February 18, 2013
Germany's New Banking Legislation Shows That "Ring Fencing" Banks Means Glass-Steagal
Posted by David Zaring

One of the things Europeans have been talking about in the wake of the financial crisis is the "ring fencing" of banks.  In theory, you can ring fence lots of parts of a bank, all of which makes the bank a little less of a nexus of contracts and a little more of a nexus-of-contracts-with-some-contracts-blocked.  The US could ring fence BNP Paribas' American subsidiary so that if one went bankrupt, the other would be solvent, for example.  That's one kind of ring fencing.  But what Europe means by ring fencing is the separation of retail banking from investment banking, as Jim Hamilton has observed about Germany's new law:


The German Government has approved legislation separating commercial and investment banking on the basis of a modified ring-fencing approach embodied in the E.U. Liikanen Report.....An important goal of the legislation is to enhance the protection of retail banking against risks arising from speculative activities. This will benefit retail customers and ultimately also taxpayers. The legislation largely follows the findings and recommendations of the E.U. Liikanen Report. The Report of the High Level Expert Group on E.U. Banking Reform (Liikanen Report) recommended that proprietary trading and other significant trading activities should be assigned to a separate legal entity if the activities to be separated amount to a significant share of a bank's business.
Under the German legislation, if certain thresholds are exceeded, deposit-taking institutions and groups that include deposit-taking institutions will no longer be allowed to combine in one entity deposit-related activities and proprietary trading, which is defined as the purchase or sale of financial instruments on the financial institution’s own account that is not a service for a third party. Instead, the financial institution will have to spin off proprietary trading into a company that is legally, economically and organizationally separate and that will require a license in accordance with Germany’s Banking Act.


It is interesting how quickly a continent that never had Glass-Steagal has gotten very interested in it after the financial crisis.  The US got rid of the separation of banking and securities partly because its banks complained they wouldn't be able to compete with European and Japanese banks that could do it all.  Maybe it will be rethought over here if this sort of legislation becomes the norm abroad.

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