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Banks concede reform is inevitable

By Patrick Jenkins and Brooke Masters

Published: February 3 2010 19:52 | Last updated: February 3 2010 19:52

London’s Canary Wharf financial district

Paul Volcker and Barack Obama have either thrown the world into chaos or given the cause
of global bank regulation new impetus – it depends on your point of view. But one thing is for
certain: the twin US initiatives to derisk banks and tax them according to their size – the
Volcker rule and the Obama levy as they have been dubbed – have seized the attention of
bankers and regulators around the world.

The US last month first made clear that it wanted to exact a levy of 0.15 per cent on any bank
balance sheet over $50bn. Then it said that banks should no longer engage in what it felt were
riskier practices – investing in hedge funds, private equity or proprietary trading, the
archetypal casino-style betting of bank funds for a quick profit. As part of that second
crackdown, US officials said banks would not be able to grow beyond their current share of
the market.

Underpinning both initiatives is a crackdown on institutions deemed “too big to fail” – an area
regulators admit had not been settled via the international supervisory authorities, such as the
Financial Stability Board and the Basel Committee on Banking Supervision, until the US
political intervention.
There are at least four competing ideas under discussion among regulators, politicians and
bankers. These include the extension of existing regulatory initiatives; the introduction of
contingency capital planning; the rewriting of rules around different capital instruments, such
as bank bonds; and a full-scale adoption at the level of the Group of 20 countries of a form of
the Obama levy.

Many bankers, like Frédéric Oudéa, head of Société Générale, who last week bemoaned the
politicisation of bank regulation, argue the first of those ideas will be sufficient.

According to such thinking, the drive by the Basel committee to pile additional capital
requirements on the riskier activities of banks – such as prop trading, or banks trading on their
own account – makes explicit bans unnecessary.

But the consensus view is that banks are going to have to submit to more radical concessions.
Several regulators, including the Basel committee, are considering the merits of a contingent
capital regime, which would put bondholders at risk of conversion into equity if a bank’s
capital strength falls below a pre-defined level. The so-called contingent convertible
instruments, or CoCos, are in their infancy, but Lloyds Banking Group issued £9bn of them
late last year in a move that regulators believe could set an attractive precedent for other

Some think such contingency planning does not go far enough. One big European bank is
pursuing an agenda to put all investors on the line in the event of a bank’s failure – a radical
proposal that would necessitate a rewriting of company law. “What you really need,” says the
bank’s chief executive, “is a resolution framework that specifies that 100 per cent of a bank’s
equity is wiped out, 50 per cent of subordinated debt goes and, say, 25 per cent of senior

It is the US proposals of the past few weeks that have really got people talking, however,
polarising opinion at home and abroad. While Asian regulators have stayed out of the debate,
Europeans have criticised aspects of the US administration’s effort to shrink what it sees as
banks’ risky businesses – prop trading, hedge funds and private equity.

“The situation is completely different here and the system that was in place has not worked
badly and does not need to be overhauled,” said one French government official. Pierre de
Lauzun, deputy director-general of the French Banking Federation, told the Financial Times:
“The content of the Obama plan is not convincing because it would be difficult to enforce and
it won’t change things significantly. In France we prefer to go with the Basel process.”

The French and the German governments generally oppose any moves to split up their
universal banks, arguing that their biggest banks survived the crisis relatively intact and that
splitting them could lead to instability rather than a safer system.

Europeans are more divided on the question of whether to tax banks to pay for future financial
rescues. Some, such as Juergen Stark of the European Central Bank, worry about the “moral
hazard” of setting up a fund – either with taxpayer money, or via a bank levy – because it
would temper the disincentive to fail.

But the camp backing a global levy seems bigger. Last week, two prominent bankers – Bob
Diamond, president of Barclays, and Josef Ackermann, chief executive of Deutsche Bank and
chairman of the Institute of International Finance – said they backed just such a tax.
Regulators including Mario Draghi, governor of the bank of Italy and chairman of the global
Financial Stability Board, and Philip Hildebrand, governor of the Swiss central bank, are also

Hector Sants, chief executive of UK Financial Services Authority, on Wednesday said the UK
“recognises the importance of making sure the taxpayer does not ultimately bear the cost of
financial failures”, though he cautioned that “the mechanism for achieving this needs further

In the end, bankers and regulators agree a combination of at least some, if not all, of the ideas
under discussion will probably be implemented in some form. And of those, a global levy is
the one that appears to be gaining support fastest.

“It’s virtually inevitable,” says Sir David Walker, author of a recent report on bank corporate
governance, and a senior adviser to Morgan Stanley. “It’s the most likely thing you could get
international agreement around.”

Additional reporting by Scheherazade Daneshkhu, James Wilson, Gerrit Wiesmann, Haig

Simonian and Vincent Boland