The question of governance among eurozone banks is firmly back on the agenda. The UK has introduced a degree of segregation between banking businesses, while since the 1st of January 2016, Europe has set a maximum guarantee for deposits in current bank accounts, in the event of the bankruptcy of a financial institution, at EUR 100k.
This question has become even more pressing since some Italian banks unhesitatingly filed for bankruptcy in December 2015 to protect their depositors from the risk of being unable to recoup their sight deposits, although this event attracted little media attention during the turbulent year-end period.
The question is also all the more sensitive as not all European banks segregate (separate) assets that they hold on behalf of clients from their own assets. France is one of the rare countries in which assets owned by banks’ clients (UCITS, physical securities, etc.) remain the property of the clients and not the property of the bank where the assets are held. For example, during the 2008 crisis, UCITS deposited at Lehman brothers London disappeared when the bank went bankrupt, whereas this scenario would not have been possible in France.
The question is all the more pertinent given that clients rarely examine the balance-sheet of the bank in which they have deposited their assets, especially the off balance-sheet items, placing their confidence in the banking authorities and regulators in their role as banking supervisors. It is paradoxical that, if a bank goes bankrupt, these same supervisory authorities will have failed to identify problems beforehand and clients are now required to know how to identify whether a bank is “at risk” or not.
This fundamental shift in the relationship between clients and bankers has stirred only very few reactions, despite being highly surprising in legal terms. Are there any other “retail” sectors in which, if a company goes bankrupt, its clients are held jointly responsible and have to participate in bailing out the company in question? When one of our car manufacturers was on the brink of bankruptcy, there was never any question of its clients having to sell the car they had bought to bail out the manufacturer in question. In insurance companies holding life insurance contracts invested in general assets, it would be possible to lose everything if the insurance company were to go bankrupt.
Given these changes in regulations, it appears vital to segregate the different businesses within global banks. Although it may be possible to expect the client of a retail bank to understand the risks associated with the retail banking business, it is less conceivable that the client may appreciate the risks incurred by a trading bank, an investment bank or even medium and long term financing and property investments.
It will probably be argued that even retail banking incurs credit risk, through client loans, and that bank segregation will have a negative impact by driving the cost of credit higher, as these retail banks will be unable to benefit from the far higher profitability and diversity among other business lines, which automatically boost inherent profitability. But are we currently able to quantify off balance-sheet risks among multi-business banks? Would they be able to undertake such off balance-sheet commitments and therefore generate such high margins from their operations, if they did not have the retail banks’ balance sheets at their disposal?
We are hoping for a heightened sense of awareness within the banking system in 2016, regarding its obligations arising from the paradigm shift represented by the segregation of business lines, to shelter trusting clients from risk. We also hope that these changes will be a source of opportunity and renovation for all market professionals.
With all of our best wishes for 2016,
Olivier de Guerre