EU ring-fencing and the defence of too-big-to-fail banks

Abstract

Bank ring-fencing is an important post-crisis regulatory response to the moral hazard dilemma surrounding too-big-to-fail banks. Since national governments bore the worst of the costs of rescuing the largest banks, it is reasonable to expect that the authorities would have the greatest incentive to promote tough ring-fence reform. However, in confrontation with the EU’s Liikanen Group and the EU Commission, France and Germany established a weaker set of national reforms. This article asks why these national governments pursued legislation that was more accommodating to their largest banks than the EU proposals. It argues that France and Germany were defending market-based banking in their largest universal banks. They were defending the ability of their largest banks to hold large volumes of trading assets which, in the view of the EU Commission and others, was a major cause of the financial crisis. The conclusions suggest that the direction of change will continue to be towards further market-based banking, despite the associated costs revealed by the crisis.

Keywords:

• too big to fail
• Liikanen
• ring-fence
• banking regulation
• market-based banking

Notes

1. The precise definition of these terms will depend on the scope of separation, i.e. which activities can be included in each type of bank.

2. The federal government had long sought Landesbanken reform, but had been generally thwarted by the states.

3. Working document #9, Working Party on Financial Services, France and Germany, from within EU Parliament.