Brussels, 13/07/2009 (Agence Europe) - On Monday 13 July, the European Commission proposed amending the Basle II directive on banks' capital requirements. This initiative aims to provide national supervisors with the possibility of penalising financial institutions that encourage excessive risk taking through their pay policies. Banks will have to have a coherent pay policy that promotes healthy and efficient risk management. National supervisors will be able to take, “efficient, proportionate and dissuasive” measures that may take the form of financial penalties. Other legislative modifications involve complex securitisation, requirements for own funds linked to trading book risks and transparency in securitisation operations. The Commission hopes that the new rules, to be adopted by codecision, will be applicable from January 2011. The Basle II directive will be the subject of a new draft amendment in October in view of including provisions in it that contribute to dynamic provisioning and limiting leverage effect related debt (EUROPE 9936).
Remuneration. In its proposal, the Commission explains, “under the current European supervisory framework, there is no express requirement that the remuneration policies of financial inst should be subject to supervisory oversight. As a result, supervisory authorities have generally not focused on the implications of remuneration policies for risk and effective risk management”. Moreover, the financial crisis has illustrated ho certain remuneration policies had a pro-cyclical character and exacerbated risk taking in periods of growth, resulting in short term profits for the professionals to the detriment of financial stability. The Ecofin Council has criticised this behaviour. Lending institutions will have to have remuneration policies based on principles (e.g. performance related, balance between the fixed and variable parts of the remuneration package, transparency and the fight against potential conflicts of interest) contained in specific Commission recommendations addressed to member states at the end of April (EUROPE 9892). This does not involve including appropriate remuneration levels into law. Financial establishments will remain in charge of developing their policy that takes into account the kind of activities, organisation and size of operation. Supervisors will ensure that the policies in question are coherent with healthy and efficient risk management. The Committee of European Banking Supervisors (CEBS) will assist them in this exercise. If they observe discrepancies, supervisors could take 'qualitative' measures and request the bank reduce the risks involved in its remuneration policy. These measures could also be 'quantitative' and stipulate a requirement for the firm to hold additional own funds against risk, which according to the Commission, would be a last resort. If national laws permit, financial penalties could also be imposed.
Securitisation. The legislative proposal increases capital requirements for banks that issue complex financial products obtained by re-securitisations. The financial crisis illustrated that these products were more risky than previously thought. “This market stopped with the crisis”, explained one European official. The Commission is therefore proposing an increase in capital requirements linked to the issuing of re-securitised assets. The same expert explained that, “a rating on a triple A re-securitisation will require three times as much capital as a normal securitisation”. If risks increase, an issuer will have to put one Euro in capital aside for one Euro of re-securitised assets, added the same expert. When a bank proves unable to demonstrate due diligence with regard to its re-securitised assets, supervisors will be able to demand a higher level of its own funds. In this respect, CEBS will develop guidelines to define what actually are the most complex re-securitised products.
Trading book. The Commission indicated that “Over 2007-08, it became clear that internal models systematically underestimate the potential loss in stressed conditions. This led to inadequate capital requirements and cyclical volatility of banks' capital as the market environment deteriorated”. It therefore suggests that capital requirements based on internal models be strengthened for the trading book and that they assess: potential losses from deterioration in credit quality short of default; a separate standardised capital charge for the risks of securitisation positions in the trading book.
Transparency. The Commission is ultimately proposing the strengthening of information requirements related to exposure to securitised products. These demands will also apply to securitisation in trading books. (M.B./trans/rh)