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Brussels on Wednesday unveiled tough rules that will require banks operating in Europe to hold more capital, beef up their governance and face higher and more unified sanctions if they step out of line.
The draft proposals – which will need approval from the 27 member states and the European parliament – are designed to implement the internationally-agreed Basel III guidelines on banking capital.
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The EU is the first jurisdiction to start enacting these into law and will apply the rules very broadly to more than 8,000 banks and investment firms. These account for about 53 per cent of global assets in the financial sector.
Unveiling the package on Wednesday, EU internal market commissioner Michel Barnier said that the measures were aimed at preventing a repeat of the 2008 financial crisis by making banks safer.
“We cannot let such a crisis occur again and we cannot allow the actions of a few in the financial world jeopardise our prosperity … The banking sector will have to hold more capital and better quality capital every time it is taking risks,” he said.
“It is a tremendously important step forward in learning the lessons from the crisis and adopting a new approach to risk”.
But the EU’s draft proposals are likely to unleash months of heated debate as member states and banking institutions haggle over the details. Some countries – including the UK – are upset that Brussels plans to impose the capital rules as a minimum and a maximum standard and would like the flexibility to introduce higher requirements if they wish.
UK officials also believe that some of the details – including some of the definitions of what constitutes high-quality capital and the treatment of groups that combine bank and insurance businesses – represent a weakening of the internationally-agreed Basel regime. The European Commission denies this, but is likely to face accusations that it has watered down the Basel rules.
By contrast, the banking industry is particularly concerned at the prospect of new liquidity rules being introduced to that would require banks to hold more cash and to sell assets and a leverage ration that would limit their overall size to a multiple of their top quality capital. Banks are likely to lobby hard to ensure that these measures are kept as flexible and discretionary as possible. Many banks also oppose allowing national regulators to exceed the new standards.
The new proposals contain a regulation which details the prudential capital requirements that banks and investment firms must meet, plus a separate directive dealing with stepped-up governance standards, sanctions and capital buffers.
Under the regulation, all EU banks would have to hold higher quantities of top-quality assets, with “common equity tier 1” increasing from 2 to 4.5 per cent of their assets adjusted for risk. But the directive adds a capital conservation buffer of 2.5 per cent on top. Banks that fall into the buffer face limits on their ability to pay dividends and bonuses, creating an effective minimum of 7 per cent.
As called for by the global agreement, a liquidity coverage ratio would also be introduced, although its exact composition and calibration would be determined after an observation and review period in 2015. Banks’ leverage ratios would also be subject to supervisory review and could turn into binding requirements by 2018, although there will be further assessments before this happens.
The proposal also creates a second counter cyclical capital buffer, which national supervisors can add to damp excess lending growth if, for example, they see a domestic property bubble developing.