and take subsequent action.