Financial Regulatory Forum

EU drafts sanctions for risky bonuses, tighter capital rules

By Reuters Staff
July 13, 2009

Flags at EU Parliament
By Huw Jones
LONDON/BRUSSELS, July 13 (Reuters) – The European Union on Monday unveiled a new law that punishes banks who encourage too much risk-taking with their policies on pay, in an effort to put an end to the practices blamed for the credit crunch.

A draft law published by the European Commission tightens EU rules on bank capital and requires banks to improve disclosure of the holdings in securitised products, bidding to apply lessons from the worst financial crisis since the 1930s.
The rules, coupled with other anticipated reforms such as a cap on leverage and other types of capital and liquidity buffers, will make it harder for banks to earn high returns on their assets.
They are due to come into force in 2011 as part of wider efforts to restore confidence in the financial sector, but may yet be delayed because they will dampen banks’ ability to lend and aid the economic recovery in the meantime.
“If we think it needs to be delayed further, that could be done, if we think they could have a detrimental effect on the general economy,” Ruth Walters, an official at the Commission’s internal market unit, told reporters.
On pay, the focus is on top officials, whose work affects the bank’s risk profile, ensuring there is an “appropriate” balance between fixed and variable pay and also taking in severance pay.
“It is true that employment contracts are likely to be renegotiated and that the fixed component awarded could be higher,” the Commission said.
Supervisors will not determine actual levels of pay.
The draft must be approved by the European Parliament and EU governments to become law.

ABSORBING LOSSES BETTER
The G20 summit in April agreed that banks must have higher capital buffers once economic recovery is assured and the draft also proposes improving disclosure and doubling capital requirements on risky assets held on banks’ trading books.
The hope is that if conditions suddenly turn sour or credit dries up like in the financial crisis, this will close one loophole and make banks hold back enough cash to absorb losses and avoid firesales of assets which depress prices further.
Hiking capital charges and improving supervision is also at the core of efforts by policymakers globally to plug regulatory gaps highlighted by the credit crunch, which saw undercapitalised banks having to be rescued by the taxpayer.
The draft’s elements on capital puts into EU law changes already underway to the Basel II rules, a three-year old globally-agreed framework for capital rules drawn up by the Basel Committee on Banking Supervision.
The Switzerland-based committee on Monday published reforms it has adopted for its Basel II rules that will act as a reference point for the EU changes.
The G20 also agreed that supervisors should have powers to oversee remuneration based on principles put forward by the Financial Stability Board, a new watchdog that will police consistency in financial rules across the globe.
The European Banking Federation said the draft law contained no surprises and that banks were prepared for changes.
“What we don’t want is supervisory authorities to determine the level or form of remuneration,” an EBF spokeswoman said.
“We also insist that the new rules in terms of remuneration are international. We want a level playing field,” the spokeswoman said.
It is the second wave of reform to EU capital rules, with a third wave due in the autumn that is expected to include proposals to toughen up liquidity requirements, introduce a simple cap on leverage and build up capital buffers in good times for drawing down in weak markets.

See also: FACTBOX – EU, Basel to tighten bank capital charges

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