22.9.2005   

EN

Official Journal of the European Union

C 234/8

1.1

On 14 July 2004 the European Commission published the proposal for a Directive (1) recasting the second Capital Adequacy Directive (93/6/EEC) and the Consolidated Banking Directive (2000/12/EC). This Directive will implement the new Basel Framework (International Convergence of Capital Measures and Capital Standards) in the European Union. The Recasting Directive will be referred to as the Capital Requirements Directive (CRD) in this paper.

1.2

The CRD will apply to all credit institutions and investment firms active in the European Union. The objective of the CRD is to deliver a highly risk sensitive banking framework in Europe. It will encourage the banking sector to converge over time towards highly sensitive risk-measurement techniques through advances in technology and investment in staff training. It will enhance consumer protection, reinforce financial stability and promote the global competitiveness of the European industry by providing a sound platform for business to expand and innovate through re-allocation of capital.

1.3

The CRD is the legislative instrument used to implement the new Basel Framework in the EU developed by the Basel Committee for Banking Supervision. The Basel Committee was established in 1974 by the central-bank Governors of the G10 countries. Agreements published by the Basel Committee are not legally binding, but are intended to provide a common supervisory framework to encourage convergence towards common approaches and to facilitate a level playing field for internationally active banks.

1.4

The Basel Capital Accord (Basel I) was published in 1988 and work began in 1999 to update the Accord in line with rapid development of risk management strategies in the 1990s. The result of this work was the International Convergence of Capital Measures and Capital Standards (2) published in June 2004 (referred to as the new Basel framework).

1.5

The new Basel Framework is divided into three parts commonly referred to as the three Pillars. Pillar 1 sets the minimum regulatory capital requirements for credit, market and operational risk. There is a menu of options of varying degrees of sophistication available to institutions. Pillar 2 is the Supervisory Review Process which is carried out through an active dialogue between the institution and its supervisor to ensure that sound internal processes are in place to assess the capital requirements relating to the risk profile of the group. Pillar 3 requires institutions to disclose their capital charges to the market. Pillar 3 is often referred to as market discipline as disclosure will incentivise best practices and will raise investor confidence.

1.6

A menu of options for the measurement of both credit and operational risk, and for the mitigation of credit risk, is available to banks and investment firms. This is to ensure that the framework is proportionate and that there are incentives for smaller institutions to move to the more advanced approaches. The advanced approaches are more costly to implement as they are based on internal models designed by the institutions. However, they are more risk sensitive and therefore result in lower capital charges.

2.1

The CRD is the legislative tool which implements the new Basel framework in the EU. The Commission has drafted a Directive which is broadly in line with the Basel rules taking account of EU specificities. It is vitally important to deliver a high level of parallelism between the Basel framework and the EU rules to ensure that European banks enjoy a level playing field with their competitors in other jurisdictions implementing the framework.

2.2

A key difference between the CRD and the Basel framework is that the rules will be applied to all credit institutions and investment firms within the EU. The Basel framework is designed for application to internationally active banks. The Commission's widened scope of application is in the interests of both depositors and borrowers in the EU. A well managed and well-capitalised banking system will allow banks to continue to lend through the economic cycle. This will deliver greater stability in the banking sector.

2.3

The benefits for the European banking industry, European business and consumers will only be sustainable if the Directive is sufficiently flexible to keep pace with developments in industry practice, markets and supervisory need. This is necessary to protect the interests of depositors and borrowers and to ensure that the EU maintains its reputation as a best practices market.

2.4

The Commission's approach of defining the enduring principles and objectives in the Articles of the recasting Directive and technical measures in the annexes, which are open to amendments using the comitology procedure, is an effective way to deliver the necessary flexibility.

3.1.1

The Committee believes that, in the context of benefiting all consumers and businesses in the EU, the scope of the Commission's proposal for a Directive is correct. Furthermore, the Committee believes that credit institutions of all sizes stand to benefit from the revised regulatory capital regime. The Commission's text strikes a sensible balance between providing incentives for smaller institutions to move to the more advanced approaches over time and delivering a proportionate framework which takes account of the resource limitations of smaller credit institutions.

3.1.2

The Commission's text also incorporates steps taken by the Basel Committee to reduce the regulatory burden on lending to Small and Medium-sized Enterprises (SMEs). These changes (which are detailed below under the ‘Impact on Small and Medium Enterprises’) are reassuring to the Committee which would otherwise have been concerned that the new framework would have resulted in growing consolidation within the European banking industry and reduced choice for consumers. In this regard the Committee is also reassured to note that the PWC impact study of April 2004 (3) concludes that, if the Directive is implemented consistently across the EU, it is unlikely to have any significant effect on competition in the industry.

3.3.1

The Committee welcomes the changes that have been made to the framework to address the impact on lending to SMEs and the Commission's incorporation of those changes in the European framework. In particular the Committee notes that:

3.3.2

The Committee welcomes the results of the Third Quantitive Impact Study (QIS3) in this regard. The results of QIS3 demonstrated that banks' capital charges on loans to SMEs included in the corporate portfolio will largely remain stable for banks using the standardised approach to credit risk and will decline by an average of between 3 % and 11 % for banks on the internal ratings based approaches (IRB). The capital charge for exposures to SMEs qualifying for the retail treatment will decline by an average of 12 to 13 % under the standardised approach (STA) and up to 31 % under the advanced internal ratings based approach (AIRBA).

3.4.1.1

Article 68 of the Directive requires credit institutions to comply with own funds requirements at individual level within the group. Article 69(1) continues to give Member States discretion to waive this requirement and apply the rules on a consolidated basis to the credit institution and its subsidiaries in the same Member State subject to the group meeting stringent conditions. This discretionary waiver could lock in an unlevel playing field between Member States for internationally active banking groups. The Committee does not feel that this is consistent with the Single Market.

3.4.1.2

Furthermore, where a Member State opted to apply requirements at the level of individual credit institutions, the supervisor's ability to understand the risk profile of a banking group would be undermined. Limiting consolidated supervision to subsidiaries within the same Member State as the parent institution would have the same effect. Therefore, supervision should be applied at the consolidated level as a rule in the EU subject to credit institutions meeting conditions to ensure that own funds are distributed adequately between the parent undertaking and its subsidiaries.

3.4.2.1

Member States have the discretion to set the risk weight for intra-group exposures. This option allows Member States to apply a 0 % risk weight to exposures between a credit institution and its parent undertaking and between a credit institution and its subsidiary or a subsidiary of its parent undertaking. To be eligible for the 0 % risk weighting the counterparty must be established in the same Member State as the credit institution. The Committee believes that a 0 % risk weight is the correct reflection of the risk associated with intra-group exposures. The discretionary approach could lead to credit institutions in some Member States being required to hold capital against intra-group exposures, without a prudential justification for doing so.

3.4.2.2

Limiting the 0 % risk weighting to counterparties within the same Member State would be inconsistent with the Single Market. Intra-group exposures to counterparties in another Member State have the same risk profile as exposures to counterparties within the same Member State. A 0 % risk weighting should be applied for intra-group exposures to counterparties within the EU as a rule.

3.4.3.1

The Basel Committee for Banking Supervision defines operational risk as ‘the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events.’ The operational risk charge in the new Basel framework is being introduced for the first time and consequently financial institutions must develop entirely new operational risk measurement systems. As detailed above, there is a menu of options available for the measurement of operational risk. The Advanced Measurement Approach (AMA) requires banks to develop internal measurement models which must be validated by the competent authorities. European financial institutions have invested heavily in developing these systems on a group-wide basis, aligning the measurement of operational risk with the business lines in which they are active.

3.4.3.2

In Article 105(4) Member States have discretion to allow credit institutions to meet the qualifying criteria for the Advanced Measurement Approach for operational risk at the top level within the EU group. Application of the AMA at the consolidated group level within the EU is in line with the business lines approach to operational risk management put in place by the European banking industry. If banks could not meet the requirements at the level of the EU group it would be impossible to provide an accurate reflection of the operational risk profile of the group. The requirements should be met by the parent institution and its subsidiaries considered together if the group can demonstrate that there is adequate distribution of operational risk capital throughout the group.

3.5.1

The Committee agrees with the European Commission that the increasing degree of EU cross-border business and the centralisation of risk management within cross-border groups reinforces the need for improved coordination and cooperation amongst national supervisory authorities in the EU. The development of an established role for the consolidating supervisor in the proposal for a Directive respects the role of national competent authorities whilst providing a single point of application (e.g. for approval of the Internal Ratings Based Approach for credit risk and the Advanced Measurement Approach for operational risk) for institutions.

3.5.2

The Committee believes that the consolidating supervisor model should be extended to both the Supervisory Review Process under Pillar 2 and the disclosure requirements under Pillar 3. Both Pillars should be applied at the top consolidated level in each group in the EU. If Pillars 2 and 3 are applied at the individual level they will not reflect the risk profile of the group as a whole. In the case of the Supervisory Review Process under Pillar 2 this would lead to subsidiaries of a group being subject to inconsistent supervisory treatment across the EU and the objective of enhancing the understanding of the group's risk profile would be jeopardised. This would not be in the interests of depositors and borrowers. If Pillar 3 is not applied at the level of the group, investors will not benefit from the disclosures in the context of understanding the financial health of the group as a whole.

3.11.1

IFRS accounts provide high-quality data which are, in general, reliable. They should, therefore, be taken as a starting point for the definition of regulatory capital. Using IFRS as the basis for capital adequacy treatment also contributes to establishing a level playing field among institutions and increases comparability. Furthermore, a high level of consistency between IFRS and capital adequacy rules is likely to avoid confusion among market participants and makes internal procedures easier and more cost effective.

3.11.2

The Committee believes that the convergence between both sets of rules should, ideally, enable banks to maintain one single set of figures and base for all financial and regulatory reporting requirements. However, regulators may take different views in specific circumstances, particularly where Accounting Standards do not reflect risk exposures in an adequate way. Therefore, regulators will need to make some adjustments to the accounting results. If one or several of the objectives of the new capital adequacy framework were compromised by the treatment provided by the accounting standard setters, prudential filters will be needed in order to assess regulatory capital. For operational reasons these adjustments, the so-called Regulatory Accepted Accounting Principles, should be limited to significant items only.

3.11.3

Against this background the Committee welcomes the filter which has been included by the Commission in Article 64(4) of the proposal for a Directive in line with the position of the Basel Committee. The Committee also welcomes the ongoing work of CEBS in developing prudential filters.

4.1

The proposal for a Directive is currently in its First Reading in the Council of Ministers and the European Parliament. The Committee feels that the emphasis now should be on agreement of a flexible Directive that is consistent with the Basel framework and encourages convergent application across the EU.

4.2

It is important that the Directive is agreed relatively quickly to ensure that the benefits of the industry's €20 billion to maximum €30 billion investment in improved risk management systems is realised. Delayed implementation would put the European banking industry at a competitive disadvantage in the global market. This would not be in the interests of Europe's depositors and borrowers. However, the quality of the legislation must take precedent and the views of all interested parties must be taken into account by the co-legislators.