EU Commission will look at how impediments to consolidated supervision can be removed.
Bankers want review clause in CRD
Senior officials at the EU Commission in Brussels believe that the various national impediments preventing a single supervisor from overseeing the European operations of each cross-border banking group could be overcome by 2009. The removal of these impediments could pave the way for European cross-border groups to allocate regulatory capital according to the demands of their business activities, rather than the requirements of multiple national supervisors. And, it would allow such groups to report to one, consolidating - or lead - supervisor, usually the home supervisor in the country where the group is headquartered.
European bankers have been pressing for this approach to be incorporated into the Capital Requirements Directive (CRD), which will transpose the new, risk-based Basel capital accord - Basel II - into EU law.
In what European Commission officials argue is a groundbreaking move, they have included provisions in the CRD that will allow limited consolidated supervision when banks' risk measurement models are validated. Such supervisory validation is required when banks apply to adopt the advanced internal ratings based approach to calculating credit risk and capital levels under the proposed directive. If national supervisors cannot agree about the details of this process after six months, a consolidating supervisor is empowered to undertake the role.
This move has been resisted by some EU member countries with largely foreign-owned banking systems, because they think it diminishes their sovereignty. By contrast, bankers say the move does not go anything like far enough. The difficulty in trying to extend consolidated supervision, however, is the array of national safety nets and other crisis management arrangements, such as liquidity requirements, lender of last resort facilities, deposit insurance schemes and bankruptcy rules.
EU officials have pledged to find ways to eliminate these impediments.
Patrick Pearson, head of the European Commission's banking and financial conglomerates unit, recently told a meeting at the European Banking Federation (FBE) in Brussels, that the impediments could be dealt with over the next four or five years.
In a letter sent earlier this year to Charlie McCreevy, the EU Commissioner for internal markets, Guido Ravoet, the FBE secretary general, said "consolidated supervision was the "only mechanism which can deliver an efficient supervisory environment for banks active on a cross-border basis in the EU." It is a paradox, he added, "that the European Union, with a clear objective of a unified financial market, should choose a fragmented approach to banking supervision, burdening banks with multiple reporting requirements and additional capital constraints."
Ravoet called on the EU Commission to include in its work an examination of how the impediments to consolidated supervision might be overcome, and for the explicit inclusion in the Capital Requirements Directive of a review of these issues after five years.
In a reply sent in February, Pearson says that a review of items such as deposit insurance, lender of last resort facilities and bankruptcy rules will be included in the work programme that will form the post-FSAP (Financial Services Action Plan) agenda. This will be laid out in a Green Paper that is expected to be published in May. Pearson also says in his response that he is prepared to discuss the extent to which this review is described in the CRD.
However, he told a London audience at a conference in March, organised for Britain's regulator, the Financial Services Authority, that dealing with these issues "will not be easy."
Unanswered questions
The key question for regulators, central bankers and finance ministers is what happens in times of stress, Pearson said. He asked, who provides emergency liquidity? Who picks up the bill when the subsidiary of a large European banking group runs into trouble? Is it the country where the subsidiary is incorporated, or the home country of the group? Or the European Central Bank? Which deposit guarantee schemes apply? And who is responsible for winding down an insolvent bank?
Pearson told Global Risk Regulator afterwards that he supported attempts to tackle these problems, and he backed the idea of reviewing the scope of consolidated supervisions in five years' time. These issues needed to be brought into the open and discussed, he said. And he was "willing to bring people together to get the discussions going."
While European bankers acknowledge the current difficulties to extending the consolidating supervisor model in relation to the minimum capital requirements of pillar 1 under the CRD, they are continuing to press for the more immediate extension of consolidated supervision under pillars 2 and 3.
While pillar 1 determines the minimum level of capital that a bank is required to hold, pillar 2 involves supervisory review of the processes and strategies used by the banks to ensure their risk capital is adequate, and pillar 3 deals with market discipline and the types of information banks must publicly disclose.
"What the FBE wants is for the home (or lead) supervisor to be the coordinator of all the pillar 2 and 3 supervisory activities," says Caitriona O'Kelly, an advisor to the FBE on banking supervision. It is the risk profile of the banking group as a whole that is subject to the supervisory review and evaluation process under pillar 2, even though capital will still have to be allocated under pillar 1 across the EU according to the assessed risk of each individual subsidiary.
Unless a lead supervisor coordinates this pillar 2 review and evaluation, banks fear they will forced to undergo the process by the host supervisor in each country that a subsidiary is located. Large European banks organise their risk management on a centralised group level and along business lines, not on the basis of individual subsidiaries, argue banking industry representatives. The Capital Requirements Directive does not reflect that reality, they say.
Banks, and in some cases countries, are now heavily lobbying the European Parliament to get changes in the directive. "There is already a very significant number of amendments floating around, many of them drafted by banking industry representatives," according to Patrick Pearson. These include three from the European Banking Federation.
The aim, in the first instance, is to try to get the amendments introduced into the report on the CRD now being prepared by Alexander Radwan, German Member of Parliament (MEP), and rapporteur of its powerful Committee on Economic and Monetary Affairs. Radwan's report is expected to be published in late April. MEPs are likely to continue to be pressed to introduce those amendments not included in the report.
Parliamentary delays likely
The signs are that the increasingly intensive lobbying could delay the progress of the CRD through the Parliament. EU officials are still saying they expect the directive to be finalised by September. Others have doubts. "The latest indications from Brussels suggest that delays in the European Parliament's consideration of the draft directive may mean that the European Council [the EU's second legislative institution, representing national governments] may not be in a position to agree the final text before November," Hector Sants, head of the FSA's wholesale and institutional markets, told the March conference, in London.
The prospect of such a delay raises the question of whether the start date of January 1, 2007 for the CRD's simpler credit and operational risk measurement approaches "would still be feasible," Sant said. For some time, Britain has had a preference for a so-called "big bang" implementation date. This would mean that all European banks and investment firms adopting the simpler approaches, and those adopting the more advanced approaches would all start together on January 1, 2008.
