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BrackenAugust 24 2015

Europe needs a proportionate rethink on bank regulation

EU bank regulation should be applied consistently on a proportionate basis that reflects the size and business model of the banks being regulated.
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Europe needs a restart and reboot. This also means a more reasonable approach in the production of rules for the banking sector. In early July, the European Banking Authority (EBA) published a few hundred pages of new technical standards and guidelines on the bank recovery and resolution directive. Introducing the concepts of recovery/resolution planning, bail-in and orderly failure into many member states’ legal systems for the first time, the directive applies to all kinds of banks in the EU.

More generally, the whole corpus of EU legislation – both level one (primary legislation) and level two (technical standards) – is addressed indifferently to all types of banks, especially within the precincts of the banking union; that is, firms in the eurozone countries. Except for a few variations to be singled out mainly by national authorities, legislative provisions and technical standards alike apply both to large cross-border listed banking groups and to one-branch local firms devoted to retail customers. However, European community or co-operative banks did not cause the great crisis of 2008 and generally proved resilient and countercyclical. Therefore, is this the best way to secure the goals of legislation: to protect investors and taxpayers and enhance the real economy? Or should legislation apply proportionate rules to different types of subjects, according to the risk they pose to the economic environment?

It seems a sheer paradox that the undifferentiated approach exists in Europe, where small and medium enterprises represent the backbone of the economy with the support of the local small-sized banking sector. However, another way is possible and already well established. The US, in fact, adopted a tiered approach in the application of Basel III prudential rules, according to four different categories of banks divided under riskiness, business model, entrepreneurial mission and size. Together with a stimulus to the economy, this has fostered a quick recovery. In Europe, on the other hand, we have experienced two combined and detrimental policy trends; strict austerity and one-size-fits-all regulation. The continuing credit crunch and high levels of unemployment, when compared with the figures of the US, show that something has to give.

Structural approach

The proportionality principle in EU banking legislation and supervision is today applied according to a case-by-case approach, whereby it is not clear who deserves proportionate rules and what such measures should materially involve. Legislators blatantly admit that different subjects deserve different rules, but due to the flawed implementation framework of the assumption, this does not translate into appropriate regulation. From legislators in Brussels, to regulators in London or Paris (the EBA or Securities and Markets Authority), down to national authorities, even where proportionality is provided somewhere in the legislation it then gets watered down along the policy-makers’ chain and ends up lost. Proportionality should therefore move from a case-by-case view to a structured approach.

The objective and scope will be clear for each category of subjects from the very start, with a certain set of rules that less risky firms deserve, to be later refined along the implementation chain. This would also allow the EBA – already engaged in attempting to define how proportionality can be achieved – to indicate concrete measures that national authorities shall apply to predetermined categories of institutions. The forthcoming review of existing legislation, including the capital requirements directive, could be a good testing ground to experiment with this new approach.

This would also capture the objectives of EU financial services commissioner Jonathan Hill and those set out in the Report of the Five Presidents as of June 22 for the completion of the Economic and Monetary Union: to limit national discretion. Structured proportionality does not in fact damage the EU Single Market or the Single Rule Book. On the contrary, it strikes down uncertain national discretion by providing a clear set of rules and tools, aiming at securing financial stability while preserving the biodiversity of the banking and industrial tissue of Europe. If a nuclear power plant and a windmill farm do not deserve identical regulation, even if they both produce electricity, neither do large financial conglomerates and small local banks.

Alessandro Azzi is president of the Italian co-operative banking association, Federcasse.

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