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Rescue by regulation? Key points of the Liikanen report

The paper lays out an interpretation of the crisis, followed by an analysis of the key proposals of the Liikanen Report. Possible implications for banks, investors and supervisory authorities are then discussed. The author closes with a consideration of unanswered questions.

SAFE policy papers / white paper No. 9, 2013
6 November 2013
Source: Center of Excellence SAFE, Goethe University Frankfurt

Jan Pieter Krahnen
The paper was written for a symposium of the Verein für Socialpolitik on the European Banking Union, held on 16 September 2013 in Frankfurt


The paper on key points of the Liikanen report summarizes the key proposals of the report by the Liikanen Commission. It starts with an explanation of a crisis narrative underlying the Report and its proposals. The proposals aim for a revitalization of market discipline in financial markets. The two main structural proposals of the Liikanen Report are: first, for large banks, the separation of the trading business from other parts of the banking business (the “Separation Proposal”), and the mandatory issuing of subordinated bank debt thought to be liable (the strict “Bail-in Proposal”). The credibility of this commitment to private liability is achieved by strict holding restrictions. The anticipated consequences of the introduction of these structural regulations for the financial industry and markets are addressed in a concluding part.


The organizers of this conference have asked me to analyze the existing concepts for a European Banking Union from an economic (and political) point of view. The fundamental arguments for the proposals introduced in the Liikanen Report, set out over the following pages, represent a personal interpretation of the “key” recommendations of the report – irrespective of my membership in the team of authors. The term “key” already represents an individual judgmental assessment, which is neither immediately evident, nor directly derived from reading the Report.

The Liikanen Report, and the proposals for structural reforms in the banking sector it sets out, was published in early October 2012. The official response from the European Commission, to whom the report was addressed, is expected toward the end of 2013. This conference is therefore taking place at a date (i.e. September 2013) that enables us to take a balanced view of these proposals within the context of the Banking Union as a whole.

Several aspects of the bigger picture of an emerging Banking Union (BU) are still in limbo. Of the four elements that define the BU – a cohesive restructuring and organizational regime (Recovery and Resolution Directive, RRD), a unified microprudential banking supervision (Single Supervisory Mechansim, SSM), the Single Resolution Agency, SRA, including an adequate funding backstop, and the joint Deposit Guarantee Scheme, DGS – only the first two are reasonably well defined and are at the stage of final agreement with the European Parliament (RRD) and/or at a stage of implementation (SSM). In both cases, the legal robustness of a shift of competence from national to European institutions continues to be a controversial issue.

A draft for a European Single Resolution Authority (SRA) was recently put forward by the Commission. The instrumental and process-related details of this relate to the Recovery and Resolution Directive (RRD) while a Resolution Authority equipped with far-reaching intervention rights is still controversial. In contrast, no such specific plans exist for a European Deposit Insurance. The main reason for the slow progress with these last two issues is due to the widespread fear, particularly in Northern European countries, of the tacit socialization of claims that have originated due to local political flaws.

This is also one of the reasons for a review of the intrinsic value of all banking assets in preparation for the European Supervisory System (SSM). A loss of value accrued in past years and not yet realized would therefore be fully accounted for either by recapitalization or by bail-in – as a necessary prerequisite for a start of the Banking Union. Under the heading of “Asset Quality Review”, discussions and negotiations are already under way about the rules of play when it comes to splitting up old and new losses. Note that a proper AQR carries significant risks for financial stability if not implemented properly.

In addition to the pronounced concern, particularly in Germany, about a Europe-wide collectivization of liability, there are also competition-based concerns about a transfer of decision-making power and resolution discretion from a national level to a European (or transnational) level. For example, key players (e.g., association representatives) in Germany regard this as a threat to the so-called threepillar banking system. It is now feared, European supervisory bodies will have no respect for the inherited banking structure as a specific national characteristic, as would be the case with a primarily national supervisory body.

Taken together, both concerns – legacy assets of current banking system and distinctive characteristics of the national financial architecture – suggest that it will still take a major political effort of epic proportions to bring the issue of European deposit insurance, as well as the problem of processing, to a positive outcome, with the Banking Union as currently envisioned. There is a need for a convincing institutional solution to the issue of limiting national liability, for which, to date, only isolated proposals have been made.

As the Banking Union (BU) project will hardly advance further without support from its biggest stakeholders, notably Germany, the sustainability of the project continues to be in question. A BU project is only workable if all four institutional features mentioned above – SSM, RRD, SRA and DGS – come into force at about the same time. These four features are complementary to one another and mutually effective. If individual elements are not implemented, the much-hoped-for restoration of the functional market-based rules in the banking sector will likely not take place. Therefore, particularly without an adequate resolution mechanism including the requisite financial reserves or commitment, it will be hard to solve the too-big-to-fail problem and return government bank rescues (and therefore also government bail-outs) to what they were always meant to be: a radical exceptional measure and not a permanent state of affairs.

The following pages lay out an interpretation of the crisis – nowadays often referred to as a crisis narrative in section 2, followed by the key proposals of the Liikanen Report in section 3. These include the creation of a separate banking system for large institutions and the obligation on the part of all banks to issue subordinate debt capital held by non-banks. Possible implications for banks, investors and supervisory authorities are discussed in section 4, including adapted business models for banks, the reaction of the investment sector to stricter liability regulations for private investors, and extended powers for banking supervisory authorities. A consideration of remaining unanswered questions brings the paper to a close in section 5.