European Politics and the Regulation of Bank/Insurance Firms

On prior occasions, European implementation of the Basel bank regulatory system had proceeded rather mechanically. The Europeans actively participated in the Basel II process, reached agreement with the world's other major banking powers, and then faithfully enacted Basel norms into EU law. This has not been the case with the latest product of Basel: Basel III. While Europe once again exerted its influence during the negotiation, it has been decidedly less determined to give full effect to its Basel III undertakings in EU legislation. And the reason -- it should be no surprise -- is politics.

The linkage between Basel III and the European implementation (known as CRD IV) involves three levels of politics: global, European and national. The uncharacteristic European reluctance to carry out the Basel III mandates to the letter results from the varying distributions of influence at each level of the lawmaking game. A case in point: so-called 'bancassurance' -- financial conglomerates that are part bank, part insurance company. France's Societe Generale and Credit Agricole are two large examples of 'bancassurance'.

The treatment of bancassurance was a sticking point in the Basel III negotiations. The United States and others (including the United Kingdom, an EU member state) identified the problem of 'double counting' equity capital in bancassurance. Basel III requires banks to maintain adequate amounts of high-quality (Tier 1) equity capital. This capital acts as a loss-absorbing buffer, protecting depositors and other bank creditors. In a similar spirit, insurance regulators demand that insurers maintain adequate equity to protect policyholders in the event insurers experience losses.

The banking business and the insurance business share many common characteristics: both take in capital (from depositors and policyholders, respectively), both invest capital, and both pay out capital (upon maturity or insured event, respectively). But the businesses also are quite distinctive. Banks lose money through improvident lending; insurance companies lose money through poor underwriting or unexpected casualties. Banks typically invest over a shorter time horizon than insurance companies. While in theory these distinctions might make banks and insurance companies good financial complements (or not), the historic outcome in many jurisdictions (including the United States) has been the separation of banking and insurance. In other jurisdictions (France, for example), mixed companies -- the bancassurance -- have thrived.

Although Basel III did not ban the bancassurance business model, it did make it more difficult to carry off. In order to avoid 'double-counting', Basel III requires banks to deduct from what otherwise would have been qualifying Tier 1 capital the capital serving as 'reserves' for purpose of meeting the mandates of insurance regulation. And there is a certain amount of appeal to this approach: capital protecting bank depositors cannot simultaneously protect insurance policy holders.

The limitation on capital held by bancassurance was hardly a major Basel III issue -- but matters critically to the French bancassurances. While the Europeans were unable to protect the bancassurances in the Basel negotiations, this did not end the game.

The treatment of bancassurance returned to prominence during the EU legislative process leading to CRD IV. Germany and other EU member states supported France in avoiding the Basel III limits with respect to bancassurance, thus protecting Societe Generale, Credit Agricole and others.
European politicians noted that other Basel participants (most notably the United States) had displayed a certain looseness in implementing Basel norms: keeping those they liked and ignoring others. Slavish implementation of Basel III by Europe suddenly seemed naive, if not foolish.

The CRD IV process has revealed Europe's new stance as a selective adherent to Basel III. In the end, the European Union may implement more Basel III terms, in a more faithful spirit, than will other countries. It is too early to tell, as most other Basel III parties are not as far along in their respective implementation tracks.

Yet Europe's recalcitrance as to the treatment of bancassurance reflects a newly energized field of political action. It is no longer the case that perfunctory implementation by the EU legislative bodies will follow when the Commission presents a result from an international negotiation such as Basel. Rather, ordinary political forces will continue to play in the course of EU implementation -- and new outcomes are possible.

The official account of the bancassurance story asserts that the special treatment reflects European realities. The European Union points to an existing special regime for bancassurance that provides for adequate capitalization. It is possible of course that the Europeans got it right all along. This may be, but they are not following the regulatory approach mandated by Basel III.