01 October 2012

Commissioner Michel Barnier's reaction to the Basel Committee's preliminary "Regulatory Consistency Assessment"

The Basel Committee on Banking Supervision has been carrying out a preliminary assessment of the consistency of the Council's general approach on the Capital Requirements Directive IV (CRD IV) with the so-called Basel III agreement on internationally agreed capital standards. The outcome of its work so far has been published today, along with reports on the regulatory consistency in the US and Japan.The Committee's work will continue with a final report on consistency being issued once CRD IV is adopted.

Commissioner Michel Barnier, responsible for financial services, reacted as follows:

"In 12 out of 14 areas of the preliminary "Regulatory Consistency Assessment" concerning the EU published by the Basel Committee today, the draft European legislation has been fairly assessed to be "compliant" or "largely compliant". I have, however, reservations about the preliminary findings in the remaining two areas, which do not appear to be supported by rigorous evidence and a well-defined methodology. I believe that this has led to an apparently significant lack of consistency in the way judgement and gradings have, in this preliminary phase, been applied in those two areas across jurisdictions. The European Commission and the European members of the Basel Committee have provided extensive information and clarifications to the Basel Committee during the process, but unfortunately this has only been partially reflected in this present preliminary report. Here at the Commission, we stand ready to support the further work by the Basel Committee to improve its assessment of standards implementation and are confident that the final report of the Basel Committee will constitute an improvement both in the assessment of the EU and in the coherence across jurisdictions"

He added that:

"The European Union remains firmly committed to the robust implementation of the internationally agreed capital standards, the so-called Basel III agreement. It will be applied to more than 8,000 banks in Europe, representing more than 50 per cent of world banking assets. EU implementation of Basel III is a key contribution to sustainable growth and financial stability, not just in the Union, but also globally. We presented our proposals in July last year. They are currently being discussed by the European Parliament and the Council. All institutions are determined to successfully conclude the legislative process this autumn.

It is of the utmost importance that the Basel III agreement is applied consistently around the world, in order to ensure global financial stability and a level playing-field. Therefore, I fully support the Basel Committee's intention to assess consistent implementation of these rules for all internationally active banks worldwide and welcome the work of the Basel Committee in this area."

Intransparent section grading

It is not transparent how the individual "potentially material" findings translate into a section grading. In the case of the IRB, a single – questionable – finding, regarding permanent partial use, seems to have turned the whole IRB section grading for the EU into "materially non-compliant". This does not seem justified given the unclear Basel rule on this point and the unquantified impact of this legislative choice on capital requirements. This finding is also not comparable to the situation in the securitisation section of one other report, where a "materially non-compliant" grading has been attributed because a methodology for assigning capital requirements is used that is not based on credit quality assessments and therefore completely different from Basel II.

In the section about the definition of capital, a section grading of materially non-compliant has been assigned even though none of the seven "main specific issues" have been clearly demonstrated to be material. Moreover, the assessments of these issues contain material shortcomings (see press release). At the same time, again comparing with one of the other reports, a similar number of individual findings in the definition of capital section that are comparable, or even identical, on substance lead to a section grading of "largely compliant".

Shortcomings in individual findings

The report fails to explain what quantitative importance a finding must have in order to be classified as material. Moreover, the "main specific issues" identified in the report are in all instances of "potential", rather than actual, materiality. The findings are usually ascribed to concerns about possible future behaviour by banks and their supervisors. However, it is never spelled out what future behaviour has been assumed by the assessors for this "potential" to materialise. Worse still, it appears that assumptions have not been made consistently across the three jurisdiction assessments. It appears that in the other two reports, more often than in the EU report, findings have been considered non-material based on an expectation that they will be mitigated by informal rules or certain behaviour of supervisors. A case in point is the recognition of capital instruments, where the proposed rules in one of the other two assessed jurisdictions give supervisory authorities far greater leeway than the EU rules do. However, only in the EU report there seems to be an assumption that competent authorities will not act appropriately, despite the existing safeguards of disclosure and discipline through the European Banking Authority.

It appears that at times, individual bank data has been used, but no account is given of the specific instance of the bank in question and of whether or not the relevant finding can plausibly be extrapolated to other banks. A case in point is the finding on non-joint stock companies. This indeed concerns a single internationally active bank. It is unclear that the issue is really material in the specific case and it is unreasonable to assume that a similar concern, which is specific to the cooperative legal form and applicable laws in one Member State, could arise at other internationally active banks.

Another instance is the permanent partial use of the IRB. The concern seems to relate to the observation that up to "around 20 per cent" of the exposures of one of the banks surveyed are treated under the standardised approach instead of the IRB approach. However, the average for the surveyed banks is only 5.49 per cent and no estimate of the impact on capital requirements is provided in order to confirm the materiality of the finding. Notably, when comparing again the three reports, it turns out that the Basel Committee's assessors are much less concerned if in another jurisdiction, all internationally active banks are still subject to the outdated Basel 1 framework and this leads to around 20 per cent lower capital requirements overall according to local supervisors. In any case, the finding is questionable given that limited permanent and transitional partial use is in principle allowable according to the Basel II accord and it is not clear that the identified partial use in the EU banks goes beyond the allowable extent envisaged by the Basel Committee. It is also not clear that the impact of applying the Standardised rather than the IRB approach to the exposures in question is actually material in terms of resulting capital requirements.

Press release

Assessment report

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