The whole financial world, including me, wants to know what the election of Francois Hollande as president of France will mean. I will not pretend to tell you. But we can identify some issues that he is putting on the European table and discuss what it might mean if his views were to prevail. Today I will discuss the idea that France - and Europe, perhaps - should separate "investment banking" from "commercial banking." What does he mean? And what might its economic effect be?
A European Glass-Steagall Act?
My first guess was that M. Hollande is calling for Europe to adopt a version of the Glass-Steagall Act that separated commercial from investment banking in the U.S. for over 60 years. I guessed that this thrust would come from the American left, for whom it is an article of faith that the effective repeal of Glass-Steagall was a major cause of the Great Recession. It was not. But I will save my reasons for that conclusion for another time, since the conclusion is not strictly relevant to this article.
It turns out that in the not-so-distant past, France had a different separation - a separation between "retail" banking and "investment" banking that goes back to the nationalization of all the major French depository banks by Gen. de Gaulle after WWII. That separation, if I am reading the sources correctly, was more stringent than the U.S. separation in that the retail banks basically took deposits and lent to the government. Funding businesses was the job of non-depository banks. This system persisted until the mid-1960s, when depository banks were permitted to broaden their deposit bases and to make loans more widely. The depository banks flourished under the new system.
Nationalization and Denationalization by Turns
Nevertheless, another round of nationalizations took place in 1982 after the election of Socialist President Francois Mitterand, a mentor of Francois Hollande, when substantially all the French banks were nationalized. All having been nationalized, the strong distinctions between types of banks were eliminated in 1984.
The denationalization process began in 1987 and continue strongly through the remainder of Mitterand's two terms of office that ended in 1995, usually prompted by more conservative leaders but assented to by Mitterand, who lost his zeal for state-run institutions, particularly in his second term of office. The process of denationalization of the banking sector was largely completed in the late 1990s.
Mitterand's flip-flop may be instructive in deducing Francois Hollande's intentions. A French Socialist no longer has to favor state-run banks.
A European Volcker Rule
With this historical background, it is natural to wonder what M. Hollande does mean by separating commercial and investment banking. The FT explained as follows on March 27:
"Advisers to François Hollande, the socialist French presidential candidate, says he does not intend to break up the French universal banking model. The intention is to separate what they call speculative trading in products not linked to the financing of the real economy from the core retail activities of the banks, writes Hugh Carnegy.
They characterize their plans as being akin to the Volcker rule in the U.S., barring banks from trading on their own account, rather than the Vickers reforms planned in the U.K. to ring-fence retail banking from investment banking.
A key aim is to ensure that any trading in speculative products is no longer covered by de facto state guarantees of the banking system."
Assuming that this explanation of M. Hollande's intentions is correct, what he wants to accomplish makes good sense. And it would not significantly harm the French banks that have strong retail operations. What form of regulation, on the other hand, might be necessary to accomplish the goal is problematic. The Fed is having a hard definitional time in the U.S. Whatever the mechanism, however, the basic thrust to create a French version of the Volcker Rule is neither socialist nor radical. It should not alarm investors in Europe's banks.
Bashing the banks is de rigueur in French politics.
Several weeks ago, I suggested that Credit Agricole (CRARY.PK) and Societe Generale (SCGLY.PK), both stocks that have been taking a beating recently, could be good long-run investments, albeit with substantial risk. I am continuing to hold them, believing that my investment thesis has not been negated. The market's sentiment toward French banks is bad, so the stocks go down. In the same light, I do not see the investment thesis changing based on what I now understand to be M. Hollande's intentions.