Brussels, 20/07/2011 (Agence Europe) - On Wednesday 20 July, the European Commission unveiled legislation to boost the quality and quantity of capital held by 8,200 banks doing business in Europe (see EUROPE 10420). EU Internal Market Commissioner Michel Barnier said the proposal would have a fundamental impact on the way banks behaved and would reduce the risk of a new financial crisis by 70%. He said the Commission had respected the spirit, letter and ambition of the Basel III Agreement reached by the Basel Committee, and the new draft legislation was the first to introduce the new Basel III rules into EU legislation. Once adopted in codecision by the European Parliament and the EU Council of Ministers, the new rules will gradually come into force from 2013 onwards and be fully implemented by 2019.
The current rules state that banks have to have at least 8% of capital as a proportion of its risk-weighted assets. The new legislation does not change this threshold, but increases by 2% to 4.5% the minimum proportion of common equity Tier 1 (high quality) capital. Harmonised definitions of the types of capital will be tightened up and shares quoted on the stock exchange will have to meet 14 detailed criteria. To increase their solvency ratios, banks will be allowed to issue new shares, withhold some of their profits and reduce risk exposure by reducing loans to certain categories of operators, and any combination of these measures. During fat years, the banks will have to set up a buffer of 2.5% of weighted assets along with a contra-cyclical buffer of a scale to be decided by the member states but which will have to be between 0% and 2.5%. Overall, Barnier calculates that the banks will have to raise some €460bn to meet the new rules.
Further capital requirements may be introduced over time for too-big-to-fail financial institutions, if the recent decisions by the Financial Stability Committee are anything to go by.
Liquidity. For the first time in EU law, rules are being introduced on liquidity coverage ratios for 2016 onwards, which will require banks to hold sufficient liquid and high quality assets to tide them over a month of crisis due to the risks they have taken. During a transition period, banks will have to provide information to their national banking supervisor to demonstrate that they respect the criteria and the Commission will fine-tune its assessment methodology to match international practice. A further liquidity ratio (“net stable funding requirement”) is expected in 2018.
The Commission suggests reducing overuse of leveraged debt by introducing a non-risk-based leverage ratio. This would be used by supervisors on an indicative basis, but would not be binding at first. Progress in its application will be assessed before deciding whether to make it compulsory in 2019 or later. The draft legislation introduces further capital requirements for banks that still sell OTC (over the counter) derivatives.
Single rule book. Apart from the capital buffers, all the above measures form part of a draft EU Regulation, which will enable rapid and more uniform implementation of the new EU rules. Barnier said the same rules were clearly needed for everyone in order to reduce banks and companies moving from one country to another to seek the most relaxed legal system. The new legislation scraps the various exemptions from the current directives negotiated by some member states.
In response to opposition from countries like the United Kingdom and Spain to the Commission's push for a high level of harmonisation (see EUROPE 10383), the Commissioner said that supervisors would be able to take account of the specific nature of banking in their countries. Each member state would be able to decide on the parameters that would apply to risks like mortgage lending, the size of the counter-cyclical buffer and the funding requirements required of more risky financial establishments.
Small business. Pointing out that banks fund around three-quarters of the European economy, Barnier said that he would pay attention to the real economy. Along with EU Industry Commissioner Antonio Tajani, he will be writing to the European Banking Authority (EBA), giving it a year to examine the feasibility of reducing the amount of capital banks must hold to cover loans to small businesses. The weighted risk for such loans is currently set at 75%, which could well be reduced.
The draft legislation introduces new rules to reduce the dependency of bank legislation on credit rating agencies. Barnier said the requirement that banks themselves must do their own credit assessments will be increased, so that they do not solely rely on rating agencies. He added that this was only the first step in the process and new legislation will be unveiled later this year to introduce greater diversity and grater transparency into the financial rating market. (M.B./transl.fl)