Changing the Structure of Banking: Volcker, Vickers and Liikanen
Abstract: This article is about structural banking regulation in the UK, US and EU (Volcker, Vickers and Liikanen respectively). Instead of analyzing and evaluating this regulatory reform from a technical point of view, this article focuses on the paradigm shift that is implied by the separation of certain risky market-based banking activities and ‘boring’, yet socially important retail banking activities. This post-crisis view on banks’ societal role emphasizes the service function of banks. Post-crisis notions of ‘too much finance’ supported by empirical evidence, fuels the shift. Other factors include the idea of an implicit social contract between banks and society and evidence on the distortive qualities of trading activities. This article argues the Volcker rule in the US, the Vickers proposal in the UK, and the EU Liikanen proposal are necessary to strengthen the links between banks and the real economy. This corrects the pre-crisis situation in which an excessively large financial sector profited during good times while society suffered the losses in bad times.
Introduction
The global financial crisis (GFC) of 2007 brought to the attention of regulators, academics, and the general public, questions on the role of the financial industry in society. The most fundamental of all questions perhaps, touches upon which goal finance is pursuing. One insight shared by many, is noted by former Senator Fred Thompson: “the real scandal here may be from not what is illegal, but what is totally permissible … The system is clearly not designed with the interest of the general public or the investor in mind.”[1]
After the GFC, structural separation of banks began to form part of the regulatory agenda. Whereas capital requirements leave the business model of banks intact, structural bank regulation means banks may not carry out certain particularly risky activities. These reforms echo the United States Glass Steagall Act of 1933[2] that prohibited the combination of investment banking and commercial banking within one banking group. This act was repealed in 1999 as a part of the deregulation process that is one of the several causes of the GFC.[3]
This post-crisis regulatory reform and the concepts upon which this reform rests, is part of a development that attempts to counteract the (pre-crisis) situation where the financial services industry greatly expanded without regard to the service the industry extended to the real economy. These structural banking reforms contribute to correcting this situation by diverting banks away from engaging in trading activities that did not benefit the real economy; even worse, caused the economy to suffer great losses. I argue the structural banking reforms mark a welcome paradigm shift on the societal role of banks. The separation of certain securities market activities from retail banking activities stem from the post-crisis view that emphasizes the service function of banks.
Cristina van Putten has an LLB from the University of Amsterdam and an LLM in Corporate and Financial Law from the University of Glasgow.
