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In response to the global financial crisis, several advanced economies have either adopted or are considering structural bank regulation measures. The common element of the various initiatives, including the “Volcker rule” in the United States, the proposals of the Vickers Commission for the United Kingdom, the Liikanen Report to the European Commission and draft legislation in France and Germany, is a mandatory separation of commercial banking from certain securities markets activities.
The proposals mark a paradigm shift. Since the 1970s, in parallel with the deregulation of financial markets, restrictions on banks’ business lines have been relaxed. There was a broad consensus that banks which offer a full range of financial services can provide the largest economic benefits in a rapidly growing global economy. Diversification of business lines, innovations in risk management, marketbased pricing of risks and market discipline were seen as effective safeguards against financial risks associated with the rapid expansion of large universal banks.
The financial crisis has triggered a reassessment of the economic costs and benefits of universal banks’ involvement in proprietary trading and other securities markets activities. With hindsight, many large universal banks shifted too many resources to trading books, supported by cheap funding. The complexity of many banks weakened market discipline, while their interconnectedness increased systemic risk, contributing to contagion within and across firms. While the crisis has shown the need to strengthen market-based pricing of risk and market discipline, the heavy burden of bank losses imposed on taxpayers has raised questions about the separation of certain banking activities.
The proposed changes do not go as far as the previous strict separation of commercial from investment banking that existed in some jurisdictions, such as the United States. But for many countries, notably a number of continental European ones, restrictions on universal banking would be new. A number of questions arise. How effective can these measures be in improving financial system soundness? What can their impact be on banks’ profitability and business models, both nationally and internationally?
This paper explores these issues. Section 2 considers in more detail the rationale behind the measures as well as their similarities and differences. Section 3 provides a basis for evaluating their effectiveness in promoting financial stability. Section 4 discusses their implications for banks’ business models and profitability.
The last section concludes.