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Capital Punishment

16 Dec 2009

As part of a wide-ranging policy response to the financial crisis, the EU is reviewing, amending and proposing a variety of financial services legislation. One of the most significant areas addressed is that of capital requirements.

The stated aim of the European Union’s Capital Requirements Directive (CRD) (2006/48/EC and 2006/49/EC) is to promote financial stability and ensure the financial soundness of banks and other financial institutions. It is also intended to promote a stronger culture of risk management and to ensure the international competitiveness of the European banking sector.

The 2006 CRD (actually a pair of related directives) effectively transposed the Basel II Accord on capital measurement and standards into European law, stipulating how much of their own financial resources banks and investment firms must hold in order to cover their risks and protect their depositors. It allowed banks to choose among various methods of fulfilling the requirements but contained a strong preference for risk analysis and risk management over the blunter tool of leverage ratios.

This directive forms the basis of an evolving legal framework that is being continually updated. Building on recommendations of the Financial Stability Forum, some technical amendments were adopted in the first half of 2009. They included new rules on securitisation, large exposures, home-host relationships, ‘hybrid’ capital and liquidity risk management, and are expected to be implemented by December 2010.The CRD is poised to undergo a new revamp in the coming months if proposals put forward by the Commission and recently approved by the Council are agreed to by the European Parliament. These proposed amendments are intended to:


  • Address capital requirements for the trading book
  • Increase capital requirements for re-securitisations
  • Increase disclosure demands for securitisation exposures
  • Impose restrictions on remuneration policies


Internal Market and Services Commissioner Charlie McCreevy has said that, with their emphasis on securitisation and remuneration, these new rules “target some of the investments and practices that lie at the root of the financial crisis.” They were recently the subject of a presentation by representatives of the Department of Finance and the Financial Regulator to an Oireachtas Committee on EU Scrutiny. Mr William Beausang of the Department of Finance noted that nationally and across all member states “there was a positive and constructive response to the proposal[s].” As in our own national policy debate, fairness, or at least the perception of fairness, is now a watchword for legislators and policymakers across Europe, and these proposals were drawn up with that in mind. The chairman of the Committee concluded: “we are confident the approach reflected in the directive is fully aligned with national priorities and objectives.”

The issue of remuneration and compensation practices in banks was discussed in an earlier blog but has gained renewed traction following the UK’s announcement of a 50% tax on bonuses over £25 000. Like the British-championed notion of a transaction (or ‘Tobin’) tax, the idea of a supertax on bonuses is now being taken seriously. France looks set to follow Britain’s lead. Angela Merkel, though demurring for the moment due to constitutional issues, has called it a “charming idea.” All of this in turn increases pressure on the US to extend the scope of its own pay constraints beyond the small group of directly bailed out banks that it has so far targeted.

Is it the case then, as the Financial Times’ Lex column puts it, that the war on greed is going global? Or is London’s supertax merely an ‘own goal’, representing, as David Mc Williams argues, a golden chance for Ireland? It is too early to tell but this is certainly a topic worth returning to in 2010.

Getting back to capital requirements: following a consultation in summer 2009, a further round of proposed amendments to the CRD is scheduled to be released soon and is likely to include supplementary measures for bank capital and liquidity, implement the new leverage ratio currently being considered by the Basel Committee, eliminate remaining national options and discretions, and include a framework for counter-cyclical buffers.

The big banks may be bouncing back and even posting bumper profits. But distinct from all the economic pros and cons, a political appetite for punishment remains. We are a long way from business as usual.

As an independent forum, the Institute does not express any opinions of its own. The views expressed in the article are the sole responsibility of the author.


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