1
European Association of Public Banks
- European Association of Public Banks and Funding Agencies -
European Commission
Mr Gerald Dillenburg
General-Directorate Internal Market
Dir F2 - Banking and Financial Conglomerates
Avenue de Cortenbergh 107
1000 Brussels
Brussels, 31 January 2003
Position of the EAPB on the EU Commission working document of
18 November 2002:
Capital requirements for credit institutions and investment firms
Dear Mr Dillenburg,
The European Association of Public Banks (EAPB) has a membership of some 100 public
banks and funding agencies from eight European countries. The direct members of the EAPB
are public banks, financial institutions and national associations. At this point, we should
like to express our thanks for the opportunity to submit a position paper on the EU
Commission working document of 18 November 2002 in the context of the “structured
dialogue” and to comment in more detail on the individual points below.
In our position paper, we confine ourselves essentially to points on which the EU
Commission either diverges from the ideas and proposals of the Basle Committee or plans
amendments in relation to the regulations existing to date in EU Directives.
Comments on the cover document
Key objectives of the review (7-25)
We welcome the EU Commission’s intention to use the specifications of the Basle Committee
as guidance. In particular, the synchronous entry into force of the new EU regulations with
the Basle rules represents a major challenge – nevertheless there is no alternative to this
procedure, as otherwise the competitive position of the European credit sector and entire
economy would be considerably weakened.
In forming a European framework to the Basle provisions, the supreme objective must be to
develop Basle II in such a way that transposition into EU and national law is possible.
Avenue de la Joyeuse Entrée 1 – 5, B-1040 Brussels ● Phone : +32 / 2 / 2 / 286 90 62 ● Fax : +32 / 2 / 2 / 231 03 47
Website : www.eapb.be
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European Association of Public Banks
- European Association of Public Banks and Funding Agencies -
Derogations should occur only in a few fields where wholesale transposition of Basle II does
not take adequate account of the financial market structures specific to the EU and as a
result jeopardises a competitive level playing field.
From our point of view, the inclusion of investment firms, undertaken with a view to equal
conditions of competition and according to the principle that the same risks should be
subject to the same regulations, must also occur in the Basle provisions.
Smaller and less complex institutions
Partial Use (72–74)
To give the institutions incentives to “grow into” more complex supervisory methods,
appropriate possibilities for partial use of the procedures are necessary. This is true for both
the credit risk field and the operational risk field. The proposal in the Commission document
for an extension of a transitional “partial use” in the internal ratings-based approach
(“phased roll-out”) and the possibility to exempt bank and sovereign exposures permanently
from the application of the IRB approach are to be welcomed in this respect. However, we
consider further recognition of partial use to be necessary. Institutions should have the
discretion to exempt specific fields to be clearly defined permanently from the application of
the IRB/AMA approaches. A possible exemption of the following seems necessary:

specific part portfolios or securities (partial recognition of own LGD estimates),

in the credit risk field or the exemption of certain business fields in the operational risk
field,

legally independent entities of the group,

legally dependent entities of the group/an institution.
The exercising of partial use should always be admissible if
(a)
it can be proved that the necessary minimum requirements for the IRB/AMA cannot
be fulfilled or only at disproportionately high effort in the exempted field,
(b)
or the inclusion of the exempted field in the IRB/AMA can be proved to be pointless,
(c)
or the exempted field is negligible in terms of its size or its risk profile.
A partial use should also be possible within the IRB with respect to the foundation approach
or the advanced approach. The incentives strived for to transfer to the advanced IRB would
as a result effectively be increased.
In particular, it should be clarified that the permanent exemption of bank and sovereign
exposures should apply irrespective of the size of the credit institution and the material
nature of the exposures. To avoid the otherwise threatening distortions of competition
between Basle banks and other institutions, the Basle Committee should be called upon to
adopt the Brussels partial use regulations.
Avenue de la Joyeuse Entrée 1 – 5, B-1040 Brussels ● Phone : +32 / 2 / 2 / 286 90 62 ● Fax : +32 / 2 / 2 / 231 03 47
Website : www.eapb.be
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European Association of Public Banks
- European Association of Public Banks and Funding Agencies -
Unrated, unlisted securities issued by credit institutions (78–80)
The fact that the Commission is considering recognising unlisted, unrated bank bonds as
collateral is to be welcomed. Such bank bonds should be included as financial or physical
collateral in the list of collateral of the new provisions and accordingly taken into account in
the methodology applied in the standardised approach and the internal ratings-based
approach.
Treatment of mortgages
Underpinning principles (133-135)
The EU Commission intends to include provisions on this subject which derogate from Basle
II. In principle, we reject this. In order to guarantee a level playing field both internationally
and nationally, a derogation should not be made from the Basle provisions in this case, as
the European financing structures do not require this either.
In particular, we reject the introduction of additional minimum requirements for real estate
lending in the standardised approach, since a deterioration could result from this compared
to the Basle proposals.
Weighting of mortgage bonds and other bonds of mortgage bond issuers (143-144)
According to Article 22(4) of the UCITS Directive, mortgage bonds can be weighted at 10%.
This treatment should be continued under the modified standardised approach with a
weighting of a maximum of 10%. Consistent treatment should be achieved in the internal
ratings-based approach. In its legal design, by partitioning off the cover assets, the
mortgage bond product is designed precisely to separate the interests of the mortgage bond
creditor from the fate of the issuer – no history of default exists, for since the introduction of
the mortgage bond 230 years ago to the present day, there has not been any default.
Against this background, we consider it to be inappropriate to apply the PD/LGD approach to
mortgage bonds. In particular, we are against making the probability of default dependent
on the financial status of the issuer. On account of its special legal framework, the mortgage
bond should be treated rather as a special kind of bond and a transfer of the flat-rate
weighting of maximum 10% called for in the modified standardised approach should also be
authorised in the internal ratings-based approach. This exception should relate to all
covered bonds according to Article 22(4) of the UCITS Directive. Other bonds issued by
mortgage bond issuers should be treated like other bank bonds of other issuers.
Supervisory review process (163-176)
We agree with the Commission that institutions must hold a level of own funds
commensurate with their risk profile. In our opinion, – especially on account of the higher
risk sensitivity of the future regulations – this will in principle be ensured by the prudential
minimum capital requirements.
Avenue de la Joyeuse Entrée 1 – 5, B-1040 Brussels ● Phone : +32 / 2 / 2 / 286 90 62 ● Fax : +32 / 2 / 2 / 231 03 47
Website : www.eapb.be
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European Association of Public Banks
- European Association of Public Banks and Funding Agencies -
The institutions should also have appropriate risk management at their disposal. This is not
only in the interests of banking supervision, but also in the interests of the institutions
themselves. Review of the management systems, methods and procedures in the context of
the supervisory review process is to be welcomed in principle against the background of the
growing complexity of business and corporate structures.
If it turns out during the supervisory examinations in the context of the supervisory review
process that the risk management of an institution is not adequate, it is appropriate that
supervisory measures to be taken apply directly to the weaknesses found. The supervisory
authorities should therefore try first of all to eliminate the shortcomings through qualitative
instructions in dialogue with the management of the institution.
Increased capital requirements, on the other hand, do not apply to the weaknesses found
and so do not turn out to be appropriate of eliminating them. Furthermore – at least in the
short term – they also leave the risk situation of the institution unchanged. What is even
worse is that increasing the capital requirements could represent an additional burden
precisely in the case of institutions under threat, since they would be forced, in a publicly
known difficult situation, to raise new capital in the short term. Additional capital
requirements therefore only appear to serve any purpose as a sanction, which should only be
imposed if the institution does not eliminate shortcomings in risk management in the long
run. The convergence in supervisory practices strived for may not therefore lead to the fact
that approaches prevail in the EU, which are based on institution’s individual capital
requirements.
Comments on the working document
Consolidation – Articles 16–21
Article 18(1) requires subordinated parent institutions to sub-consolidate if not all
institutions in the sub-group are supervised by the authorities of a Member State. According
to Article 18(3), sub-consolidation can be refrained from if the subordinated parent
institution deducts the book value of its financial holdings from its capital. The obligation to
sub-consolidate is to be rejected. The formation of sub-groups represents considerable
effort, as it is not matched by any additional supervisory value or benefit.
Differentiated supervisory treatment of a European group of institutions depending on
whether the individual supervision of the institutions belonging to the group is exercised by
one or more Member States is not justifiable from risk points of view. In this respect, the
proposal is in blatant contradiction with the mutual recognition of supervisory decisions
within the EU.
Avenue de la Joyeuse Entrée 1 – 5, B-1040 Brussels ● Phone : +32 / 2 / 2 / 286 90 62 ● Fax : +32 / 2 / 2 / 231 03 47
Website : www.eapb.be
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European Association of Public Banks
- European Association of Public Banks and Funding Agencies -
Taking all these considerations into account, we advocate that the current EU provisions on
consolidation should be left unchanged.
Modified standardised approach – Articles 26–40
We call for the explicit adoption of the Basle risk weightings and definition of the risk asset
classes. According to point 3.1.2 of Annex C-1, on account of the reference to points 6.3
and 6.4 of this Annex, in future only a weighting of at least 20% can be granted for
exposures to so-called “public sector entities”. The possibility of zero-weighting for such
exposures afforded under current EU law accordingly no longer exists, without any
justification for this appearing from the documents. Since zero-weighting is also possible
according to the Basle proposals, we advocate, already for reasons of consistency between
the Basle and the EU provisions, continuation of this weighting rule.
IRB approach – Articles 46-51
The following points are problematic in the field of the IRB approach:
(a)
The “SME Use Test” for the inclusion of small and medium-sized enterprises in the
retail portfolio called for in Article 47(5)(a) should be renounced.
(b)
Treatment of equity exposures of banks in other undertakings:
The planned treatment of equity exposures of banks in other undertakings in the socalled PD/LGD approach in our opinion exaggerates the risks of these assets. This is
true, on the one hand, of the LGD of 90% proposed in the IRB for equity exposures of
banks in other undertakings, which is clearly excessively high compared to the LGD
of 45% for unsecured corporate exposures. We propose instead to use the same LGD
as for subordinated credits (i.e. 75%) in the PD/LGD approach, on account of the
comparable risk. On the other hand, the setting of minimum risk weights also does
not seem to be justified, since as a result the risk of equity exposures in
undertakings of excellent financial status would be exaggerated. Furthermore, we
assume that the institutions in the PD/LGD approach, as in the IRB corporate client
approach, can undertake a size adjustment for small and medium-sized enterprises
(SMEs). The requirement to draw a distinction between the various types of equity
exposure within the approach would be superfluous after the minimum risk
weighting ceased to exist and should be dropped, as it increases the complexity of
the IRB approach.
Operational risks – Articles 106–114
The use of the standardised approach to assess the operational risk capital requirement
depends
on
fulfilling
extensive
qualitative
standards.
The
specifications
are
only
insignificantly different from the planned qualitative requirements for an advanced
measurement approach (AMA). If the same organisational and data requirements are
Avenue de la Joyeuse Entrée 1 – 5, B-1040 Brussels ● Phone : +32 / 2 / 2 / 286 90 62 ● Fax : +32 / 2 / 2 / 231 03 47
Website : www.eapb.be
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European Association of Public Banks
- European Association of Public Banks and Funding Agencies -
imposed for the standardised approach and the AMA, there are no incentives at all to use the
standardised approach. In order to establish the standardised approach as a separate stage
in the “ spectrum of approaches ” to be attainable for the majority of institutions, the
qualifications requirements must be reduced to a level appropriate to a standard method.
This is true, for example, regarding the inclusion of every single operational risk exposure
called for so far, as well as the collection of differentiated loss data.
The working document does not specify the scope for partial use of the various operational
risk measurement procedures (Article 111, Annex H-5).
The EU provisions on operational risks must ensure that EU banks and EU groups of
institutions are not disadvantaged in competition with non-EU banks and financial
institutions not supervised on an individual basis. In particular against the background of
the distinctly wider EU scope of consolidation compared to Basle II, pragmatic solutions are
necessary.
Please do not hesitate to contact us for further questions.
With kind regards,
European Association of Public Banks
Henning Schoppmann
Germaine H. Klein
Avenue de la Joyeuse Entrée 1 – 5, B-1040 Brussels ● Phone : +32 / 2 / 2 / 286 90 62 ● Fax : +32 / 2 / 2 / 231 03 47
Website : www.eapb.be