Opinion of the European Central Bank of 17 February 2005 at the request of the Council of the European Union on a proposal for directives of the European Parliament and of the Council recasting Directive 2000/12/EC of the European Parliament and of the Council of 20 March 2000 relating to the taking 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 (CON/2005/4)
Date: 2005-02-17
Institutions: European Central Bank
Subjects: banking, credit control, credit institution, financial legislation, investment company, law of banking

2.3.2005

EN

Official Journal of the European Union

C 52/37

EUROPEAN CENTRAL BANK

OPINION OF THE EUROPEAN CENTRAL BANK

of 17 February 2005

at the request of the Council of the European Union on a proposal for directives of the European
Parliament and of the Council recasting Directive 2000/12/EC of the European Parliament and of
the Council of 20 March 2000 relating to the taking up and pursuit of the business of credit institu-
tions and Council Directive 93/6/EEC of 15 March 1993 on the capital adequacy of investment
firms and credit institutions

(CON/2005/4)

(2005/C 52/10)

from the Council of

1. On 15 September 2004, the European Central Bank (ECB)
received a request
the European
Union for an opinion on a proposal for two directives of
the European Parliament and of the Council (1): the first
the ‘proposed banking directive’)
directive (hereinafter
recasting Directive 2000/12/EC of the European Parliament
and of the Council of 20 March 2000 relating to the
taking up and pursuit of the business of credit institu-
tions (2) and the second directive (hereinafter the ‘proposed
capital adequacy directive’)
recasting Council Directive
93/6/EEC of 15 March 1993 on the capital adequacy of
investment
(hereinafter
together the ‘proposed directives’).

firms and credit

institutions (3)

standards

international

convergence of
for

institutions and investment firms. They will ensure the
the EU of the revised
coherent application throughout
framework for
capital
measurement and capital
internationally
active banks (4) (hereinafter ‘Basel II’) agreed in June 2004
by the Basel Committee on Banking Supervision (BCBS)
and endorsed by the central bank governors and heads of
bank supervisory authorities in the Group of Ten coun-
tries. In particular, the proposed directives provide for a
more comprehensive and risk-sensitive approach, fostering
enhanced risk management by financial institutions, which
will contribute to financial stability, inspire confidence in
financial institutions and strengthen consumer protection.

2. The ECB's competence to deliver an opinion is based on
the first indent of Article 105(4) of the Treaty establishing
the European Community, which provides that the ECB
shall be consulted on any proposed Community act in its
fields of competence. The proposed directives contain
provisions which are essential for the soundness and stabi-
lity of the financial system. In accordance with the first
sentence of Article 17.5 of the Rules of Procedure of the
the Governing Council has
European Central Bank,
adopted this opinion.

3. The proposed directives are essential components of the
Financial Services Action Plan. Their objective is to moder-
nise the existing capital adequacy framework for credit

(1) COM(2004) 486 final, Volumes I and II and Annexes techniques.
(2) OJ L 126, 26.5.2000, p. 1 (hereinafter the ‘Consolidated Banking
Directive’). Directive as last amended by Commission Directive
2004/69/EC (OJ L 125, 28.4.2004, p. 44).

(3) OJ L 141, 11.6.1993, p. 1 (hereinafter the ‘Capital Adequacy Direc-
tive’). Directive as last amended by Directive 2004/39/EC (OJ L 145,
30.4.2004, p. 1).

4. In its previous contributions (5), the ECB has been very
supportive of the work of the BCBS and the European
Commission over recent years to establish a revised set of
rules on capital adequacy for credit institutions and invest-
ment firms. The ECB welcomes the fact that the BCBS
reached a final agreement on Basel II. It also welcomes the
fact
the Commission shortly afterwards adopted
proposals which will ensure a consistent and timely imple-
mentation of Basel II by internationally active banks and
investment firms in the EU, and will also extend the Basel
II approach to other EU financial institutions, taking into
account their specific features.

that

(4) Basel Committee on Banking Supervision,

‘International Conver-
gence of Capital Measurement and Capital Standards: A Revised
Framework’, Bank for International Settlements (BIS), June 2004;
available on the BIS's website.

(5) See in particular the comments of the ECB on the BCBS's second
consultative package of 31 May 2001, the reply of the ECB to the
BCBS's third consultative proposals (CP3) of August 2003, and the
comments of the ECB on the third consultative document of the
European Commission on regulatory capital review (hereinafter the
‘third consultative document’) of November 2003; documents all
available on the ECB's website.

C 52/38

EN

Official Journal of the European Union

2.3.2005

5. The ECB is convinced that the proposed directives, once
properly transposed by the Member States, will consider-
ably strengthen the soundness and stability of
the EU
banking system through the application of more sophisti-
cated, risk-sensitive capital standards. The ECB therefore
stresses its generally positive view of the proposed direc-
tives. However, without prejudice to this general view, the
ECB has a number of general and specific remarks with
regard to the proposed directives and their future applica-
tion (1).

GENERAL REMARKS

Legal

instruments for consistent implementation across

the EU

6. The ECB has on several occasions,

in particular in ECB
Opinion CON/2004/7 on the proposed committee struc-
ture directive (2) (which aimed to introduce into a number
of existing Community directives the required amendments
for the extension of the ‘Lamfalussy process’ for financial
regulation from the securities sector to all other financial
sectors), supported the recommendations of the Inter-Insti-
tutional Monitoring Group to limit Level 1 Community
legal acts to framework principles and use regulations
wherever possible at Level 2. As stated in paragraph 6 of
ECB Opinion CON/2004/7, the ECB considers that imple-
mentation of
the Inter-Institutional Monitoring Group's
recommendations could gradually lead to Level 2 acts
emerging as the main body of technical rules applicable to
EU financial institutions.

7. In the same vein, in its comments on the third consultative
document, the ECB suggested that in order to implement
Basel II the technical annexes to the proposed directives
should be adopted directly as Level 2 measures, and, where
compatible with necessary flexibility in terms of national
implementation, via Community regulations.

8. In the ECB's view, the implementation of Basel II offered a
unique opportunity to revise EU capital
requirements
along these lines, which has not been seized. The ECB
acknowledges that pursuant
the
proposed banking directive, the Commission will have the

to Article 150(1) of

(1) It is noted that at its meeting on 7 December 2004 the ECOFIN
Council agreed on a general approach regarding the proposed direc-
tives (hereinafter the ‘Council's general approach’). It requested the
Presidency of the Council to continue contacts with representatives
of the European Parliament in order to explore the possibility of
adopting the proposed directives at the first reading. The Council's
general approach also addresses some of the issues that the ECB
raises in this opinion. Where appropriate, reference is made to the
Council's general approach.

(2) ECB Opinion CON/2004/7 of 20 February 2004 at the request of
the Council of the European Union on a proposal for a Directive of
the European Parliament and of the Council amending Council
Directives 73/239/EEC, 85/611/EEC, 91/675/EEC, 93/6/EEC and
94/19/EC and Directives 2000/12/EC, 2002/83/EC and 2002/87/EC
of the European Parliament and of the Council, in order to establish
a new financial services committee organisational structure (OJ C
58, 6.3.2004, p. 23).

power to adopt, in accordance with the ‘comitology’ proce-
dure referred to in Article 151 of the proposed banking
directive, ‘adjustment[s] of the provisions in Annexes V to
XII in order to take account of developments on financial
markets
in
accounting standards or requirements set out
in Com-
munity legislation’.

in particular new financial products, or

9. However, in line with the agreement to extend the Lamfa-
lussy process from the securities sector to all other finan-
cial sectors (3),
it would have been preferable to have
limited the proposed directives to cover framework princi-
ples reflecting the basic political choices and substantive
matters in the field of capital adequacy for credit institu-
tions and investment firms and to have brought the tech-
nical provisions on capital adequacy together
in one
directly applicable Level 2 regulation. This approach would
reinforce
II
a
implementation of Basel
facilitate compliance by financial
throughout
groups operating across different EU countries and reduce
costs, as well as promoting a level playing field and further
financial integration.

convergent

the EU,

10. If it is considered that the proposed directives cannot at
this stage be amended in line with this approach, the ECB
considers that the envisaged legal structure should not be
viewed as the final desirable outcome, but rather as one
step in a long-term process towards establishing, whenever
possible, a directly applicable set of Level 2 technical rules
for financial institutions within the EU.

The reduction of national options and national discretion

11. The reduction of national options is of the utmost impor-
tance, as this would simplify the regulatory framework,
assist the convergence of supervisory practices and contri-
bute to a level playing field. The ECB recognises the
progress that has been achieved by the Committee of Euro-
towards reducing the
pean Banking Supervisors (CEBS)
number of options and waivers.
fully supports the
It
endeavours of CEBS and strongly encourages further work
in this field as, despite the progress achieved, a significant
number of options remain which potentially hinder a level
playing field. Articles 68 to 73 of the proposed banking
directive contain options to waive capital requirements at

(3) See page 12 of the press release of the 2 580th ECOFIN Council
Meeting held in Brussels on 11 May 2004; available on the Council's
website.

2.3.2005

EN

Official Journal of the European Union

C 52/39

various levels within groups. In the ECB's view,
if these
options are considered too important to dispense with in
some jurisdictions, there should at least be convergence
and transparency on the situations in which they are exer-
cised, to ensure a level playing field in the EU. Given the
need for a further reduction in national options, the ECB
would support the introduction of a specific provision
requiring the Commission to monitor the progress made
in this direction and, within a reasonable period of time
(e.g. three years), to report to the Community institutions
on the use of residual national discretion, assessing how
necessary it is and whether there is a need for further regu-
latory initiatives.

12. The general wording of several provisions of the proposed
directives leaves a substantial margin for divergent inter-
pretations by national authorities, thereby creating the risk
of there not being a level playing field throughout the EU.
A specific, but not unique, example of
this issue is
Article 84(2) of the proposed banking directive, which
provides that the competent authorities may allow the use
of the Internal Ratings Based Approach (hereinafter the
‘IRB Approach’) by a credit institution if its systems for the
management and rating of credit risk exposures comply
with a number of conditions (such as being ‘sound’, ‘imple-
mented with integrity’ and providing for a ‘meaningful
assessment’). This article refers to additional conditions laid
down in Part 4 of Annex VII to the proposed banking
directive, which leave a large degree of discretion to
implementation. While the ECB acknowledges
national
that it is sometimes necessary to use wording which leaves
a significant degree of discretion to national authorities
(for instance in order not to hamper the development of
risk management practices in credit institutions or to facili-
tate flexible transposition and application taking into
account
structures of national banking
systems or national regulatory regimes), as best practices
emerge in the market it would be beneficial to foster a
consistent interpretation of such terms by the competent
authorities. To this end, the Commission may decide to
issue recommendations based on advice from CEBS.

the different

13. The ECB also recommends the use of consistent termi-
nology to express how the competent authorities can inter-
vene prior to the use of certain risk weights and measure-
techniques. A clear distinction could be made
ment
are
between cases where
expected to communicate a formal administrative decision
upon application by the credit institution and those where
the competent authorities can simply review the proposed
technique without the need to take a formal decision.

competent

authorities

the

Role of the authority responsible for supervision on a
consolidated basis

14. The ECB considers that enhancing the role of the authority
responsible for supervision on a consolidated basis (herein-
after the ‘supervisor on a consolidated basis’), as envisaged

in Articles 129 to 132 of the proposed banking directive,
is a step forward, which may, however, raise complex
issues when the proposed directive is transposed and
applied. The coordinating role provided for in Article
129(1),
together with the provisions on information
sharing laid down in Article 130(2) and Article 132, will
streamline relations between supervisory authorities and
between supervisory
thereby
authorities
increasing efficiency by facilitating the decision-making
process and reducing the overall cost of supervision. This
constitutes an appropriate response to the increasing
demand from banking groups with substantial cross-
border activities (1)
in
meeting supervisory and regulatory requirements imposed
on them by different national supervisors and regulators,
which in some cases overlap or are not fully harmonised.

to reduce the costs they incur

and banks,

15. Furthermore, the ECB expects that the coordinating role
played by the supervisor on a consolidated basis, together
with the explicit requirement
to exchange information,
will contribute to the stability of the banking sector both
at EU and Member State level. From the perspective of the
supervisor on a consolidated basis, enhanced input from
national supervisors regarding the local activities and risks
of EU subsidiaries of a group should be combined to
provide a thorough review and evaluation of the group as
a whole, as required by Article 124 in conjunction with
Articles 71 to 73 of the proposed banking directive. From
the perspective of national supervisors, the information
gathered by the supervisor on a consolidated basis could
make it easier to assess potential financial problems occur-
ring in other entities of a group, which may affect local
subsidiaries. Moreover, the additional information available
to national supervisors should also facilitate the exercise of
central banking functions in the area of financial stability,
payment systems and monetary policy.

16. Article 129(2) of

the proposed banking directive (in
conjunction with Article 37(2) of the proposed capital
adequacy directive) offers an opportunity to foster financial
integration. It lays down a legal basis for group-wide use
of the IRB Approach, Advanced Measurement Approaches
(AMAs) and the Internal Models Approach for market
risks, which is complemented by a procedure streamlining
the group-wide approval process. This should enable align-
ment of group-wide management practices in relation to
compliance with regulatory capital requirements, which
should improve integration of group structures and, as a
consequence, of the banking sector as a whole.

(1) An indicator of the increasing relevance of cross-border activities is
the growing share of non-domestic branches and subsidiaries in
total banking sector assets, which was more than 20 % in 2003. See
the ECB's ‘Report on EU Banking Structure’, November 2004; avail-
able on the ECB's website.

C 52/40

EN

Official Journal of the European Union

2.3.2005

17. Notwithstanding the potential benefits of Article 129(2),
complex issues may arise when it is applied and these need
to be anticipated and resolved in order to maximise its
there are
effect. For instance, problems could arise if
disagreements between the home and host supervisors of
subsidiaries of a group that are considered significant (1)
over the interpretation of the proposed banking directive's
requirements. Even though the third subparagraph of
Article 129(2) requires the supervisor on a consolidated
basis to make a determination in the absence of an agree-
ment between supervisory authorities within six months,
disagreements between home and host supervisors need to
be addressed so as not to undermine the powers of the
competent national supervisory authorities, which have to
rely on the outcome of the group-wide approach at local
level and guarantee a level playing field (2).

II

18. The potential benefits of Article 129(2) also depend on
how the powers of competent national supervisors to
impose supervisory measures on local subsidiaries under
the second pillar of Basel
(the supervisory review
process)
interact with group-wide approval decisions.
Credit institutions filing applications under Article 129(2)
need legal certainty. In this respect, applicable procedures
and review by the courts of group-wide decisions as well
as the ongoing supervision of use of the group-wide IRB
Approach and AMAs deserve attention. The respective
powers of supervisory authorities to rectify shortcomings
in a group's approach, which arise after approval has been
granted, and to withdraw an approval, should therefore be
addressed in the proposed banking directive.

19. Given the importance of the above issues for an effective
application of Article 129(2) of
the proposed banking
directive, the ECB strongly supports the work to be carried
out by CEBS on the application of Article 129 as a whole
and is confident
that consistent application will result.
However,
it recommends inserting a provision into the
proposed banking directive which requires an assessment
and, if necessary, a revision of Article 129 three years after
transposition of the directive in order to take into account
how Article 129 is being applied in practice and whether
it is achieving its ends.

20. The ECB would also support work of CEBS with respect to
Article 131 of
the proposed banking directive, which
requires the supervisor on a consolidated basis and the
other competent supervisory authorities to have ‘written
coordination and cooperation arrangements in place’. The
ECB therefore supports work by CEBS to develop a model
arrangement for coordination and cooperation to be used
by all supervisory authorities concerned.

(1) ‘Significant’ can refer either to the relative importance of the subsidi-
aries for the group as a whole or for the banking system in the host
jurisdiction.

(2) The level playing field could be jeopardised if some banks' IRB
Approaches were validated by the supervisor on a consolidated
basis, whereas for other banks the validation was carried out by the
domestic supervisor.

Timing and transitional provisions

21. The ECB welcomes the provisions on the timing of the
introduction of the new capital requirements in Chapter 1
of Title VII of the proposed banking directive. These provi-
sions mirror the timing provided for in Basel II and should
ensure that European credit institutions are not put at a
disadvantage vis-à-vis their competitors from third coun-
tries. Furthermore, a postponed application would, to a
certain extent, undermine the preparations which EU
credit institutions have made to keep to the initial time-
frame. For these reasons the ECB encourages the Com-
munity institutions to maintain the schedule proposed by
the Commission.

22. Moreover,

the ECB considers that attention should be
given to the far-reaching nature of the reform and the resi-
dual uncertainty about its influence on the level of capital
in the EU financial system as a whole (even if this uncer-
tainty has been reduced as far as possible by quantitative
impact studies). For this reason, the ECB fully supports the
introduction of the transitional requirements in Article 152
of the proposed banking directive, which limit the impact
on credit institutions' minimum capital requirements over
the first three years after transposition of the directive.

23. Notwithstanding the need to base estimations of risk
factors on data histories that are long enough to cover
fluctuating economic conditions,
the transitional provi-
sions should support credit institutions in their transition
to the more sophisticated IRB Approach by temporarily
relaxing certain requirements, which are gradually tigh-
tened as an institution's ability to collect data improves.
This refers to the obligation to have a minimum of five
years' data on historical observations of the probability of
to the
(paragraph 66 of Part 4 of Annex VII
default
proposed banking directive). In that respect, Article 154(5)
of the proposed directive will permit Member States to
apply a reduced two-year data requirement to credit insti-
tutions which have decided to implement
IRB
institu-
Approach before 31 December 2007. However,
tions adopting the IRB Approach after 31 December 2007
must have three years' data by the end of 2008, four years'
data by the end of 2009 and five years' data by the end of
2010. In practice, it will be impossible for them to have
three years' data by the end of 2008 unless they have
already gathered two years' data by the end of 2007. The
ECB consequently considers it desirable to modify this
provision in a way which would realistically allow use of
the IRB Approach to be recognised during the transition
period as well.
the ECB welcomes the
changes to Article 154(5) and (6) set out in the Council's
general approach, which represent a pragmatic solution.

In this regard,

the

2.3.2005

EN

Official Journal of the European Union

C 52/41

Monitoring

structural

the
impacts of the new framework

and possible pro-cyclical

24. The overall structural

impact of the proposed directives
has been an issue of concern stemming, inter alia, from the
challenging task of combining capital neutrality and
increasingly sophisticated approaches. The ECB fully
supports the overall calibration of the regulatory capital
requirements set out in the proposed directives and notes
that the results of a quantitative impact study (QIS3) (1)
covering Member States gave an overall positive assess-
ment regarding the effect on smaller EU credit institutions,
EU investment firms and lending to small and medium-
sized enterprises (which,
it seems, will not be disadvan-
taged by the proposed directives), as well as the preserva-
tion of a level playing field within the EU vis-à-vis compe-
titors from third countries. The ECB also notes the overall
positive assessment provided by a report prepared under
the auspices of the European Commission on the financial
and macroeconomic consequences of the revised capital
requirements (2). However, an ex-ante assessment of the
quantitative impact of
the proposed directives cannot
cover their dynamic effects, given that the behaviour of
financial
institutions may change due to the incentives
provided by different risk weights under the revised as
compared to the current capital requirements. Therefore,
the ECB would support regular ex-post monitoring, which
should also cover the structural implications and the allo-
cation of risks.

25. In addition to monitoring of the general

that

the preferential

impact of the
proposed directives, certain specific features may also
require future monitoring. By way of example, the ECB
observes
treatment available for
commercial real estate lending under the Standardised
Foundation IRB Approach (3) offers
Approach and
enhanced flexibility compared to Basel II. The ECB would
emphasise that the interaction between the availability of
commercial real estate lending and property prices should,
apart from prudent valuation of collateral by banks, also
be subject to close monitoring from a macro-prudential
perspective. The ECB intends to contribute to this moni-
toring process.

26. With regard to the potential pro-cyclical

impact of the
proposed directives (i.e. the possibility that capital require-
ments could tighten during a recession and relax during an
economic upturn, thus exacerbating cyclical swings), the
ECB acknowledges the importance of tackling this issue
and the significant progress made in reducing these

(1) European Commission ‘Review of

the Capital Requirements for
Credit Institutions and Investment Firms, Third Quantitative Impact
Study: EU Results’, 1 July 2003; available on the Commission's
website.

(2) PricewaterhouseCoopers, MARKT/2003/02/F, ‘Study on the financial
and macroeconomic consequences of
the draft proposed new
capital requirements for banks and investment firms in the EU’, 8
April 2004; available on the Commission's website.

(3) The Standardised Approach is described in Articles 78 to 83 of the
proposed banking directive. The Foundation IRB Approach is an
IRB Approach as described in Articles 84 to 89 of the proposed
banking directive, but where a credit institution does not make use
of own estimates of losses given default (LGDs) and/or conversion
factors pursuant to Article 84(4).

concerns by means of adjusting the proposed directives to
limit pro-cyclical effects. Indeed, EU supervisory authorities
have a common interest in considering appropriate ways
to reduce the risk of heightened pro-cyclicality, since
macroeconomic conditions are gradually becoming more
closely interwoven, particularly in the euro area. A
common approach to addressing pro-cyclicality would also
support a level playing field and transparency in the single
market. However, the ECB still considers monitoring by
the Commission and the competent national authorities to
be necessary.

27. Therefore,

the proposal

the ECB supports

the
that
Commission should periodically monitor whether
the
proposed banking directive has significant effects on the
economic cycle, as set out in Article 156 thereof. Further-
more, the ECB observes that it is the Commission's prero-
gative to adopt proposals for any amendment to the recast
Consolidated Banking Directive, and that this also applies
to the possible legislative ‘remedial measures’ mentioned in
Article 156. However, from a macro-prudential perspective
it is crucial that possible legislative ‘remedial measures’ are
of a symmetric nature and that capital standards are only
changed when the adjustment is prudentially sustainable
through the entire cycle. The ECB suggests explaining this
need in recital 59 to the proposed banking directive.

SPECIFIC REMARKS

Definition of central banks

28. The ECB sees a need to clarify its status regarding the
exemption of central banks from the proposed banking
directive. The first indent of Article 2 exempts ‘central
banks of Member States’ from the scope of the proposed
banking directive, while Article 4(23) defines the term
‘central banks’ (as opposed to ‘central banks of Member
States’) to include the ECB unless otherwise indicated. The
ECB proposes amending Article 2 to indicate expressly
that the exemption also applies to the ECB.

Solo consolidation

29. Article 70 of the proposed banking directive gives the
competent authorities the possibility to allow, on a case-
by-case basis and subject
to certain conditions, parent
credit institutions in a particular Member State to incorpo-
rate subsidiaries located in the EU into the calculations
required by Article 68(1) of the proposed banking direc-
tive. This process is referred to as ‘solo consolidation’.

C 52/42

EN

Official Journal of the European Union

2.3.2005

30. The ECB recommends reconsidering the conditions under
which solo consolidation (1) may be applied. One of these
conditions is in Article 69(1)(a) of the proposed banking
directive, which requires that there are no impediments to
the transfer of own funds from the parent undertaking to
the subsidiary. In the ECB's view this is not an appropriate
condition to impose on the parent undertaking in the
context of solo consolidation requirements. In this regard,
the ECB strongly welcomes the fact that the changes to
Article 70 of the proposed banking directive set out in the
Council's general approach will impose requirements with
respect to the availability of own funds from the subsidiary
to the parent undertaking and remove the requirement
that there must be no impediments to the transfer of own
funds from the parent undertaking to the subsidiary. The
ECB notes that solo consolidation would extend to subsidi-
aries located in Member States other than that of the
parent undertaking. In practice this implies that a subsi-
diary's
treated for capital
adequacy purposes as if it were part of the parent underta-
king's own financial position. The parent undertaking's
supervisor must therefore have full access to information
regarding the quality of the assets, liabilities and capital of
the subsidiary. The ECB suggests adding a further criterion
to ensure
supervisory
authority can effectively verify such information regarding
the financial position of subsidiaries located in another
Member State. As a matter of principle,
the ECB also
strongly supports transparency on the use of Article 70 of
the directive and welcomes the provisions to this end set
out in the Council's general approach.

financial position will be

the parent undertaking's

that

The ECB emphasises that all exposures to credit risk
should be subject to adequate capital requirements. The
conditions under which the exemption pursuant to Article
80(7) applies do not eliminate credit risk in the lending
transactions concerned given that, for example, one credit
institution may fail to meet its obligations vis-à-vis another
credit institution controlled by the same parent under-
taking. In addition, the ECB notes that Article 80(7) will
primarily apply to interbank lending where capital require-
ments are essential to limit systemic risks. The ECB further
notes that such an exemption is not available under Basel
II (3) and could, in certain banking systems, affect the level
the ECB
playing field at national
recommends that this form of lending remains subject to
capital requirements.

level. Consequently,

External Credit Assessment Institutions

31. The ECB notes that Article 70 of the proposed banking
directive does not question the application of individual
capital requirements to EU subsidiaries incorporated into
the parent credit
institution's individual capital require-
ments. It would be beneficial to clarify that Article 70 is
without prejudice to the requirements imposed by Article
68 on the subsidiaries concerned.

33. As regards the recognition of External Credit Assessment
the ECB would like to raise three

Institutions (ECAIs),
issues.

Capital requirements for intra-group interbank lending

32. Article 80(7) of the proposed banking directive allows the
competent authorities, under certain conditions, to exempt
lending by a credit institution to its parent undertaking, to
its subsidiary or to other subsidiaries of the same parent
undertaking from capital requirements for credit risk (2).

(1) Solo consolidation is an element of the proposed banking directive
which is not addressed in Basel II. Paragraph 23 of Basel II requires
supervisors to test that ‘individual banks are adequately capitalised
on a stand-alone basis’.

(2) This exemption only applies

to the Standardised Approach;
however it may also be applied to credit institutions by means of a
specific type of permanent partial use (Article 89(1)(e) of
the
proposed banking directive).

34. First, the ECB sees scope for further specification of the
requirement of ‘independence’ in Section 1.2 of Part 2 of
Annex VI to the proposed banking directive. In the assess-
ment process, competent authorities should take into
account factors such as the ownership and organisation
structure of the ECAI, its financial resources, staffing and
expertise, as well as its corporate governance. In the ECB's
view,
the competent authorities should also verify that
ECAIs have effective internal procedures in place to iden-
tify, avoid and manage potential conflicts of interest, thus
ensuring that confidential information is not inadvertently
disseminated, disclosed or misused. These issues are widely
recognised as key policy concerns and are acknowledged
in the International Organization of Securities Commission
(IOSCO) Statement of Principles Regarding the Activities
of Credit Rating Agencies of 25 September 2003 (4).

(3) Basel II applies to internationally active banks at every layer of a
banking group on a consolidated basis. This means that a subsidiary
which is an internationally active bank will have to hold capital to
cover credit exposures to other group entities that are not its subsi-
diaries. Basel II does not permit a waiver of such capital require-
ments.

(4) Available on IOSCO's website.

2.3.2005

EN

Official Journal of the European Union

C 52/43

35. Second, the ECB would like to highlight the need for a
prudent and fair approach to supervisors' assessment of
the credibility and market acceptance of ECAIs. In particu-
lar, it is important that the competent authorities, when
assessing potential ECAIs, do not create any barriers to
entry for new market players by imposing an unreasonable
burden to meet the criteria set out in Section 2.1 of Part 2
of Annex VI to the proposed banking directive (market
share, revenues and financial resources, impact on pricing).
Instead, competent authorities are invited to properly focus
their evaluation on the robustness and soundness of the
assessment methodology. The relevant provisions should
therefore be developed further so as to allow for a suffi-
ciently differentiated assessment process. In this context,
the ECB would support rewording this section in accord-
ance with Basel II, to ensure that credibility derives both
from market acceptance and sound methodology.

Permanent partial use for certain exposures

37. The ECB notes that, in contrast to Basel II, the proposed
banking directive allows permanent partial use of the IRB
Approach for material exposures and in significant busi-
ness units, under the various circumstances listed in Article
89(1)(a), (b) and (d) to (g) of the proposed banking direc-
tive. The ECB notes that the intention behind restricting
permanent partial use is to avoid banks permanently
the Standardised
treating high-risk exposures under
Approach while using their own estimates of risk para-
meters for lower-risk portfolios, thereby selecting the most
advantageous approach in each case.

institutions and investment

38. The ECB supports making permanent partial use available
to small credit institutions for their exposures to central
governments, credit
firms
because in such cases the application of own estimates
would be overly burdensome,
thus potentially barring
small credit institutions from adopting the IRB Approach.
The position of
is correctly
addressed in a new recital 35A, which is proposed in the
Council's general approach. The ECB recommends that the
Commission should review whether the application of
Article 89 of the proposed banking directive has been
effective in achieving its purpose three years after transpo-
sition of the directive.

small credit

institutions

Consistent treatment of commitments in IRB and Stand-
ardised Approaches

the stability of

39. An inconsistency has emerged between the capital treat-
ment of commitments under the Standardised and Founda-
tion IRB Approaches. The ECB understands that the diver-
gence is unintentional. If not addressed, however, it could
have the effect of creating, under the Foundation IRB
Approach, a capital charge for certain guarantees which
reduce risks and protect
the financial
system by ensuring the completion of settlement in certain
payment systems. The ECB therefore recommends that the
wording in paragraph 1.11(a) of Part 3 of Annex VII to the
proposed banking directive should be rephrased to match
applying to the Standardised
the
Approach,
lines, which are
to state that for credit
uncommitted, that are unconditionally cancellable at any
time by the institution without prior notice, or that effec-
tively provide for automatic cancellation due to deteriora-
tion in a borrower's creditworthiness, a conversion factor
of 0 % shall apply.

equivalent
i.e.

clause

36. Third, the ECB stresses the need for adequate supervisory
convergence and cooperation regarding the recognition of
ECAIs. A high degree of consistency between Member
States' practices will be indispensable to ensure the
comparability of external ratings assessments and a level
playing field for credit institutions making use of these
assessments under the Standardised Approach to credit
risk, and will also help reduce the risk of regulatory arbit-
rage. Moreover, supervisory cooperation will be crucial in
reducing the costs of regulation for those ECAIs which
seek recognition in more than one Member State. At
present, Articles 81(3), 82(2) and 97(3) of the proposed
banking directive only include a discretionary option for
mutual recognition. In line with consistent case-law of the
Court of Justice of the European Communities with regard
to the free provision of services, the ECB considers that
mutual recognition should be the general principle for
ECAIs within the EU. This would not preclude a supervisor
deciding to impose additional eligibility requirements in
order to take account of the specificities of the national
market, as long as such requirements did not duplicate
equivalent conditions already satisfied in the Member State
of origin. The ECB welcomes CESR's consultation paper on
potential regulatory approaches for credit rating agen-
cies (1). It also strongly supports the work currently under-
taken by CEBS to harmonise the criteria for recognition of
ECAIs. The ECB considers that the Mapping Process (set
out in Annex 2 to Basel II) under which, inter alia, national
authorities map credit risk assessments into the available
risk weights is very important, and CEBS should therefore
encourage convergence in this field.

(1) ‘CESR's technical advice to the European Commission on possible
measures concerning credit rating agencies — Consultation Paper’,
30 November 2004; available on CESR's website.

C 52/44

EN

Official Journal of the European Union

2.3.2005

Supervisory review process

Cooperation in an emergency situation

40. The ECB emphasises the importance of the second pillar
being treated as of equal importance to the other Basel II
pillars, namely minimum capital requirements and market
discipline. The ECB considers
the very general
wording of Articles 123 and 124 of the proposed banking
directive, which reflects the second pillar, may wrongly
imply that the three pillars are not of equal importance.

that

44. The ECB welcomes Article 130(1) of the proposed banking
directive, which is particularly important as it establishes
the obligation for the supervisor on a consolidated basis to
notify the authorities mentioned in Article 49(a) and
Article 50 of the proposed directive when an emergency
situation arises which could potentially jeopardise the
stability of the financial system.

the concept of

41. From the ECB's perspective, as there is no definition in the
‘internal
proposed banking directive of
(which is used in Article 123 of the directive),
capital’
supervisors' and credit institutions' understanding of what
internal capital means will need to converge as industry
practice evolves. The ECB considers it desirable to develop
guidance encompassing what credit institutions should do
to fulfil the requirements of Article 123. The ECB is aware
that such guidance can only be developed over time in line
with evolving industry practices and the experiences of
national supervisors and does not insist on a more detailed
definition of internal capital at this stage.

concerns

42. With respect to capital buffers, attention should be drawn
to the BCBS statement of July 2002 which explicitly recog-
nises the importance of capital buffers in relation to poten-
about pro-cyclicality (1). The proposed
tial
banking directive currently does not refer to this issue, and
the ECB suggests referring to it in a recital to the proposed
banking directive, indicating that supervisors should expect
banks to operate with capital buffers so that they can
levels, even under condi-
comply with minimum capital
tions of stress.

ratio above

43. Finally, the ECB notes that a number of Member States
currently fix, under specific circumstances, the minimum
the 8 % threshold stipulated in
capital
Article 75 of the proposed banking directive. An automatic
application of higher capital requirements to certain cate-
gories of institutions is undesirable as divergent minimum
capital ratios endanger the level playing field within the EU
and provide incentives to restructure groups with a view
to regulatory arbitrage between capital regimes.

(1) ‘To help address potential concerns about the cyclicality of the IRB
approaches, the Committee agreed that meaningfully conservative
credit risk stress testing by banks should be a requirement under the
IRB approaches as a means of ensuring that banks hold a sufficient
capital buffer under Pillar Two of the new Accord’, BCBS press
release, 10 July 2002; available on the BIS's website.

45. The ECB understands that Article 130(1) applies to both
the national and EU dimension of the financial system.
Therefore the ECB understands that information has to be
transmitted to the authorities mentioned in Article 49(a) at
either national or cross-border level. This is important as
the progress made in the integration of financial markets
and market infrastructures in the EU, while increasing the
liquidity and efficiency of those markets, may also increase
the likelihood of systemic disturbances affecting more than
one Member State and possibly increase the risk of cross-
border contagion in the EU banking sector. In this context,
the ECB welcomes the fact that Article 130(1) follows a
recommendation of the Economic and Financial Commit-
tee's report on financial crisis management (2) by imposing
an obligation to inform these authorities in a timely
manner in a crisis situation. In order to clarify the scope of
Article 130(1), the ECB would recommend stating that the
obligation to alert the authorities mentioned in Article
49(a) applies to authorities within the EU.

46. The ECB also understands that the reference in Article
130(1) to the authorities mentioned in Article 50 (3)
is
intended to ensure that members of the governments of
Member States responsible for financial services are alerted
of the existence of an emergency situation as soon as
possible. The ECB suggests making this more explicit by
replacing the reference to the authorities mentioned in
Article 50 with an express reference to the ‘competent
government members’, thereby ensuring that there is no
impediment to the transmission of the confidential infor-
mation needed to manage the emergency situation, subject
to the conditions laid down in national and Community
legislation (i.e. when their policy functions are affected by
the emergency situation).

(2) Economic and Financial Committee,

management’ of 17 April 2001, Economic Paper No 156,
2001; available on the Commission's website.

‘Report on financial crisis
July

(3) Article 50 of the proposed banking directive, recasting part of
Article 30(9) of
the Consolidated Banking Directive, permits
Member States to authorise the disclosure of confidential prudential
information to ‘departments of their central government administra-
tions responsible for legislation on the supervision of credit institu-
tions,
services and insurance
companies and to inspectors acting on behalf of those departments’.

institutions,

investment

financial

2.3.2005

EN

Official Journal of the European Union

C 52/45

47. The ECB also strongly supports the wording of Article
130(1) of the proposed banking directive, as it leaves the
authorities involved at both national and EU level appro-
priate scope to define flexible arrangements, which are
necessary in the context of crisis management.
In this
regard,
the ECB would like to draw attention to the
existing arrangements between central banks and supervi-
sors, which specify the principles and procedures for
communication and cooperation in situations of financial
crisis management.
the Memorandum of
Understanding on high-level principles of cooperation
between the banking supervisors and central banks of the
European Union in crisis management situations (herein-
after the ‘MoU’) sets out principles and procedures dealing
specifically with the
the authorities
responsible for crisis management, the required flows of
information between all the involved authorities and the
practical conditions for sharing information at a cross-
border level. The MoU also provides for the establishment
of
infrastructure to support enhanced cross-
border cooperation between authorities (1).

identification of

In particular,

logistical

48. Moreover,

In particular,

the ECB notes that certain initiatives have
already been launched to further develop the crisis
management arrangements under Article 130 of
the
the Banking
proposed banking directive.
Supervision Committee of the European System of Central
Banks and CEBS have established a Joint Task Force on
Crisis Management which will assist the development of
further practical arrangements for handling crises. In this
context, the ECB encourages further work to develop effi-
cient cooperation arrangements. The ECB considers that
smooth interaction between supervisory and central
banking functions will facilitate an early assessment of the
systemic impact of a crisis and contribute to effective crisis
management at both national and EU level.

Consistency with Basel II in the context of operational
risk

49. The ECB notes

that

the provisions of

the proposed
banking directive covering operational risk diverge from
Basel II to a degree that might undermine the level playing
the
field. The ECB therefore
following elements of the proposed directive.

recommends

revising

50. First, the relevant indicator in Parts 1 and 2 of Annex X to
the proposed banking directive, calculated on the basis of
the ‘last six twelve-monthly observations at the middle and
at the end of the financial year’ and the acceptance of esti-
mated figures when audited figures are unavailable,
is
II, which stipulates that yearly
inconsistent with Basel
observations are to be used. The ECB welcomes the fact
that the changes to paragraph 3 of Part 1 and paragraph 5
of Part 2 of Annex X to the directive set out in the Coun-
cil's general approach would align the directive with Basel
II in relation to this issue.

(1) See ECB press release of 10 March 2003; available on the ECB's

website.

51. Second, the proposed calculation of capital requirements
under the Standardised Approach places EU credit institu-
tions at a disadvantage vis-à-vis third country credit institu-
tions under Basel II. In addition, this approach may hinder
the objective of encouraging banks to move from the Basic
Indicator Approach to the Standardised Approach. Basel II
allows negative gross income in certain business lines to
be used to partially offset positive gross income in other
business lines within each year, and thereby achieves
consistency with the Basic Indicator Approach under
which compensation between business lines in each year
occurs as a matter of course. The ECB notes that the
approach chosen in the proposed banking directive is in
fact more prudent. However
the ECB would favour
aligning the proposed banking directive with Basel II.

52. Third,

the requirements in Part 4 of Annex X to the
proposed banking directive deviate from Basel II in that in
principle they allow unlimited permanent partial use of
AMAs. The ECB notes that restrictions on the scope and
duration of
the partial use of AMAs were considered
crucial
in Basel II, to avoid possible regulatory arbitrage
and potential adverse effects on the level playing field. The
ECB shares the BCBS's concerns and recommends that
limits on the partial use of AMAs are put in place as a
general rule and not only on a case-by-case basis.

53. Finally, the transitional provisions incorporated in Article
155 of the proposed banking directive allow for a relevant
indicator of 15 % to be applied to the ‘trading and sales’
business line until 31 December 2012, in cases where this
business line constitutes at least 50 % of the total relevant
indicators. This represents an unwelcome divergence from
Basel II, where no such transitional provision is available.

Legal risk as part of operational risk

54. The ECB notes that Article 4(22) of the proposed banking
directive introduces the concept of
‘legal risk’ as one
element of the wider notion of ‘operational risk’. The ECB
recognises that legal risk is an important category of risk
which has to be taken into account for capital measure-
ment, but it also notes that the concept of legal risk is not
further defined in the proposed directive and could there-
fore become an area of uncertainty and divergent transpo-
sition and application. In this respect, the ECB believes it
would be useful to introduce into the EU framework the
more precise wording of Basel II, which in particular states
that operational risk includes ‘legal risk, but excludes stra-
tegic and reputational risk’ (paragraph 644 of Basel II). The
footnote to this paragraph of Basel II states that ‘legal risk
includes, but is not limited to, exposures to fines, penalties,
or punitive damages resulting from supervisory actions, as
well as private settlements’; this could usefully be repro-
duced in a recital to the proposed banking directive.

C 52/46

EN

Official Journal of the European Union

2.3.2005

institutions.

55. A general definition of legal risk would facilitate proper
risk assessment and risk management, as well as ensure a
consistent approach between EU credit
It
would also be worthwhile examining the extent to which
one should take into account the fact that legal risks are
inherently unpredictable and do not generally conform to
a pattern. In addition, the management of legal risk would
have to be consistent with the management of operational
risk as a whole. For these reasons, the ECB suggest that
CEBS should carry out further work to clarify the defini-
tion of legal risk.

56. The ECB notes that the legal certainty requirements for
credit risk mitigation techniques listed in Annexes VII to
IX to the proposed banking directive can be considered as
mitigating the legal risks involved in the use of these tech-
niques. The reason for this is that these requirements do
not address the calculation of risk-weighted assets directly,
but rather concern the question of whether the credit risk
mitigation techniques have a sound legal
foundation.
However, in the light of paragraph 14 of Section 1.2 of
Part 3 of Annex X to the proposed banking directive, the
ECB understands that losses due to a legal defect in credit
risk mitigation techniques will not be subject to an opera-
tional risk charge if they are treated as credit risk for calcu-
lating the minimum capital requirements.

Capital requirements for certain investment firms

57. Article 20 of the proposed capital adequacy directive gives
the competent authorities the discretion to exempt certain
investment firms from capital requirements for operational
risk. However, recital 22 to the proposed directive stresses

that ‘Operational risk is a significant risk faced by institu-
tions requiring coverage by own funds’. The Commission
included this discretion on the basis of a study published
in July 2004 (1), and the discretion was designed to alle-
viate the impact of operational risk charges on the overall
requirements imposed on investment firms. The ECB notes
that the authors of this study adopted a relatively cautious
stance on the question of whether an increase in capital
requirements on investment firms due to the introduction
of a capital requirement
in respect of operational risk
should be viewed as disproportionate. Furthermore, the
study mentioned that the data used seemed to have been
incomplete. The ECB would also caution that the discre-
tionary and firm-specific nature of the exemptions allowed
under the proposed capital adequacy directive could affect
the level playing field in three respects: between different
types of investment firms; between investment firms of the
same type competing across borders; and between invest-
ment firms and credit institutions. The ECB consequently
suggests that the Commission should in due course review
the effect of
these exemptions and the way they are
applied by competent authorities, and that a provision
should be included in the proposed capital adequacy direc-
tive to reflect this.

Done at Frankfurt am Main, 17 February 2005.

The President of the ECB

Jean-Claude TRICHET

(1) European Commission, ‘Review of the Capital Requirements for EU
Investment Firms — 2004 Quantitative Impact Study — Main
Conclusions’, undated; available on the Commission's website.