Blog Post

No ringfencing makes sense, but don’t take off the gloves – implementing the recommendations in the Liikanen report

Michel Barnier, European commissioner in charge of regulatory reform, has indicated implementation of the recommendations in the Liikanen report will stop short of ringfencing certain bank activities. The argument is that this could undermine fragile European growth outlook. This viewpoint makes sense.

By: Date: February 4, 2013 Topic: Macroeconomic policy

Michel Barnier, European commissioner in charge of regulatory reform, has indicated implementation of the recommendations in the Liikanen report will stop short of ringfencing certain bank activities. The argument is that this could undermine fragile European growth outlook. This viewpoint makes sense. The benefits of ringfencing are quite uncertain. Although economies of scale in banking may stop far below the size of the banking giant we see in everyday life, the presence of economies of scope is more likely. Ringfencing might kill those economies of scope.

There are, however, two additional arguments against ringfencing, as also noted in my previous post on the Liikanen report. First, the implementation of such regulation suffers heavily from information asymmetry. How can we decide what banking activities add real economic value and what banking activities are mere speculation? The boundary between these activities is a grey area. Regulators will face constant discussion on which side of the fence a particular transaction takes place. Second, ringfencing is not credible. When the activities of a systemic bank outside of the fence run into trouble, the risk of contagion of the ring-fenced part of that bank will be large. Authorities will most likely prevent such contagion by stopping the fire where it starts – namely outside the fence.

However, this step should not signal a lenient treatment of the European financial sector. Indeed, European banks still receive sizeable implicit subsidies through their implicit too-big-to-fail guarantees. As discussed by, e.g., Wouter den Haan already some time ago, these subsidies lower banks funding costs and distort the economy in several ways. They make financial services too cheap, resulting in oversized financial sectors. In addition, the implicit bailout guarantee results in incentives to take-on too much risk. Although they may generate substantial profits during normal times, oversized and risky financial sectors are very costly when crises occur. These costs are especially high when firms depend strongly on bank financing – as is the case in many European countries. This is the real problem the European Commission should acknowledge and tackle. The commission is taking steps in the right direction (the proposed bank recovery and resolution directive, the single supervisory mechanism, and the forthcoming proposal for a single resolution mechanism), but still has a long way ahead of it.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More by this author
 

Opinion

European governance

Can the EU fiscal rules jump on the green bandwagon?

By and large, setting a new green golden rule would be a useful addition to the existing EU fiscal framework.

By: Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: October 22, 2021
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read about event
 

Past Event

Past Event

Monetary policy in the time of climate change

How does climate change influence monetary policy in the eurozone? What potential monetary policy measures should be taken up to address climate risks?

Speakers: Cornelia Holthausen, Jean Pisani-Ferry and Guntram B. Wolff Topic: Green economy, Macroeconomic policy Date: October 20, 2021
Read article More by this author
 

Podcast

Podcast

Rethinking fiscal policy

A look at the past, present and future of fiscal policy in the European Union with Chief economist of the European Stability Mechanism, Rolf Strauch.

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: October 20, 2021
Read about event More on this topic
 

Upcoming Event

Nov
4
14:00

European monetary policy: lessons from the past two decades

This event will feature the presentation of “Monetary Policy in Times of Crisis – A Tale of Two Decades of the European Central Bank."

Speakers: Grégory Claeys and Wolfgang Lemke Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More by this author
 

External Publication

Global Economic Resilience: Building Forward Better

A roadmap for systemic economic reform calling for step-change in global economic governance to increase resilience and build forward better from economic shocks, prepared for the G7 Advisory Panel on Economic Resilience.

By: Thomas Wieser Topic: Global economy and trade, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Opinion

Letter: Declining investment may explain why rates are low

Perhaps an analysis of the causes of the declining investment rate would bring us closer to explaining why real interest rates are so low.

By: Marek Dabrowski Topic: Macroeconomic policy Date: October 1, 2021
Read article More by this author
 

Podcast

Podcast

A green fiscal pact

How can the European Union increase green public investment while consolidating budget deficits?

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: September 29, 2021
Read article More on this topic More by this author
 

Blog Post

Monetary arithmetic and inflation risk

Between 2007 and 2020, the balance sheets of the European Central Bank, the Bank of Japan, and the Fed have all increased about sevenfold. But inflation stayed low throughout the 2010s. This was possible due to decreasing money velocity and the money multiplier. However, a continuation of asset purchasing programs by central banks involves the risk of higher inflation and fiscal dominance.

By: Marek Dabrowski Topic: Macroeconomic policy Date: September 28, 2021
Read article More on this topic More by this author
 

Opinion

The pandemic’s uncertain impact on productivity

The pandemic has certainly permanently affected our way of working. Whether this is for the better remains to be seen.

By: Maria Demertzis Topic: Macroeconomic policy Date: September 28, 2021
Read about event More on this topic
 

Past Event

Past Event

How to strike the right balance between the three pillars of the pension system?

In this event panelists will discuss the future of European pension schemes.

Speakers: Elsa Fornero, Svend E. Hougaard Jensen and Suvi-Anne Siimes Topic: Macroeconomic policy Date: September 23, 2021
Load more posts