Commission set to change banks’ risk-calculation rules

By Anna McLauchlin

Date: 08/07/04

THE European Commission will adopt a long-awaited proposal on Wednesday (14 July) that will significantly change the way European banks calculate risks and the amount of capital required to cover them.

But the Commission will have to push hard if the law is to be implemented at national level at the end of 2006 as proposed.

One of the main headaches is likely to be agreeing on the scope national supervisors will have to adjust the new rules to fit individual banks.

The Basel II framework lays down a three-pronged approach to ensuring that banks have the capital to cover their risks. Using a complicated formula, the bank calculates its risks and how much capital would be needed to cover them. Banking regulators have the power to adjust the calculations according to a bank's individual risk profile. The framework then requires banks to disclose relevant information to its investors.

While the industry agrees that there is a need for regulators to have some flexibility in applying the new rules, in Europe there is a fear that if legislation is insufficiently clear this room for manoeuvre might damage the internal market.

CEBS, the committee of banking supervisors, which has been working hand in hand with the Commission on the law's implementation, recently published a consultation paper insisting regulators will have to "reflect the individual circumstances of the institution, with a view to ensuring consistency of capital treatment across institutions". But the banking industry is less certain.

Steve Johnson, of the European Banking Federation, said that the process of supervisory review had the potential to be "a significant source of inconsistencies".

"Failure to provide consistent application of the process could lead to market distortion and possibly regulatory arbitrage," he said.

There is also disagreement over the issue of "home host", or which supervisor should be responsible for regulating a bank's capital.

The banking industry is in favour of group level treatment which means, for example, that a regulatory issue involving the Czech subsidiary of a Belgian bank would be dealt with by the Belgian banking authorities.

According to one UK banking advisor, this is largely a political matter.

"Would a Polish politician be happy effectively to devolve his domestic legislation to a foreign regulator, given that his banks are owned by the Irish, Austrians and Germans?" he said.

The most basic parts of the Basel framework, officially endorsed by the world's central banks on 26 June after a six-month delay, are supposed to come into force from the end of 2006, with the more advanced rules coming into play in 2007.

But the Commission, while happy to be producing its proposal within weeks of the official endorsement, is aware that time is in short supply. The US has already postponed its implementation date to the end of 2007 and there is a possibility that the EU might follow suit.

The Commission's proposal has to be approved by the Council of Ministers and the European Parliament. If the issues of regulatory discretion and home host become a major battleground the draft may not pass through government and Parliamentary scrutiny as quickly as the Commission hopes, which would make the 2006 deadline impossible.

One possibility, thinks Simon Hills of the British Bankers Association, is that the Commission will allow banks to choose their own adoption date.

Some banks are keen to use the Basel rules as they offer them a more advantageous method of calculating their regulatory capital. Others will need extra time to make the heavy investment necessary. "I expect they'll give banks the choice," says Hills. "Those banks that are ready, and can prove to their regulator that they are ready, will be allowed to adopt Basel from 2006. Those who aren't can wait until 2007."

• Anna McLauchlin is a Brussels-based freelance journalist.

http://ec.europa.eu/comm/internal_market/en/finances/banks/index.htm http://ec.europa.eu/comm/internal_market/en/finances/banks/index.htm

Committee of European Banking Supervisors: Homepage http://www.c-ebs.org/

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