Banks have been at the centre of the financial crisis the global economy is facing since 2008. 1Lessons have been drawn from this and mistakes of the past should not repeat themselves. This is why the European Commission has brought forward today proposals to change the behaviour of the 8000 banks that operate in Europe.
The overarching goal of this proposal is to strengthen the resilience of the EU banking sector while ensuring that banks continue to finance economic activity and growth. The Commission’s proposals have three concrete goals.
- The proposal will require banks to hold more and better capital to resist future shocks by themselves. Institutions entered the last crisis with capital that was insufficient both in quantity and in quality, leading to unprecedented support from national authorities. With its proposal, the Commission translates in Europe international standards on bank capital agreed at the G20 level (most commonly known as the Basel III agreement). Europe will be leading on this matter, applying these rules to more than 8000 banks, amounting for 53% of global assets.
- The Commission also wants to set up a new governance framework giving supervisors new powers to monitor banks more closely and take action through possible sanctions when they spot risks, for example to reduce credit when it looks like it’s growing into a bubble.
- By putting together all legislation applicable on this matter, the Commission proposes to have a Single Rule Book for banking regulation. This will improve both transparency and enforcement.
Internal Market Commissioner Michel Barnier said, “The financial crisis has hit European families and businesses hard. We cannot let such a crisis occur again and we cannot allow the actions of a few in the financial world to jeopardize our prosperity. That’s why today, we have brought forward proposals to make the more than 8,000 banks that are active in Europe stronger. The banking sector will have to hold more capital and better quality capital every time it is taking risks It is a tremendously important step forward in learning the lessons from the crisis and adopting a new approach to risk. I am pleased to note that Europe continues to take the lead and is the first jurisdiction at a global level to transpose the G20 commitments. Only when all these rules are in place can we really say we’ve fully learnt the lessons of the crisis”.
The proposal contains two parts: a directive governing the access to deposit-taking activities and a regulation governing how activities of credit institutions and investment firms are carried out. Both legal instruments form a package and should be considered together. The proposal is accompanied by an impact assessment which demonstrates that this reform will significantly reduce the probability of a systemic banking crisis.
- The Regulation contains the detailed prudential requirements for credit institutions and investment firms and it covers:
- capital: The Commission’s proposal increases the amount of own funds banks need to hold as well as the quality of those funds. It also harmonises the deductions from own funds in order to determine the amount of regulatory capital that is prudent to recognise for regulatory purposes.
- liquidity: To improve short-term resilience of the liquidity risk profile of financial institutions, the Commission proposes the introduction of a Liquidity Coverage Ratio (LCR) – the exact composition and calibration of which will be determined after an observation and review period in 2015.
- leverage ratio: In order to limit an excessive build-up of leverage on credit institutions’ and investment firms’ balance sheets, the Commission also proposes that a leverage ratio be subject to supervisory review. Implications of a leverage ratio will be closely monitored prior to its possible move to a binding requirement on 1 January 2018.
- counter party credit risk: consistent with the Commission’s policy vis-à-vis OTC (over the counter) derivatives (IP/10/1125), changes are made to encourage banks to clear OTC derivatives on CCPs (central counterparties).
- single rule book: the financial crisis highlighted the danger of divergent national rules. A single market needs a single rule book. The Regulation is directly applicable without the need for national transposition and accordinly eliminates one source of such divergence. The Regulation also sets a single set of capital rules.,
- The new Directive covers areas of the current Capital Requirements Directive where EU provisions need to be transposed by Member States in a way suitable to their own environment, such as the requirements for access to the taking up and pursuit of the business of banks, the conditions for their exercise of the freedom of establishment and the freedom to provide services, and the definition of competent authorities and the principles governing prudential supervision.
New elements in this directive are:
- enhanced governance: the proposal strengthens the requirements with regard to corporate governance arrangements and processes and introduces new rules aimed at increasing the effectiveness of risk oversight by boards, improving the status of the risk management function and ensuring effective monitoring by supervisors of risk governance.
- sanctions: If institutions breach EU requirements, the proposal will ensure that all supervisors can apply sanctions that are truly dissuasive, but also effective and proportionate – for example administrative fines of up to 10% of an institution’s annual turnover, or temporary bans on members of the institution’s management body.
- capital buffers: it introduces two capital buffers on top of the minimum capital requirements: a capital conservation buffer identical for all banks in the EU and a countercyclical capital buffer to be determined at national level.
- enhanced supervision: the Commission proposes to reinforce the supervisory regime to require the annual preparation of a supervisory programme for each supervised institution on the basis of a risk assessment, greater and more systematic use of on-site supervisory examinations, more robust standards and more intrusive and forward-looking supervisory assessments
Finally, the proposal will seek to reduce to the extent possible reliance by credit institutions on external credit ratings by: a) requiring that all banks’ investment decisions are based not only on ratings but also on their own internal credit opinion, and b) that banks with a material number of exposures in a given portfolio develop internal ratings for that portfolio instead of relying on external ratings for the calculation of their capital requirements.
Today’s proposal replaces the former Capital Requirements Directives (2006/48/EC and 2006/49/EC) with a Regulation and a Directive and constitutes another major step towards creating a sounder and safer European financial system.
In order to restore stability in the banking sector and ensure that credit continues to flow to the real economy, both the EU and its Member States adopted a broad range of unprecedented measures with the taxpayer ultimately footing the related bill. In this context, the European Commission has approved €4.1 trillion of state aid measures to financial institutions of which more than €2 trillion were effectively used in 2008 and 2009.