EU Attempts To Strengthen Europe's Banks
Monday, July 25, 2011

Michel Barnier, the European Commissioner responsible for the Internal Market and Services, has introduced a proposed European Union (EU) joint directive and regulation which, after a long consultation and preparatory process, are aimed at strengthening the resilience of the European banking sector which represents more than 50% of world banking assets.

By adopting the international standards on bank capital most commonly known as the Basel III agreement, the European Commission (EC) proposal will require banks that operate in the EU to hold more and better capital to resist future shocks by themselves. In addition, by putting together all the legislation applicable to bank governance, the EC further proposes to have a ‘single rule book’ for banking regulation, to improve both transparency and enforcement.

Barnier said: "We cannot let (the financial) 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.”

The regulation contains detailed prudential requirements for credit institutions and investment firms, by transposing precisely the new requirements of Basel III. EU banks will be required to hold stronger capital requirements (8% plus two supplementary layers, which each can amount to 2.5%) and, in case of an overheated credit cycle, banks will have to hold a counter-cyclical buffer.

Furthermore, to be able to distribute dividends and bonuses, banks will have to hold a significant capital conservation buffer, and the EC will set-up rules for a liquidity coverage ratio (to be determined, after a review, in 2015) and a leverage ratio for capital and assets. There will also be improved measures to account for counterparty credit risk linked to the exposure to derivatives.

Above all, the EC believes that the financial crisis highlighted the danger of divergent national rules, such that the EU needs a single rule book. For example, the proposals strengthen EU-wide requirements with regard to corporate governance arrangements and processes and introduce 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.

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 – while the EC will reinforce the supervisory regime to require the annual preparation of a supervisory programme for each supervised institution on the basis of a risk assessment.

However, Barnier pointed out that “common rules do not mean that we do not take into account national specificities and the precise risks faced by each bank. As such, our regulation includes all the necessary flexibility to allow supervisors to respond to the risks they identify by setting additional capital requirements at the appropriate level.”

Each member state will be able to set the parameters applicable to some specific risks (for example, real-estate credit), and each member state will also be able to set the exact level of the counter-cyclical security buffer according to its own economic situation. Supervisors will be able to require a bank considered to be more at-risk to hold more of its own capital.

“The important thing,” Barnier stressed, “is that the core requirements, which are not linked to any specific fragility, be the same everywhere. There is no reason for the core prudential rules to be different in Madrid, Warsaw, London, Paris, Rome and Berlin.”

Finally, he disclosed that the new prudential rules will represent a “considerable effort” since EU banks will have to find some EUR460bn (USD654bn) of additional capital, but the effort will take place over period of time from 2013 to 2019, and it is estimated that, with the proposed measures, the probability of severe systemic crises should decrease by 70%.