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))
Date: 2005-03-09
Institutions: European Economic and Social Committee
Subjects: credit guarantee, credit institution, drafting of EU law, financial instrument, financial solvency, management audit, provision of services, share capital

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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
(International Convergence of Capital
Measures and Capital Standards) in the European Union. The
Recasting Directive will be referred to as the Capital Require-
ments Directive (CRD) in this paper.

Framework

1.2
The CRD will apply to all credit institutions and invest-
ment 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
techniques
time towards highly sensitive risk-measurement
through advances
in staff
training. It will enhance consumer protection, reinforce finan-
cial 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.

in technology and investment

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.

The Basel Capital Accord (Basel

1.4
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 Conver-
gence of Capital Measures and Capital Standards (2) published
in June 2004 (referred to as the new Basel framework).

The new Basel Framework is divided into three parts
1.5
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
to move to the more advanced
approaches. The advanced approaches are more costly to
implement as they are based on internal models designed by
they are more risk sensitive and
the institutions. However,
therefore result in lower capital charges.

institutions

smaller

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

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

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Credit Risk

Operational Risk

Internal models

Advanced Internal
Ratings Based
Approach
(AIRBA)

Advanced Credit
risk mitigation

Pillar 1

Standard
Approaches

Foundation
Internal Ratings
Based Approach
(FIRBA)

Standardised
Approach
(STA)

Standardised
Credit risk mitiga-
tion

Advanced
measurement
approach
(AMA)

Standardised
Approach
(STA)

Basic Indicator
Approach
(BIA)

Pillar 2

Pillar 3

2. General Observations

amendments using the comitology procedure,
way to deliver the necessary flexibility.

is an effective

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.

3. Specific observations

A key difference between the CRD and the Basel frame-
2.2
work 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, Euro-
pean 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 Direc-
tive and technical measures in the annexes, which are open to

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
including participation in the Basel
level of consultation,
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 bene-
fiting 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
to move to the more
institutions
incentives
advanced approaches over time and delivering a proportionate
framework which takes account of the resource limitations of
smaller credit institutions.

smaller

for

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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 confi-
dence 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
in the economy will
the EU. The better targeting of capital
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 expo-
sures and can now administer these exposures on a pooled
basis as part of their retail portfolio;

— the Basel Committee has eliminated the granularity require-
ments for loans to small business allowing more banks to
enjoy the preferential treatment; and

— there has been a wider recognition of collateral and guaran-

tees in the new framework.

The Committee welcomes the results of

3.3.2
the Third
Quantitive Impact Study (QIS3) in this regard. The results of
QIS3 demonstrated that banks' capital charges on loans to
largely remain
SMEs included in the corporate portfolio will

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

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 Require-
ments 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
framework for depositors and
borrowers in the EU by increasing the cost of credit and by
limiting choice in financial products.

the overall

3.4.1 L e ve l of a p p li ca t i on of ca p i ta l r e q u i r e me nt s

3.4.1.1
Article 68 of the Directive requires credit institutions
level
to comply with own funds requirements at individual
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 subsidi-
aries 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.

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3.4.2 Intr a -g r ou p E x p osu r e s

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 under-
taking. To be eligible for the 0 % risk weighting the counter-
party 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.

Limiting the 0 % risk weighting to counterparties
3.4.2.2
within the same Member State would be inconsistent with the
Single Market.
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 coun-
terparties within the EU as a rule.

Intra-group exposures

to counterparties

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 E x p osu r e s to i nsti tu ti ons u nde r
di se d A ppr oa ch to c r e di t r i sk

th e St a nda r -

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 pruden-
tial reasons. Credit institutions operating across borders could
to competitors
be subject
operating in the same market. This would be inconsistent with
Single Market objectives. Therefore, a single approach should
be applied in the EU.

to materially different

treatment

3.4.3 A dv a nc e d M e a su r e me nt A p p r oa c h for O p e r a -

ti onal R i sk (A MA)

The Basel Committee

3.4.3.1
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 measure-
ment of operational
risk. The Advanced Measurement
Approach (AMA) requires banks to develop internal measure-
ment models which must be validated by the competent autho-
rities. 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 busi-
ness 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

3.4.5 M a t u r i t y a dj u stme n t

to the new Basel

framework, Member States have
Parallel
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 devel-
opment 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 appli-
cation (e.g. for approval of the Internal Ratings Based Approach
for credit risk and the Advanced Measurement Approach for
operational risk) for institutions.

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3.5.2
The Committee believes that the consolidating super-
visor 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 consoli-
in each group in the EU. If Pillars 2 and 3 are
dated level
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 finan-
cial 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 Interna-
tional Organisation of Securities Commissions (IOSCO), the
international body which cooperates on financial market regu-
lation, 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 implemen-
tation. The Committee agrees that the work on double default

(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 capa-
city 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.

the Commission. However,

and counterparty risk should be completed rapidly and incor-
the
porated in the Directive using the legislative tools at
disposal of
the
the matter of
boundary between the Trading Book and the Banking Book is
extremely technical and should not be subject to hasty treat-
ment. 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 Euro-
pean 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

IFRS accounts provide high-quality data which are, in
3.11.1
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 estab-
lishing a level playing field among institutions and increases
consistency
comparability.
between IFRS and capital adequacy rules is likely to avoid
confusion among market participants and makes
internal
procedures easier and more cost effective.

a high level of

Furthermore,

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the

that
convergence
3.11.2
The Committee believes
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
the new capital adequacy framework were
objectives of
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 adjust-
ments, the so-called Regulatory Accepted Accounting Princi-
ples, 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.

Brussels, 9 March 2005.

4. Conclusion

The proposal for a Directive is currently in its First
4.1
Reading in the Council of Ministers and the European Parlia-
ment. 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 manage-
ment 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.

The President

of the European Economic and Social Committee

Anne-Marie SIGMUND