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Report wants Europe's banks to wall off risky ops

SARAH DiLORENZO, AP Business Writer
Tuesday, 2 Oct 2012 | 6:21 AM ET

BRUSSELS -- Europe's banks should create a firewall between their traditional retail banking operations and more risky investment banking ones and force executives to personally take losses when their banks fail, a new expert report suggested Tuesday.

The continent's banks are in trouble: Government and real estate debt taken on in boom times _ when both were considered safe _ have plummeted in value. That's left many banks going hat in hand to their governments for rescue loans. But European governments are themselves struggling with high debt and are in many cases having difficulty helping their banks.

Ireland has already gone bankrupt rescuing its banking sector, and Spain could, too. On top of the strain on governments, the struggling banks aren't lending to consumers and companies, worsening the already poor state of the economy.

As part of efforts to break the link between banks and countries and ensure Europe's debt crisis never repeats itself, the European Union is strengthening its banking regulation. It is considering making the European Central Bank a supervisor for all 8,000 banks in the 17 countries that use the euro, with wide-ranging powers. It is also looking at regulation that would force creditors of failing banks, such as bondholders and shareholders, to take losses rather than having governments pour in taxpayer money.

The report released Tuesday builds on these suggestions. It was requested by the EU's executive arm, the European Commission, and put together by a group of experts, including economists, bankers, regulators and consumers, led by Erkki Liikanen, governor of the Bank of Finland.

Michel Barnier, a European commissioner charged with improving banking regulation, said he will study what impact the report's suggestions would have on banks' ability to lend to companies and consumers.

The most significant recommendation the report makes is that banks should separate their risky investment banking operations, like proprietary trading, from their more traditional retail operations, which lend to customers. The two entities could still be part of one big bank holding company but would have to separately meet the capital requirements, put in place to make sure banks have enough money to cover losses in tough times. In other words, the retail banking arm should never be used to prop up the investment arm if it makes bad trades, for instance.

The report also calls for increased surveillance of the banks and particularly of their management. It suggests that the executives should get some of their compensation in the form of "bail-in instruments." That would make management personally on the hook to help rescue their struggling bank.