FIN-USE

Expert Forum of

Financial Services Users

Providing expertise for policymakers

FIN-USE position on the public consultation on possible changes to the Capital Requirements Directive

(CRD, consisting of Directives 2006/48/EC and 2006/49/EC)

16 June 2008

Introduction

The European Commission has launched a public consultation on possible changes to the Capital Requirements Directive (2006/48/EC and 2006/49/EC). The purpose of this consultation is to collect comments from the industry and other stakeholders on these modifications.

The objective of capital requirements is to have in place a comprehensive and risk-sensitive framework and to foster enhanced risk management amongst financial institutions. This will maximise the effectiveness of the capital rules in ensuring continuing financial stability, maintaining confidence in financial institutions and protecting consumers. For this purpose, FIN-USE would like to give the Commission its view on these issues, by means of the present position paper:

Changes to Directive 2006/48/EC

-Article 4, paragraph 45,B:

It seems very sensible (and also much needed in view of the recent events derived from the sub-prime and the subsequent CDO-collateralized debt obligations crisis) that the specification that is made in the consultation paper regarding “group of connected clients” means: “…if one of them were to experience financial problems, in particular funding or repayment difficulties, the other or all of the others would be likely to encounter funding or repayment difficulties”.

We are of the opinion that this new wording (adding expressly the underlined words) amplifies the current text: “if one of them were to experience financial problems, the other or all of the others would be likely to encounter repayment difficulties”.

-Article 106, (new) paragraph 3: The same remark.

-Art. 110: The first paragraph is a good example of rewording in order to improve much needed transparency and risk disclosure (especially in collateralized and risk-concentred products).

In addition it seems a good idea simplifying and harmonizing (at present each state shall provide according with two eligible methods) the number of reporting to be carried out by credit institutions. This is done in article 110, paragraph 2: “Member States shall provide that reporting is to be carried out not less than twice each year”.

One important issue which arose as a result of the sub-prime crisis has been the lack of disclosure and transparency shown by the European financial industry, up to the point that even in the present moment some industry experts have recently declared that European credit institutions have recognized only two-thirds (2/3) of their failures in collateralized bonds. So, at the present moment, the sticking problem in Europe is the lack of confidence between the same credit institutions (lending in the inter-banking market has dried up because banks themselves are unaware of the degree of risk-exposure to sub-prime-structured products by the borrower-bank, and they are suspicious that the loan will not be repaid) than the real weight or risk caused by the sub-prime mortgages on their balance-sheets.

It is evident that the markets are seriously weak, and the changes being proposed to paragraph 3 seem to be very appropriate in order to put light and transparency in this sick market: “ Member States shall (not just “may” as the previous wording) require credit institutions to analyse, to the extent possible, their exposures to collateral issuers and providers of unfunded credit protection for possible concentrations and where appropriate take action and report any significant findings to their competent authority.”

However it would be desirable adding that the report to the authority must be done immediately, without delay.

-Article 111, ii, in fine: The proposed wording is: “Member States may impose a lower amount than EUR [X] million.” We are contrary to such discretion as this is an exception to the desirable general principle of harmonization the CRD rules. In fact not only in the new second paragraph (art. 111,2) the harmonization criteria have emerged, but also in the new wording of article 113, and others.

-Art. 111,2: “A credit institution shall at all times comply with the limits laid down in paragraph 1. If in an exceptional case exposures exceed this limit, the value of the exposure shall be reported without delay to the competent authorities which may, where the circumstances warrant it, allow the credit institution a limited period of time in which to comply with the limits.” This wording is an improvement on the previous one, not only for the new obligation for the credit institution of reporting the value of the exceeded exposure value (if this would be the case), but also for allowing the competent authorities to set to the credit institution a limited period of time in which to comply with the established limits. Notwithstanding, harsher penalties (such as a fine) should be imposes on those credit institutions that frequently relapse into the risk excess. And last but not least, those recidivists credit institutions should be included in some kind of public (ECB website, for instance) warning-list so that it should serve as a warning for the users.

-Art. 113: This article is a good example of the simplification, clarification and harmonization of the existing regulation. The previous wording was extremely complicated.

-Art. 114,3: “A credit institution that makes use of the Financial Collateral Comprehensive Method or is permitted to use the methods described in paragraph 2 in calculating the value of exposures for the purposes of Article 111(1), shall conduct periodic stress tests of their credit-risk concentrations, including in relation to the realisable value of any collateral taken.” In our opinion, “periodic” test is too vague. In FIN-USE opinion, and based on the present and so-rapidly changing market conditions, it would be desirable that the mentioned stress test should be carried out at a quarterly basis, and –at least- every six months.

-On page 27 of consultation paper (article 129, No. 3) in the third paragraph (from above) the text reads: “Where these competent authorities disagree, the matter shall be referred for consultation to the Committee of European Banking Supervisors, which shall give its advice within two months.” This time limit is too broad and should be shortened to just one month.

THE NEED FOR WIDER REFORMS :

FINUSE welcomes the updating of the CRD. However, we would like to emphasise that this initiative has a very narrow focus. The recent upheaval in the capital markets, and the impact this has had on end-users, means that major reform of capital markets regulation (including capital markets firms and professionals) is paramount if consumer confidence and trust in the financial system is to be maintained and efficient markets encouraged.

The challenge for all stakeholders is to ensure the regulatory system meets the following objectives. Regulation must:

•maintain stability of the financial system;

•protect consumers;

•promote consumer confidence in the financial system and providers; and

•promote efficient markets.

In particular, we would encourage the Commission to:

•ensure the way off-balance sheet investments are used and accounted for

is reformed;

•regulate effectively the conflicts of interest in the capital markets

have caused much detriment such as aggressive remuneration practices that encourage unreasonable or excessive risk taking, and the role of so-called independent third party ratings agencies;

•introduce greater transparency and disclosure into the market to promote

greater accountability and more effective regulation and enforcement.

We would also emphasise that we are calling for more effective regulation not more regulation for the sake of it. We recognise that policymakers at Commission and national level face a difficult challenge in getting the balance of regulation right and we look forward to providing a consumer perspective on the reforms.

Finally, we would also make the point that if policymakers are to benefit from the input of consumer representatives then we need access to an improved evidence base and cost-benefit-assessments of the potential impacts of various reforms.

Conclusion

In conclusion FIN-USE welcomes the updating of CDR Directive, which had an extremely technical and complex wording and framework, and as a result, it has been improved. In addition to the envisaged changes, an urgent piece of work is needed to investigate, amongst others the following issues:

-To what extent has the impact of recent developments in the institutional funding markets (such as the use of securitization, EU lenders exact exposure to the US sub-prime crisis, and the resulting credit crunch) impacted on consumers/end users?

-To what extent has the evident lack of independence of some collateral valuation agencies in some member states been a cause of the problem (such as in Spain, where are usually dependent from the credit institutions and imposed by them on the user)? Consumers have the feeling that this real estate valuation method has been one of the causes of the immense real estate bubble. In this sense, it is evident that the better valuated the state property has been prior to be collateralized, the term of the mortgage granted by the credit institutions has been more and more extended, up to 40 and nearly 50 years, with extended periods of interest payment on more than twice the price of the house! Paradoxically, now that the bubble has exploded and the value of the real estate has diminished to a great extent, it seems that users are again the victims of the said situation, not only because many of them are paying for a house with a lower market value which is less than the remaining capital required to be paid, but also existing legislation (in Spain, at least) permits credit institutions to ask for more collateral from the borrowers as a result of the real estate depreciation.

FIN-USE hopes that the responses to this consultation will provide guidance to the Commission services for the next step, which is the preparation of a Commission proposal that is scheduled to be adopted in September 2008 and to which FIN-USE will be able to provide its feedback in more detail.

Public consultation on possible changes to the Capital Requirements Directive1