EU advised: Ringfence risky banking and reform bonuses

Top banks should separate high risk trading activities from ordinary retail operations, according to a high-level group advising the European Commission. Other proposals include linking bankers' pay more closely to long-term sustainable success and capping the total amount paid to staff in bonuses.

The group, led by Bank of Finland governor Erkki Liikanen, was set up by European Commissioner for financial services Michel Barnier and presented its findings today. Liikanen said that if his recommendations were implemented they would "provide for a more stable and efficient banking system serving the needs of citizens, the European Union economy and the internal market".

Among Europe's banks "no particular business model fared particularly well, or particularly badly, in the financial crisis", the report concludes. Ideas put forward by the group include the "mandatory separation" of high risk trading activities from retail banking and a review of the capital requirements on trading assets and real estate related loans. Large banking groups would not be split, their activities separated within the company.

Meanwhile the report said reforming bankers' pay so that it was "proportionate to long-term sustainable performance" would be "essential" to regaining the trust of the public. Liikanen advised paying top executive bonuses in bonds and setting a cap on the total amount of bonuses distributed to all staff.

Barnier welcomed the findings and said the report underlined the "excessive risks taken by banks in the past". He added that the commission would study the potential impact of the group's suggestions on growth and the integrity of the financial system before deciding what steps to take.

Monique Goyens, director general of the European Consumer Organisation and a member of the Liikanen group, said dividing banks would "protect the deposit bank, and so its depositors, from the more risky activities of trading entities". She warned that lobbying from the financial sector to prevent the adoption of the rules would be "tremendous" but said the "real economy deserves that this pressure be properly resisted by our lawmakers".

Indeed, Simon Lewis, chief executive of the Association for Financial Markets in Europe, said that while supporting the aim of restoring confidence in the system, "we do not believe that further changes to the structure of the banking system are necessary or will contribute to Europe's economic growth".

But Philippe Lamberts, finance spokesman for Green members of the European Parliament, said that even "more ambition" was need in some areas. "Ringfencing trading activities in banks would play a vital role in limiting contagion within and between banks and ensuring retail banking customers are not damaged by losses from investment banking activities in the their bank, which have nothing to do with them.

"However, the proposals fall short of what is needed to end the 'too big to fail' conundrum. Further measures – such as a cap on the size of assets that a bank can hold – are needed to reduce the systemic footprint of the banking industry. Exemptions for certain trading activities within retail banking open significant loopholes that would potentially nullify the effect." He said Greens regretted "that more radical – but equally easier to enforce – options such as a total separation of retail and investment banking have not been considered".