Banking StandardsLetter from Erkki Liikanen
On 22nd October 2012, the Parliamentary Commission on Banking Standards heard me in my role as Chair for the High Level Expert Group on reforming the structure of the EU Banking sector. As a continuation of the hearing, I hereby provide the Commission with some written evidence on the question “How to get more engagement from shareholders on how banks are run”.
The High-level Expert Group did not put for suggestions that would directly increase shareholder engagement in how banks are run. The importance of shareholder engagement in eg the nominations committee was, however, highlighted. In particular, the High-level Expert Group proposed that more attention needs to be given to the ability of [...] boards to [...] monitor large and complex banks. Specifically, fit-and-proper tests should be applied when evaluating the suitability of [...] board candidates.
The High-level Expert Group did put forth suggestions that would increase shareholder engagement indirectly. The indirect impact of reducing complexity and increasing transparency as ways to facilitate shareholder engagement is not to be underestimated. First, the suggested mandatory separation of proprietary trading and other high risk trading activities will reduce the complexity of the banks thus facilitating monitoring by the shareholders. Second, the suggestion of the quality, comparability and transparency of risk disclosures should be improved by requiring detailed financial reporting for each legal entity and main business lines also improves transparency thus increasing the ability of shareholders to efficiently monitor banks. Moreover, the suggestion of the High-level Expert Group will have a significant impact on the incentives for shareholder engagement by tackling the “too-big-too-fail” problem. Risk sensitivity is reintroduced in bank funding through the requirement that the deposit bank and trading entity are separately capitalised and funded.
The High-level Expert Group acknowledged that shareholder engagement, and corporate governance in a broader sense, differ across banks with different ownership structure and legal form. Firstly, the lack of shareholder engagement is amplified if the share ownership is dispersed as the incentive to monitor is decreasing in the size of the shareholding. Secondly, while some institutional investors take a long-term perspective, others are known to focus more on short-term profits rather than the long-term prospect of the company in which they invest. Thirdly, the solution to improve shareholder engagement and strengthen corporate governance might not have the same impact in all banks as the legal form of eg cooperative banks and saving banks, without ownership in the traditional sense differ from one of the commercial banks.
Finally, in addition to shareholder engagement, bank creditor engagement is also of great importance. The High-level Expert group acknowledged this by giving its support to the use of the bail-in instruments as a way to ensure creditor responsibility of losses; a concrete incentive to monitor how banks are run.
5 November 2012