andreas dombret : cutting the gordian knot or splitting hairs – the debate about breaking up the banks speech by dr andreas dombret, member of the executive board of the deutsche bundesbank, at the ilf ( institute for law and finance ) conference “ too big to fail iii : structural reform proposals – should we break up the banks? ”, frankfurt am main, 21 january 2014. * 1. * * introduction ladies and gentlemen thank you for inviting me to speak at today ’ s conference. it is a pleasure and an honour to be here. the story goes that at some point in history the kingdom of phrygia was without a king. the priests therefore consulted an oracle to determine who should fill the vacant position. the oracle decreed that the next man to enter the city in an ox cart should become the new king. that man was gordias, a peasant. gordias became the king of phrygia and, out of gratitude, his son dedicated the ox cart to the gods. the gods in turn tied the cart to a pole with a complicated knot – the famous gordian knot. this knot was so complex that for centuries no one was able to untie it. hence, the cart was still tied to its pole when alexander the great entered the scene in 400 bc. meanwhile, it had been prophesied that whoever untied the knot would become king of asia. alexander, full of ambition, took on the challenge. unable to find the loose end of the knot, he drew his sword and sliced the knot in two, thereby undoing it. since then, the gordian knot has become a symbol for solving seemingly insoluble problems by thinking outside the box and then taking bold action. the insoluble problem in our case is how to secure financial stability. and after six years of crisis, more and more people are, understandably, looking for a gordian solution. to some, the solution would be to break up the banks – with one bold stroke of the sword, as it were. broadly speaking, the dividing line would run between those parts of a bank engaged in commercial banking and those parts engaged in investment banking. in my speech today, i will address the question of whether this is a sensible approach. as i speak first at this conference, my objective is to give an overview of the issue, discuss the pros and cons of the proposal and try to draw a tentative

their business models – i ’ m talking specifically about the ones that run highly interest - driven franchises. that is why any institution that is over - reliant on revenues from interest business needs to rethink its approach. and while banks are busy reviewing their strategies, there ’ s another scenario they must also bear in mind – that interest rates are going to pick up again. this will give rise to interest rate risk, which an institution ’ s risk management will need to be able to cope with. institutions should each have a meticulously crafted response to this scenario at the ready – rather than hectically drawing up a plan when things come to a head and interest rates start climbing. furthermore, the new recipes of the future will also need to include some digital ingredients, and that goes for business models and risk management operations in equal measure. state - of - the - art risk management needs to devote far more attention to cyber risks, which are a matter of general business management. efficient processes which harness economies of scale on the cost side can help stabilise earnings. innovative information technology can play a role here, and it can also be supportive in reshaping business models. 1 in fact, to a limited extent, it can help tap new sources of income. another way in which institutions can unlock new sources of revenues and optimise their existing profit centres is by cooperating with fintechs. 5 stricter rules for the baking process : regulation and bank management but it is not just the business models which need to be scrutinised – the management approaches should be reviewed as well. and this is where regulation comes into play. up until just a few years ago, integrated performance and risk management largely revolved around allocating capital according to an institution ’ s exposures. the chief objective was to allocate capital resources as efficiently as possible whilst adhering to the minimum regulatory capital requirements. this principle is still the essence of bank management today. yet the regulatory reforms introduced since the financial crisis have been forcing institutions to rethink their set - ups somewhat. the problems facing the banking sector have shown that setting a minimum capital requirement that is based solely on risk - weighted criteria doesn ’ t go far enough to create sufficient resilience within the sector. because risk - weighted capital requirements alone did not provide the necessary level of protection, additional safety nets were introduced as part of the basel iii package. thus, the existing risk - weighted standards have now been joined by