Risk & Compliance

Europe Eyes Sweeping Bank Regulation Changes

New rules would tighten capital requirements, limit inter-bank exposures and create new supervisory bodies for cross-border banking.
Jason KaraianOctober 1, 2008

In response to “the current meltdown of the financial system,” the European Commission proposed a series of rules to tighten the regulation of banks within the European Union today. Most notably, the commission wants sellers of securitised products to retain a material stake in these creations, widely blamed for bringing about the credit crunch.

Charlie McCreevy, commissioner for the internal market, called the proposals “sensible and proportionate to the financial turmoil we are experiencing.” A report from JPMorgan today estimated that write-downs by European banks will reach €116billion by the end of the year.

Under the new rules, originators and sponsors of securitised products must retain ownership of at least five percent of the resulting instruments. This summer, McCreevy had suggested a ten-percent threshold. At the moment, there are no requirements to hold capital once loans are re-packaged and sold on.

In addition, the commission insisted that investors in securitised products “be allowed to make their decisions only after conducting comprehensive due diligence.” The specifics of this charge remain vague, but investors that fail to comply “will be subject to heavy capital penalties,” the commission warned.

On counterparty risk, a new rule would limit any bank’s loan exposure to another institution to 25 percent of core capital or €150 million, whichever is larger. The threshold is waived for banks in networks, certain savings banks and some clearing and settlement transactions.

In order to encourage an “unfettered multilateral exchange of information,” the commission proposed setting up “colleges of supervisors” comprised of national and international regulatory bodies. These groups would monitor the liquidity risk of banks within their borders, including the “systemically important branches” of subsidiaries based in other countries. Earlier this week, the governments of France, Belgium, the Netherlands and Luxembourg co-ordinated bailouts, in various combinations, of stricken lenders Fortis and Dexia.

The commission also proposed to develop principles on what types of hybrid instrument is allowed to count towards Tier 1 capital, “so that there is no doubt that it can support depositors and other creditors in times of stress.” Though presented with some fanfare—the commission’s website gives top billing to “new rules on the table to curb bank practices blamed for financial crisis” — the proposals will come into force in two years, at the earliest, as they need to pass muster with the European Parliament and Council of Ministers.”It is not possible for the commission’s proposals to solve the current meltdown,” the institution admitted.