REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL Second Report on Effects of Directives 2006/48/EC and 2006/49/EC on the Economic Cycle
Date: 2012-07-17
Institutions: European Commission
Subjects: application of EU law, bank, economic analysis, economic growth, euro area, financial control

EUROPEAN COMMISSION 

Brussels, 17.7.2012  
COM(2012) 400 final 

REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND 
THE COUNCIL 

Second Report on Effects of Directives 2006/48/EC and 2006/49/EC on the Economic 
Cycle 

{SWD(2012) 218 final} 

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TABLE OF CONTENTS 

1. 

2. 

3. 

4. 

5. 

6. 

6.1. 

6.2. 

6.3. 

6.4. 

6.5. 

7. 

8. 

Introduction .................................................................................................................. 3 

Cyclicality of regulatory capital requirements............................................................. 4 

Impact of capital requirements on bank capital levels ................................................. 6 

Impact of bank capital levels on bank lending activity................................................ 7 

Impact of credit availability on the economic cycle .................................................... 8 

Measures to address pro-cyclicality ............................................................................. 8 

Single Rule Book ......................................................................................................... 9 

Countercyclical Capital Buffer (CCB)......................................................................... 9 

Leverage Ratio ............................................................................................................. 9 

Credit Rating Agencies (CRAs)................................................................................. 10 

Small and Medium-sized Enterprises (SMEs) ........................................................... 10 

Conclusions ................................................................................................................ 11 

References .................................................................................................................. 13 

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REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND 
THE COUNCIL 

Second Report on Effects of Directives 2006/48/EC and 2006/49/EC on the Economic 
Cycle 

1. 

1. 

2. 

3. 

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2 

3 

INTRODUCTION 

The  minimum  capital  requirements  for  banks  under  the  EU  Capital  Requirements 
Directive  (CRD)1,  based  on  the  Basel  II  framework,  are  risk  sensitive.  In 
consequence,  as  credit  and  market  risk  increases  in  a  downturn,  minimum  capital 
requirements for banks will also increase to meet those higher risks. Banks may need 
to  raise  additional  capital  to  meet  these  higher  requirements  at  a  time  when  their 
capital resources are being eroded by losses and opportunities for raising capital are 
scarce  and  costly.  This  may  constrain  banks'  lending  capacity  into  the  economy, 
amplifying the downturn. Similarly, during an economic upturn when prices steadily 
rise  and  defaults  decrease,  the  apparent  reduction  in  risk  may  reduce  capital 
requirements  and  increase  lending,  boosting  the  economy  further.  If  the  regulation 
has such an effect it is described as 'pro-cyclical'.  

The  possibility  that  the  CRD  may  contribute  to  the  pro-cyclicality  observed  in  the 
financial system under the predecessor Basel I framework led to the inclusion in the 
CRD  of  Article  1562  which  requires  the  European  Commission  (Commission)  to 
periodically examine whether the CRD has 'significant effects on the economic cycle' 
and to submit a biennial report to the European Parliament and the Council together 
with any appropriate corrective measures.  

The  Commission  prepared  its  first  report  on  pro-cyclicality  in  2010.  This  second 
report is again based on the analysis of the ECB, which was supported by the Impact 
Study  Group  (ISG)  that  was  set  up  jointly  by  the  ESCB  Financial  Stability 
Committee (FSC) and the European Banking Authority (EBA) in 2011 as a successor 
of the Joint Task Force on the Impact of the new Capital Framework (JTFICF). The 
focus of the ECB report was a quantitative analysis of IRB bank data, although there 
is brief discussion of the likely pro-cylicality of the Standardised Approach, included 
in this report.3  

Comprising Directive 2006/48/EC of the European Parliament and of the Council relating to the taking 
up  and  pursuit  of  the  business  of  credit  institutions  and  Directive  2006/49/EC  of  the  European 
Parliament and of the Council on the capital adequacy of investment firms and credit institutions 
In  2009  amended  by  Directive  2009/111/EC  of  the  European  Parliament  and  of  the  Council  of  16 
September 2009 
The  ECB's  quantitative  assessment  includes  quarterly  data  from  Q4  2008  – Q2  2011  from  around 80 
banks using the internal ratings based approach (IRB) for the calculation of their capital requirements. 
Qualitative  assessment  is  based  on  survey  evidence  from  national  supervisory  authorities  and  the 
Eurosystem’s Bank lending Survey (BLS). 

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4. 

Analysing  the  relationship  between  regulatory  capital  requirements  and  the  pro-
cyclical lending of banks remains a complex exercise. As outlined in the first report, 
the main questions to be answered are the following:  

(a) 

(b) 

(c) 

Are capital requirements cyclical? 

If yes, do cyclical capital requirements have an impact on the level of capital 
that banks desire or actually hold? 

If  yes,  does  the  desired  or  actual  level  of  bank  capital  have  an  impact  on  the 
cyclicality of lending? 

(d) 

If yes, does cyclical lending have an impact on the economic cycle? 

On  July  2011,  the  Commission  proposed  a  legislative  package  for  the  reform  of 
banking  regulation,  including  a  directive  (CRD  IV)  and  a  regulation  (CRR).  The 
Commissions'  proposal  includes  some  measures  that  may  mitigate  pro-cyclicality. 
This report concludes with an outlook on the extent to which these counter-cyclical 
policy measures may mitigate the pro-cyclical impacts of the CRD on the financial 
and economic cycle. 

CYCLICALITY OF REGULATORY CAPITAL REQUIREMENTS 

There  is  a  consistent  view  among  the  national  supervisory  authorities  surveyed  by 
the  ECB  in  2011  that  the  CRD  minimum  required  capital  (MRC)  is  more  risk-
sensitive  and  tends  to  be  more  cyclical  than  previous  Basel  I  requirements.  The 
increase of cyclicality in capital requirements is mainly attributed to the higher risk 
sensitivity of the overall framework, in particular as regards the calculation of capital 
requirements under the internal ratings based (IRB) approaches.  

The ECB quantitative analysis examined the extent to which input risk parameters to 
IRB  models,  namely  probabilities  of  default  (PDs)  and  loss  given  default  (LGDs) 
estimations,  and  exposures,  are  correlated  with  macroeconomic  factors,  and  how 
much  this  feeds  through  into  cyclical  MRC.  Their  findings  are  to  be  treated  as 
preliminary indications rather than robust empirical results.4  

The  ECB  found  that  PDs  of  non-defaulted  corporate  and  retail  exposures  tend  to 
increase  more  strongly  with  lower  macroeconomic  activity,  lower  property  prices 
and  higher  unemployment,  fulfilling  one  precondition  for  cyclical  capital 
requirements.  By  comparison,  there  was  a  rather  limited  cyclical  impact  found  for 
LGDs,  likely  to  reflect  that  LGD  values  employed  in  banks'  internal  models  are 
somewhat  stickier  than  respective  PDs  and  thus  may  react  less  immediately  to 
changes  in  the  macroeconomic  environment.  Changes  in  exposure  were  correlated 
with  lagged  changes  in  industrial  confidence  and  consumer  confidence  (indicators 
for  the  economic  cycle)  for  the  corporate  and  retail  portfolio  respectively,  also 

There  remain  two  primary  caveats:  the  implementation  of  the  CRD  is  relatively  recent  (advanced 
models used from 2008) thereby limiting the availability of relevant data over a whole business cycle, 
so the analysis depends on cross country differences in business cycle stages; and the available sample 
period  covers  the  recent  financial  crisis  where  crisis  induced  behavioural  changes  and  policy 
interventions may have distorted general behavioural relationships. 

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2. 

6. 

7. 

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implying  cyclicality:  banks  reduce  exposures  to  these  portfolios  in  the  face  of  an 
adverse economic outlook.  

Overall, the assessment of the input parameters to MRC calculations suggests some 
counterbalancing effects between cyclical risk parameters such as PDs or LGDs on 
the one side and cyclical developments in exposures on the other: in a downturn the 
effect of  a  higher PD may be  offset by a cut back of exposures when combined as 
inputs into the MRC. These counterbalancing effects may render the cyclical effect 
on  overall  MRC  somewhat  unclear  or  even  non-stable  over  time  as  the  speed  of 
adjustments may differ across parameters and portfolios. 

The results of the estimation of changes in overall bank-level MRC do not point to a 
significant relationship between the change in MRC and GDP growth for the overall 
sample  at  the  bank  (rather  than  portfolio)  level.  However,  when  the  analysis  is 
limited to Group 1 banks5 there is a significant correlation between a decline in GDP 
growth and an increase in MRC. This tentatively points to some MRC cyclicality for 
Group 1 banks.  

It  should  be  noted  that  the  dataset  was  limited  to  IRB  banks  with  many  smaller 
Group  2  banks  –  that  use  the  Standardised  Approach  –  excluded.  Therefore,  MRC 
cyclicality for Group 2 banks as a whole may also be significant, although statistical 
evidence for this is beyond the scope of the ECB study (see §13). 

There are indications for some cyclicality of MRC at the portfolio level. For lagged 
GDP  growth,  the  principle  indicator  of  the  economic  cycle,  there  is  a  significant 
negative relationship with the MRC of the corporate portfolio of Group 1 banks only. 
However, there is also a significant negative relationship between lagged commercial 
property  prices  and  the  corporate  portfolio  MRC  for  all  banks  in  the  sample. 

For the retail portfolio, GDP growth also has a relationship with the Group 1 banks 
only, although to a lower significance level. Changes in unemployment rates have a 
significant impact on retail portfolio MRC for the overall sample, with no significant 
difference for Group 1 banks.  

To  summarise,  cyclical  effects  at  portfolio  level  seem  to  be  mitigated  at  the  bank 
level.  As  already  indicated  by  the  findings  on  counterbalancing  cyclical  effects 
among  the  MRC  parameters,  these  mitigations  are  likely  to  be  primarily  due  to 
portfolio  adjustment  concerning  the  size  and  composition  of  banks’  overall 
portfolios. However, the observed reallocations of assets were likely triggered by the 
financial  crisis  rather  than  changes  in  the  underlying  risk  parameters  per  se.  For 
instance, banks may have targeted a higher amount of assets eligible as collateral in 
central bank liquidity operations to improve their liquidity position and to be able to 
benefit from cheap central bank funding. In the absence of the crisis, then, the MRC 
may have been more cyclical.  

An  important  additional  factor  that  may  contribute  to  the  cyclicality  of  minimum 
capital  requirements  derives  from  external  rating  actions  concerning  some  specific 
assets  included  in  bank  balance  sheets.  A  substantial  number  of  banks  in  EU 

A bank is considered a Group 1 bank if its Tier 1 capital is above €3 billion and it is well diversified 
and internationally active. All other banks are classified as Group 2 banks. 

9. 

10. 

11. 

12. 

13. 

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countries apply (fully or partially) the standardised approach (SA) for the calculation 
of  their  capital  requirements.  Since  the  SA  heavily  relies  on  the  use  of  external 
ratings  for  regulatory  purposes,  any  cyclicality  in  external  ratings  would  result  in 
cyclical variations  of  capital requirements as  well.6 Banks  using the SA may be an 
additional and significant force for any CRD-driven pro-cyclicality in bank lending. 

Furthermore,  the  requirements  set  by  credit  rating  agencies  (CRAs)  are  important 
factors in banks’ capital allocation decisions, because banks often aim at maintaining 
or reaching a target rating as a matter of business strategy, which may imply a higher 
and more cyclical capital ratio than that mandated by the CRD. 7  

IMPACT OF CAPITAL REQUIREMENTS ON BANK CAPITAL LEVELS 

The ability and willingness of banks to lend depends in part on the degree to which 
the minimum capital constraints are binding. A pro-cyclical MRC increasing during 
an economic downturn would cut more sharply into a bank's capital buffer above the 
minimum, forcing a prudent bank to seek more capital or alternatively to reduce the 
MRC by cutting lending.  

The academic literature on the behaviour of bank capital buffers over the economic 
cycle  in  general  finds  that  banks'  capital  buffers  above  the  MRC  decrease  when 
business activity goes up, implying excessive risk-taking during economic upswings 
and cutting back lending in downturns.8  

The  ECB  empirical  analysis  finds  slightly  significant  correlations  between  GDP 
growth  and  firm  capital  buffers  implying  the  reverse  behaviour  –  higher  buffers 
during  upswings  and  lower  buffers  in  downturns.  However,  in  view  of  the  short 
sample period and  crisis-driven capital buffer raising in 2010H2 and 2011H1 these 
observations must be treated with caution.9  

Capital levels held by banks can also be driven by anticipation of future regulatory 
requirements.  Future  requirements  cover  the  regulation  set  out  in  “Basel  III” 
agreements, the recent measures of the EBA10 and any other additional national-level 
regulations concerning banks’ capital ratios that have recently been approved or are 
expected to be approved in the near future. Overall, survey indications point to some 

See commentary and charts 1, 2 and 3 in the accompanying Staff Working Document 
See also section 0 
See for example Ayuso, Perez and Saurina (2004), Bikker and Metzemakers (2004), Lindquist (2004). 
Jokipii and Milne (2008) and Stolz and Wedow (2011).  
However the ECB notes that a few theoretical papers (e.g. Heid (2007), Zhu (2008), Jokivuolle, Kiema 
and Vesala (2009) and Repullo and Suarez (2009)) have pointed to the possibility of a change in banks’ 
capital  buffer  behaviour  when  moving  to  a  Basel  II-based  framework.  Banks  may  decide  to  operate 
with  additional  buffers,  and  in  more  forward-looking  manner,  to  insure  against  the  perceived  more 
cyclical MRC. This might give rise to capital buffers that move with the cycle; being higher in upturns 
and vice versa. 
The EBA set capital target for 70 European banks, consisting of two parts to be implemented by June 
2012.  The  first  part  is  a  temporary  capital  buffer  against  sovereign  exposures  at  market  prices  as  of 
September 2011. The second part consists in raising core Tier 1 capital ratios to 9%. 

14. 

3. 

15. 

16. 

17. 

18. 

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19. 

4. 

20. 

notable  impact  of  regulatory  changes  on  both  their  balance  sheets  and  lending 
policies, including credit standards.11  

EBA  has  publicly  disclosed  preliminary  evidence  on  the  recapitalisation  exercise.12 
The  total  actions  give  a  preliminary  aggregated  capital  surplus  of  approximately 
26%. The actions predominantly focus on direct capital measures which account for 
96% of the capital shortfall and for 77% of the total amount of actions proposed. The 
majority of these are capital raising, retained earnings and conversion of hybrids to 
common  equity.  Measures  impacting  risk-weighted  assets  (RWAs)  account  for  the 
remaining  23%  of  total  amount  of  actions.  After  taking  account  of  the  measures 
arising  from  EU  State  Aid  decisions  on  banks  restructuring  or  other  country 
programmes, the impact of actions reducing lending into the real economy would be 
less  than  1%  of  the  total  amount.  However,  the  Commission,  EBA  and  ECB  are 
committed  to  conduct  a  close  monitoring  of  the  deleveraging  process,  whether 
related or not to the recapitalisation plan. In particular, since deleveraging is likely to 
occur with non-core activities and/or outside the home jurisdiction, close home-host 
cooperation within the EU and also outside its borders is important.  

Moreover,  euro  area  banks'  share  of  total  credit  for  Central  and  Eastern  Europe 
(CEE) (47.3%) is high compared with other emerging economies, suggesting a very 
high  level  of  credit  dependence  and  a  particularly  high  sensitivity  to  deleveraging 
decisions of the parent entities. For some specific countries in the region the credit 
supply is controlled almost entirely by euro area banking groups.13  

IMPACT OF BANK CAPITAL LEVELS ON BANK LENDING ACTIVITY 

The large majority of national supervisory authorities stated that there are clear links 
between bank's capital management policies and their loan granting process. In most 
cases the regulatory capital requirements of CRD play an important role. However, 
authorities  have  not  identified  clear  impacts  of  regulatory  capital  requirements  on 
certain asset classes or loan categories. 

Other  drivers  behind  capital  management  policies  make  it  difficult  to  separate  the 
influence of CRD on bank lending. Such drivers include the risk appetite policies of 
banks,  stress  tests,  Pillar  I/II  requirements  and  RAROC14  and  portfolio  growth 
targets.  As  regards  other  supply  and  demand  side  factors  that  may  affect  the 
cyclicality in loan exposures, authorities have divergent views, but these other factors 
are  mostly  seen  as  more  important  than  regulatory  capital  requirements.  Relevant 
factors  for  loan  supply  include  the  macroeconomic  environment  (cost  of  funding, 
availability of capital and liquidity, market confidence) and banks' individual lending 
strategy.  Loan  demand  is  mainly  influenced  by  macroeconomic  conditions  (growth 
rate,  inflation,  unemployment,  income  development,  insolvencies,  consumption 

11 

12 

13 

14 

See charts 4, 5, 6, 7 with some results from the euro area Bank Lending Survey (BLS) on the impact of 
regulatory changes on banks’ lending behaviour. However, it must be emphasised that this is a different 
phenomenon to the pro-cyclicality of existing requirements. 
EBA  website,  9  Feb  2012,  http://www.eba.europa.eu/News--Communications/Year/2012/The-EBAs-
Board-of-Supervisors-makes-its-first-agg.aspx  
See Table 1: EU banking assets and charts 8 and 9 in the SWD for further information and discussion 
on cross-border credit supply. 
Risk adjusted return on capital, a risk-based profitability measure 

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(expectation),  exports  etc.),  but  market  conditions  (interest  rates,  funding 
availability) were also mentioned. Authorities also noted that impairments and write-
offs  of  loans  are  more  cyclical  than  regulatory  capital  requirements  for  performing 
loans.  Fair  value  accounting  and  IFRS  are  also  seen  as  important  drivers  for  bank 
lending activity.  

IMPACT OF CREDIT AVAILABILITY ON THE ECONOMIC CYCLE 

Quantifying the impacts of MRC changes on lending and GDP remains difficult. The 
ECB  reviewed  the  results  of  an  analysis  carried  out  by  the  Macroeconomic 
Assessment Group (BIS, 2010) that was set up by the Basel Committee on Banking 
Supervision and the Financial Stability Board to assess the macroeconomic effects of 
the transition to higher capital and liquidity requirements under Basel III. However, 
this  study  is  mentioned  for  illustrative  purposes  only  as  it  focused  on  a  one-off 
transition  to  higher  requirements  rather  than  determining  a  standard  co-movement 
between MRC, lending and GDP.  

MAG  noted  that  standard  macroeconomic  models  do  not  readily  allow  for  direct 
investigation of the effects of prudential policy changes on lending and GDP. While 
different models employed by the MAG capture many of the key aspects, there is no 
single  model  that  incorporates  all  the  relevant  mechanisms.  Therefore  the  study 
presents  the  median  outcome  of  several  models  as  a  central  estimate  of  the  impact 
across models and countries.15  

However,  given  all  the  caveats  encountered  in  the  ECB's  quantitative  analysis  of 
MRC  cyclicality,  for  instance  the  very  limited  data  available  and  the  impact  of  the 
financial crisis both via additional regulatory changes, government interventions and 
behavioural adjustments, it seems to be too early to make a quantitative estimate of 
how  big  the  pro-cyclical  impact  of  CRD  capital  requirements  on  lending  and  GDP 
might be.  

MEASURES TO ADDRESS PRO-CYCLICALITY 

In  July  2011,  the  Commission  proposed  a  legislative  package  for  the  reform  of 
banking  regulation,  including  a  directive  (CRD  IV)  and  a  regulation  (CRR).  This 
follows the Basel III agreement and will meet the key objective of maintaining the 
credit supply to the real economy in the EU. 

The  proposal  includes  a  number  of  measures  that  may  mitigate  pro-cyclicality  in 
banking lending: a single rule book, a countercyclical capital buffer, the introduction 
of  a  leverage  ratio,  reduced  dependency  on  credit  rating  agencies  for  prudential 
requirements,  and  scope  to  undertake  further  measures  to  enhance  loan  availability 
for small and medium sized enterprises. 

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22. 

23. 

6. 

24. 

25. 

15 

See chart 10: Macroeconomic Assessment Group model study results in the SWD 

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6.1. 

Single Rule Book 

26. 

As  noted  above  in  §19,  due  to  the  integration  of  the  EU  banking  sector,  de-
leveraging of credits in international banks in response to regulatory requirements set 
by national supervisors may occur outside home jurisdictions. The introduction of a 
single rule book will not only reduce regulatory arbitrage but also mitigate the pro-
cyclical effects of asymmetric de-leveraging in "host countries". 

6.2. 

Countercyclical Capital Buffer (CCB) 

27. 

28. 

29. 

One key regulatory response to the perceived pro-cyclicality of bank lending is the 
countercyclical  buffer  (CCB),  an  integral  part  of  the  Commission's  CRD  IV 
proposal.  This  extra  buffer,  built  up  gradually  over  good  economic  times,  can  be 
released in an economic downturn to allow banks to absorb their losses in an orderly 
way that does not lead to costly increases in the price of credit, which can aggravate 
recession.  It  will  mitigate  both  the  existing  unresponsiveness  of  regulatory 
requirements to risk build-up at the macro level and their cyclicality. 

Since  dynamics  can  be  very  different  across  different  markets,  the  buffers  are 
determined on a national market base. The European Systemic Risk Board would be 
in  charge  to  develop  common  guidelines  and  facilitate  and  coordinate  this 
macroprudential tool within the framework of its mandate.  

The ECB report highlights that although there are some conceptual issues that arise 
with regard to the practical implementation of the CCB16, the overall amount of CCB 
would have followed a clear counter-cyclical trend. In line with the credit growth in 
the years before the crisis and on the basis of a hypothetical implementation of the 
CCB  in  2005,  the  buffer  guide  would  have  increased  gradually,  to  a  peak  of  circa 
290bn euro for all countries in the EU in 2007.17  

6.3. 

Leverage Ratio 

30. 

31. 

16 
17 
18 

The Leverage Ratio is an additional capital requirement  that can become a binding 
ceiling  on  leverage  beyond  a  certain  multiple  of  assets  compared  to  Tier  1  capital. 
This would help to limit excessive bank lending during the upswing of an economic 
cycle when banks have momentum to expand balance sheets without an appropriate 
increase in capital.  

In line with Basel III, the Commission has proposed the Leverage Ratio as a Pillar 2 
measure  with  “a  view  to  migrating  to  a  binding  (pillar  1)  instrument,  after 
appropriate review and calibration”. As the Leverage Ratio is a new instrument for 
the  EU  (and  in  its  current  form  for  nearly  the  whole  world)  the  Commission 
proposed a diligent approach with a thorough review and parallel trial period before 
deciding on the final form of the instrument.18  

The ECB examined the Basel III reference guide, the credit-to-GDP ratio in different MS.  
See chart 11 in the SWD 
The  CRD  IV  proposal  tasks  the  EBA  with  preparing  a  report  on  the  effectiveness  and  impact  of  the 
Leverage Ratio to be submitted to the Commission by June 2016. On the basis of the EBA report, the 
Commission  shall  report  to  the  European  Parliament  and  the  Council  by  31  December  2016  on  the 

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6.4. 

Credit Rating Agencies (CRAs) 

32. 

33. 

34. 

Credit rating agencies (CRAs) as well as economic capital models may also play an 
important role in the determination of the actual capital level of banks. As noted in 
§13,  external  ratings  are  closely  correlated  to  the  economic  cycle,  implying  that 
capital requirements linked to these will also follow a clear cyclical pattern, at least 
at  the  level  of  individual  exposures.  The  heavy  reliance  of  the  Standardised 
Approach  to  credit  risk  on  external  ratings  means  that  this  issue  is  particularly 
relevant for banks who have not yet migrated to the IRB approach.  

In  view  of  this,  the  CRD  IV  proposal  encourages  the  use  of  internal  ratings,  while 
reducing the number of references to external ratings and strengthening provisions on 
how  external  ratings  can  be  used.19  It  respects  the  principle  of  proportionality  by 
allowing  smaller  credit  institutions  and  investment  firms  to  opt  for  the  less  CRAs-
dependent  (and  more  risk  sensitive)  IRB  approach  by  permitting  the  use  of  the 
simplest  possible  rating  procedures.20  The  use  of  the  IRB  approach  requires 
independent risk assessment capability and also incentivises better risk management 
techniques to control the credit risk in bank portfolios. 

Furthermore, the Commission adopted a legislative proposal21 on 15 November 2011 
that includes a general obligation for all regulated financial institutions to make their 
own  credit  risk  assessments,  and  similar  proposals  for  insurers  will  follow  later  in 
2012. The Commission is also very much involved in and supportive of work going 
on  in  Basel  seeking  to  reduce  the  importance  of  ratings  as  a  criterion  for  defining 
liquid  assets  and  looking  for  alternatives  to  calculate  capital  requirements  for 
securitization  investments.  All  this  should  reduce  the  pro-cyclicality  of  financial 
regulation arising from overreliance on CRAs.  

6.5. 

Small and Medium-sized Enterprises (SMEs) 

35. 

36. 

19 

20 
21 
22 

SMEs  are  more  bank-dependent  institutions  since  they  have  fewer  opportunities  to 
find alternative sources of finance, and as the backbone of the European economy22 
any pro-cyclicality in capital requirements may most significantly impact growth in 
the real economy through constrained SME lending.  

Access  to  bank  loans  for  SMEs  was  found  to  have  deteriorated  in  the  April  to 
September  2011  ECB  'SAFE'  survey,  and  this  trend  was  confirmed  in  the  October 
2011  to  March  2012  survey.  According  to  these  latest  survey  results,  euro  area 
SMEs' financing needs increased during the period with 19% reporting an increase in 
their  need  (demand)  for  bank  loans,  up  from  17%,  while  11%  reported  a  decrease, 
compared  with  12%  before.  The  net  balance  of  firms  reporting  a  worsening  in  the 

effectiveness  and  impact  of  the  leverage  ratio  and  'where  appropriate'  make  in  2018  a  legislative 
proposal for the introduction of a Leverage Ratio (Article 482 (1)).  
At the international level, the Financial Stability Board (FSB) issued in Oct 2010 principles to reduce 
authorities’ and financial institutions’ reliance on CRA ratings. 
(http://www.financialstabilityboard.org/publications/r_101027.pdf) 
Recitals 28-29 of the July 2011 CRR proposal 
See http://ec.europa.eu/internal_market/securities/agencies/index_en.htm for further information 
SMEs account for 99.8% of enterprises, 66.9% of employees, and 58.4% of gross value added in the 
(2010  estimate,  Eurostat/National  Statistics  Offices  of  Member  States/Cambridge 
EU-27 
Econometrics/Ecorys) 

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availability (supply) of bank loans was 20%, up from 14% in the previous round.23  

At  the  same  time,  in  the  latest  (April  2012)  ECB  quarterly  Bank  Lending  Survey 
(BLS) the net tightening of credit standards on loans to SMEs fell from 28% in the 
Q4 2011 to 1% in Q1 2012, with net tightening of credit standards to the group of 
non-financial  corporations  as  a  whole  falling  from  35%  to  9%,  a  much  larger  drop 
than  was  expected  by  survey  participants  at  the  time  of  the  previous  survey  round. 
This could be explained by a marked decline in the net percentage of euro area banks 
reporting  that  cost  of  funds  and  balance  sheet  constraints  had  contributed  to  a 
tightening of credit standards – 8% of banks reported a challenging market financing 
environment  compared  with  28%  previously.  Nevertheless,  a  respite  from  an  even 
further tightening of credit standards does not ease the challenging funding situation 
for SMEs. 

SME exposures are subject to a favourable treatment under the existing CRD. In the 
CRD  IV  proposal  capital  requirements  are  increased  across  the  board  for  all  credit 
risk exposures, which means that SMEs maintain their preferential treatment in Basel 
II  relative  to  other  exposures.  Even  so,  the  Commission  has  requested  the  EBA  to 
analyse  and  report  on  the  current  risk  weights  of  SME  lending  and  the  thresholds 
employed  for  identifying  SMEs  in  the  context  of  the  new  Basel  III  standards. 
Options  to  further  improve  the  favourable  treatment  of  SME  exposures  include  for 
instance  decreasing  the  risk  weighting  from  75%  to  50%  or  raising  the  exposure 
threshold  for  SMEs  from  €1m  to  €2m  or
  €5m.  The  Commissi on  would  carefully 
consider  these  options  within  the  overarching  CRD  IV  objective  of  enhancing 
financial stability.  

It is also worth noting that SMEs, to the extent that they are credit rationed by banks, 
are  expected  to  be  the  primary  beneficiaries  of  smoothened  pro-cyclicality  brought 
about by the enhanced countercyclical measures in CRD IV. 

CONCLUSIONS 

The ECB found some evidence for a cyclical MRC driven by cyclical PDs for larger 
Group  1  banks  using  the  IRB  approach  to  credit  risk,  offset  somewhat  by  cyclical 
exposures  (i.e.  reduced  in  a  downturn).  Although  cyclical  MRCs  are  tentatively 
identified  at  the  portfolio  (corporate  and  retail)  level,  this  effect  seems  to  be 
mitigated at the bank level when the whole sample of banks is considered.  

This  mitigation  may  primarily  be  due  to  crisis-driven  portfolio  adjustment,  for 
instance  to  target  more  assets  eligible  as  collateral  in  central  bank  liquidity 
operations, and therefore absent the crisis there could have been firmer evidence for 
a  cyclical  MRC.  Banks  using  the  Standardised  Approach  may  also  have  a  cyclical 
MRC due to the method's reliance on external CRAs whose ratings are cyclical. 

The ability and willingness of banks to lend depends in part on the degree to which 
the minimum capital constraints are binding. Although the MRC calculated under the 
current  CRD  may  have  had  some  impact  on  actual  capital  levels  held  by  banks,  in 

Survey  on 
http://www.ecb.europa.eu/stats/money/surveys/sme/html/index.en.html  

finance  of  SMEs 

the  access 

the  euro  area 

to 

in 

(SAFE)  available  at 

37. 

38. 

7. 

39. 

40. 

41. 

23 

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addition 
to  several  other  factors  expectations  of  stricter  future  regulatory 
requirements may have resulted in capital targets set considerably above the MRC, 
with  significant  impacts  on  balance  sheets  and  lending  policies.  However,  this  is  a 
driver that is different from the cyclicality of the current legislation.  

42. 

CRD IV, which will implement Basel III in the EU, will represent a structural break 
with the past with a more demanding MRC in terms of quality and quantity of capital 
required, as well as new requirements for liquidity and leverage. Importantly, it will 
include a number of countercyclical policy measures, including a single rule book, a 
countercyclical  capital  buffer,  a  leverage  ratio,  and  measures  on  CRAs  and  SMEs. 
Where  appropriate,  the  implementation  of  measures  will  be  phased  in  over  time  in 
order to avoid pro-cyclical effects. 

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8. 

REFERENCES 

Basel Committee on Banking Supervision, Bank for International Settlements, 16 December 
2010,  "Basel  III:  A  global  regulatory  framework  for  more  resilient  banks  and  banking 
systems", available at http://www.bis.org/publ/bcbs189.pdf  

(2010),  Macroeconomic  Assessment  Group: 

BIS 
the 
macroeconomic  impact  of  the  transition  to  stronger  capital  and  liquidity  requirements", 
August 2010, available at http://www.bis.org/publ/othp10.pdf  

Interim  Report,  "Assessing 

ECB, EBA (2012), Pro-Cyclicality of Capital Requirements, Second Report 

ECB (2010), "EU Banking Structures", available at: 

http://www.ecb.int/pub/pdf/other/eubankingstructures201009en.pdf  

European  Commission,  June  2010,  "Report  from  the  Commission  to  the  Council  and  the 
European Parliament on effects of Directives 2006/48/EC and 2006/49/EC on the economic 
cycle", available at: 

http://ec.europa.eu/internal_market/bank/docs/regcapital/monitoring/23062010_report_en.pdf  

Also includes further references 

European Commission, July 2011, New proposals on capital requirements (CRD IV), further 
information available at: 

http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm  

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