the eu banking sector identified by hleg ] we also identified strengths that needed to be maintained in the prospective structural changes of european banks. for example, we thought it would be very important to accommodate the diversity of business models of banks in the european market place. in our deliberations we considered two avenues as possible ways forward. in the two avenues we put different emphasis on the most promising measures to end the too - big - to - fail problem ; capital requirements, resolution regimes, and structural reform. [ page 6 : two avenues as possible ways forward were considered ] in the first avenue, additional, non - risk - weighted capital requirements on trading activities and credible recovery and resolution plans for banks would have been the main instruments. we acknowledged that the measurement of risks inherent in trading assets is prone to a significant “ model risk ”. robust capital requirements which do not rely on complicated models are one way to tackle this issue ( as are limits on risk concentrations and counterparty exposures ). avenue 1 was based on this approach. the possibility of structural measures did enter avenue 1, but only as a conditional instrument. the idea was that if a bank was not able to prove that the required recovery and resolution plans were credible, separation of trading activities was to be imposed by authorities. in the second avenue, by contrast, any significant trading activities would be required to be separated from retail deposit banking. the separation proposal outlined in avenue 2 was based on the notion that capital requirements are not by themselves sufficient to limit excessive risk - taking incentives induced by deposit insurance if risks are difficult to measure and risk profiles can be changed rapidly, as in trading activities. avenue 2 also acknowledges the risk of heterogeneous application of tailor - made separation based on the credibility of the recovery and resolution plans of individual banks. thus avenue 2 includes uniform separation ex ante in order to facilitate resolution of large and complex banks without public funds and hence reduce the too - big - to - fail problem. further, a sufficiently broad separation of trading activities from deposit banking would avoid definitional problems which would arise, for example, if the dividing line had to be drawn between proprietary trading and market making. hleg proposal for mandatory separation after a long discussion, where both avenues were supported, the group decided to propose mandatory separation ( or subsidiarisation as it has been labelled in the international discussion ). [ page 7 : the high - level expert group ’ s proposal for mandatory separation within a banking group ] first, the

proposed that there would be an additional layer of designated bail - in instruments to further improve the loss - absorption capacity of banks. we believed that this would best combine loss absorbency and market discipline with legal certainty and the stability of markets. the designated bail - in instruments would have clear pre - specified terms and holding restrictions which would prevent other banks from holding these debt instruments. the holding restrictions would reduce the risk of contagion within the banking sector and thus constrain the fear of triggering a systemic crisis at the time of a capital conversion or a write - down. in addition, we proposed that the governance and control of banks ought to be strengthened further. particular attention ought to be given to the ability of management and boards to run large and complex banks, the powers of the risk management function and the quality, comparability and transparency of risk disclosure, the possibility to use designated bail - in instruments in remuneration schemes, and the appropriateness of imposing caps on variable as well as overall compensation. we also saw the need to enhance the sanctioning powers of supervisors so as to ensure enforcement of risk management responsibilities. how the hleg proposals address the malign diagnosis of the size and structure of the banking sector subsidiarisation of trading facilitates resolution by making bail - in rather than bail - out a more credible option. the recommendation that banks should have a layer of designated bail - in instruments further supports the aim of making bank bail - out at taxpayers ’ risk only a rare exception. only functions that are essential to the functioning of the society, i. e. the deposit taking and payment system, would benefit from a government guarantee. as a result, the separated trading activities will be funded from the market at a price better reflecting the true riskiness of the operations. this is expected to restrain incentives for excessive growth and risk taking in the trading entity. the recommendations will not only have an impact on the size of the financial sector, but also on what kind of operations there will be. first of all the proposals reduce the distorted incentives which endangers socially optimal allocation of resources. for example, as the subsidy of the implicit government guarantee is reduced, competition particularly in the trading activity is revitalised, which will improve the allocation of funds in the economy. moreover, separation restricts banks with insured deposits from engaging in high - risk trading bis central bankers ’ speeches activities which are not essential to deposit banking. the efforts of the deposit bank are thus expected to be