Brussels, 15/07/2011 (Agence Europe) - On Wednesday 20 July, EU Internal Market Commissioner Michel Barnier will unveil a flagship legislative initiative to transpose into EU law the Basel Committee's Basel III Agreement on improving the quantity and quality of bank capital requirements (see EUROPE 10213 and 10190). The draft legislation will comprise an EU directive and a regulation to introduce a single rule book for the EU. It will include detailed provisions for risk management and will try to reduce the dependence of EU rules on ratings by credit rating agencies.
The 2008 financial crisis that culminated in the collapse of Lehman Brothers of the US made it clear to the world that banks were under-capitalised. A draft version of the new legislation, discussed at a special meeting of the heads of EU Commissioners on 14 July (which has been seen by this newsletter) points out that in order to protect financial stability, the governments of a number of countries have bailed out banks to an unprecedented extent. The Commission says that insufficient EU harmonisation of the definition of eligible capital is one of the reasons why the banks were given more than two trillion euro of state aid. The draft legislation tightens the eligibility criteria for various types of capital and increases the actual amount of capital required of each financial institution. The Basel III Agreement stipulates that the lowest permissible level of shareholder income shall increase by 2015 from 2% to 7% of total assets, including 4.5% of the core capital (shares and profits held in reserve), and 2.5% of the protective cushion. In order to help banks introduce the new rules, a ten-year phasing out is foreseen of the old capital systems that are not allowed under the new rules. The rule whereby the capital requirements of the Basel II system must always be at least 80% of the capital requirements set out in the Basel I Agreement will remain in force until 2015.
Liquidity. For the first time, the EU will be introducing rules on banks' ability to deal with a credit crunch. After an observation period that will run until 2015, a liquidity coverage ratio will be introduced for banks to ensure they keep enough cash to deal with a six-month contingency period depending on the type of risk exposure. The Commission believes this measure alone will generate growth in the EU economy of between 0.1% and 0.5% of GDP. The head of the European Banking Federation, Guido Ravoet, told a few reporters, however, that exact liquidity figures must not be introduced because otherwise the markets will expect them to be respected by banks throughout the long observation period.
A non-risk based leverage ratio will be introduced to restrict leveraged debt, but the ratio will not be binding. National regulators will, however, be able to make use of it in their regular monitoring of risk and its compulsory introduction in 2018 will be considered in the light of the success of the optional measure.
Draft regulation. The Commission says that a high level of harmonisation of rules through an EU regulation is crucial to set up an identical group of rules as stipulated by the new EU financial supervision system, and it hopes the banking industry will comply. The Commission explains that inappropriate, uncoordinated stricter requirements in a number of member states could lead to a capital and risk drain from these banks to another country. Seven member states, including the United Kingdom, oppose such harmonisation because it would restrict their ability to introduce higher standards and would fail to take into account the particular situation in their country (see EUROPE 10383). Tighter rules could be introduced on a temporary basis at EU level by means of a delegated act to introduce higher prudential requirements, for example, for risk exposure or for individual regions or countries. The European Commission says that member states will have the option of introducing the new rules right from the start of the transition period (which will run until 2019).
The draft directive will replace EU Directives 2006/48/EC and 2006/49/EEC and introduce two types of capital cushion in addition to the other prudential measures, namely a protective cushion of 2.5% of high quality risk-weighted capital; and for loans to individuals and companies, the member states will decide on a contra-cyclical cushion of between 0% and 2,5% of risk-weighted assets. Restrictions on dividend and bonus payments will be introduced for financial institutions that fail to meet the cushion requirements.
Rating agencies. The European Commission wants to reduce reliance on financial ratings provided by rating agencies, saying that banks' own methodology should not exclusively rely on outside agencies. The draft legislation required lending establishments to draw up their own credit rating methods and the European Banking Authority (EBA) will be given the power to publish information each year about measures taken by financial institutions and national supervisors to reduce reliance on ratings by rating agencies.
The draft directive will require financial institutions to set up a special crisis management committee to help the board of directors prepare risk management strategy. In the event of violation of key areas of the new EU legislation, national authorities will have a list of EU penalties to choose from. The list will include withdrawal of authorisations, the sacking of senior management and fines of at least €5 million. The new legislation does not mention prison sentences. (M.B./transl.fl)