EN Official Journal of the European Union C 234/8

Opinion of the European Economic and Social Committee on the Proposal for Directives of the European Parliament and Council re-casting Directive 2000/12/EC of the European Parliament and Council of 20 March 2000 relating to the take up and pursuit of the business of credit institutions and Council Directive 93/6/EEC of 15 March 1993 on the capital adequacy of investment firms and credit institutions

(COM(2004) 486 final — 2004/0155 and 2004/0159 (COD))

(2005/C 234/02)

On 13 September 2004, the Council decided to consult the European Economic and Social Committee, under Article 95 of the Treaty establishing the European Community, on the abovementioned proposal.

The Section for the Single Market, Production and Consumption, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 14 February 2005. The rapporteur was Mr Ravoet.

At its 415th plenary session of 9 and 10 March 2005 (meeting of 9 March), the European Economic and Social Committee adopted the present opinion by 124 votes to 1.

1. Content and scope of the proposal

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. Pillar 1 Credit Risk Operational Risk Pillar 2 Pillar 3 Internal models Advanced Internal Ratings Based Approach (AIRBA) Advanced Credit risk mitigation Advanced measurement approach (AMA) Standard Approaches Foundation Internal Ratings Based Approach (FIRBA) Standardised Credit risk mitigation Standardised Approach (STA) Standardised Approach (STA) Basic Indicator Approach (BIA)

2. General Observations

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. Specific observations

The Committee congratulates the Commission for the high quality of the proposal for a Directive. There are a limited number of issues which the Committee feels must be addressed. The quality of the draft legislation reflects the unprecedented level of consultation, including participation in the Basel Committee's impact studies, carried out by the Commission during the process of converting the Basel rules into the EU law. As the representative body for organised civil society in the EU, ECOSOC commends this development and urges the co-legislators to continue to incorporate the views of market participants in the EU legislative process.

3.1 Impact on smaller credit institutions within the EU

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.

3.2 Impact on consumers

The financial stability and greater risk sensitivity provided by the new rules will benefit consumers through increased confidence in the financial system and significantly reduced systemic risk. According to the PWC impact study, the move to a more risk-sensitive regime will reduce overall bank capital held which will in turn precipitate a slight improvement in GDP in the EU. The better targeting of capital in the economy will contribute to the delivery of the EU's wider economic and social objectives.

3.3 Impact on Small and Medium-sized Enterprises (SMEs)

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: — there has been a reduction in the capital charges for loans to small businesses achieved through a flattening of the retail curve; — some banks treat their exposures to SMEs as retail exposures and can now administer these exposures on a pooled basis as part of their retail portfolio; — the Basel Committee has eliminated the granularity requirements for loans to small business allowing more banks to enjoy the preferential treatment; and — there has been a wider recognition of collateral and guarantees in the new framework.

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 Removing national discretions in the European Union

The consistent application of proportionate supervisory rules by the Member States would deliver both sound prudential supervision and Single Market objectives. The number and scope of national discretions in the proposed Capital Requirements Directive would undermine consistent application. The Committee firmly believes that national discretions should generally be removed in a defined time frame and welcomes the work that the Committee of European Banking Supervisors (CEBS) is doing in this regard. There are a number of national discretions which could significantly distort the Single Market for cross-border banking groups and which will result in instability in the financial system. This would therefore reduce the benefits of the overall framework for depositors and borrowers in the EU by increasing the cost of credit and by limiting choice in financial products.

3.4.1 Level of application of capital requirements

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 Intra-group Exposures

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 Advanced Measurement Approach for Operational Risk (AMA)

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.

3.4.4 Exposures to institutions under the Standardised Approach to credit risk

Parallel to the new Basel framework, Member States have the discretion to apply one of two methods for determining the risk weight for exposures to institutions (Annex VI, paragraphs 26-27 and 28-31). The approach applied to a credit institution would be determined by its nationality rather than by prudential reasons. Credit institutions operating across borders could be subject to materially different treatment to competitors operating in the same market. This would be inconsistent with Single Market objectives. Therefore, a single approach should be applied in the EU.

3.4.5 Maturity adjustment

Parallel to the new Basel framework, Member States have discretion to apply the effective maturity formula (paragraph 12, part 2, Annex VII) for credit institutions on the Advanced Internal Ratings Based Approach also to institutions on the Foundation Approach. The effective maturity formula aligns the measurement of the capital charge for short-term products more closely with their actual risk profile. Credit institutions operating across borders could be subject to materially different treatment to competitors operating in the same market. Again the Committee believes this to be inconsistent with the Single Market objectives. The national discretion should be removed to ensure that all credit institutions on the Foundation IRB Approach are subject to the same treatment.

3.5 Supervisory cooperation, Pillar 2 and Pillar 3

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.

3.6 Treatment of Investment Firms

The Committee welcomes the inclusion of investment firms in the European framework. It is important for the stability of the European financial system, which is increasingly dependent on the performance of financial markets. The Committee believes that where credit institutions and investment firms are exposed to the same risks they should be subject to the same rule as far as possible.

3.7 Supervisory Disclosure

The Committee fully supports the introduction of a supervisory disclosure regime in the proposal for a Directive. Supervisory disclosure will encourage convergence in the Single Market and inform debate on any necessary changes to the EU capital requirements framework. It will also help to identify material divergences in implementation of the Directive. Delivering a level playing field across the EU is in the interest of both banks and consumers.

3.8 The Trading Book Review

The Basel Committee is undertaking jointly with the International Organisation of Securities Commissions (IOSCO), the international body which cooperates on financial market regulation, a review of counterparty risk and Trading Book issues (4). The Committee broadly welcomes the commitment by the Commission to ensure that the results of the Trading Book Review are reflected in the Directive before its implementation. The Committee agrees that the work on double default and counterparty risk should be completed rapidly and incorporated in the Directive using the legislative tools at the disposal of the Commission. However, the matter of the boundary between the Trading Book and the Banking Book is extremely technical and should not be subject to hasty treatment. Incomplete work on this vitally important matter could have a negative impact on European investors in the future. The Committee would welcome a more thorough review of this issue and incorporation into EU legislation at a later date.

3.9 Implementation dates

The Committee believes that the implementation dates of the Directive should be 1 January 2007, rather than 31 December 2006, for the standardised approach and 1 January 2008, rather than 31 December 2007, for the advanced approaches. The requirement to implement the Directive on 31 December would result in burdensome reporting requirements.

3.10 Cyclicality

There are serious concerns that the new framework could have a pro-cyclical effect. This would result in banks limiting lending in times of economic downturn due to the greater levels of capital required in an increasingly risky environment. Although limitations on the availability of credit in periods of stress are inevitable, an increase in these limitations could aggravate recessional tendencies in the economy. The Committee firmly welcomes the requirement under the Capital Requirements Directive to stress-test throughout the economic cycle. The intention to keep the pro-cyclical impact of the framework under review through biennial reports drawn up by the European Commission and submitted to the European Parliament and Council is the minimum action which should be taken regarding pro-cyclicality.

3.11 Impact of IFRS on Regulatory Capital

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. Conclusion

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.

Brussels, 9 March 2005. The President of the European Economic and Social Committee Anne-Marie SIGMUND

(1) http://europa.eu.int/comm/internal_market/regcapital/index_en.htm

(2) http://www.bis.org/publ/bcbs107.pdf

(3) PriceWaterhouseCoopers was commissioned to carry out the study on Financial and Macroeconomic Consequences of the Proposal Directive by the European Commission.

(4) Financial Institutions have two primary categories for their assets, the ‘banking book’ and the ‘trading book.’ Most long to medium-term transactions are booked through the banking book (loans, deposits, etc.), while the trading book is a proprietary portfolio for short-term financial instruments held by an institution in its capacity as a dealer. Investment banks place virtually all their financial instruments into the trading book. The boundary between the Banking Book and the Trading Book has never formally been defined.