Risk management presentation April 8 2013

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International Association of Risk and Compliance
Professionals (IARCP)
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA
Tel: 202-449-9750 www.risk-compliance-association.com
Top 10 risk and compliance management related news stories
and world events that (for better or for worse) shaped the
week's agenda, and what is next
Dear Member,
Franz Kafka hassaid that alawyer is aperson
whowritesa10,000-word document and callsit
abrief.
Lou, a member of theIARCP, reminded it tome.
He ―thanksus‖ for the 210+ pagesof thepreviousTop 10 list, but he
complainsthat it takestoomuch time to readit!
Toomuch time(herepeated).
And, he cannot resist the temptation. If there is somethinginterestingin
his hands, hewill read it.
Lou, if you cannot resist TH IStemptation, the Top 10list is the leastof
your problems.
Ok, thisweek‘sTop 10list is under 200pages!
What should wedo?Should wehave audioaswell? - talk is cheap... until
lawyersget involved :)
This week westart (Number 1) witha great overview of theBasel III
implementationin Europe. And, it takesonlyabout 60 pagestoread!
International Association of Risk and Compliance Professionals (IARCP)
www.risk-compliance-association.com

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If you flyfrom NY toDC you can studyit (weather,check in time and
delays have beentaken intoaccount).
What would you prefer to read?TheAuditing Standards of thePCAOB?
No.
According to JamesR. Doty, Chairman of the PCAOB (at Number 3 of
our list) …
―Thecurrent PCAOB standardsincludeboth interim standards(the
"AU" standards, whichhave accretedover time, aswrittenby the
profession) and 16additional standards, promulgated bythePCAOB (the
"AS" standards). As printed, thesestandards run to over 2,000pages. To
navigatethesestandards can, weare told, provedaunting.‖
Oh, no. Theyare not serious.TheAU andAS
standards… to restore investorconfidence.
JamesR. Doty alsosaid:
―I shall stop there, and won't suggest this
reorganizationproject will rival the Code of
Hammurabi or Charlemagne'scodifications‖
Look at the picture. TheCode of Hammurabi
is a well-preservedBabylonian lawcode, dating
back toabout 1772BC.
It is one of the oldest deciphered writingsof
significant length in theworld.
Thesixth Babylonian king, Hammurabi, enactedthe code, and partial
copiesexist on a human-sizedstone stele and variousclaytablets.
At least wehave the Top 10list in adobeacrobat format.
Can you imaginereceiving―copies‖ similar tothepicture?

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Provisionsof the Code of Hammurabi addressissuesconcerning
relationshipssuch asinheritance, divorce, paternityand behavior.
There is nothing about corporategovernance. Enron collapsedin 2001
(waylater).
Oneof themost well-knownof Hammurabi's
lawsis:
If aman put out theeye of another man, his
eye shall beput out.
It is more like Sarbanes-Oxley, than Basel III.
I can seeat thepicture the king and the
management consultant explainingthetop 10
list of the time.
Welcometo this―brief‖ Top 10 list.
BestRegards,
GeorgeLekatis
President of the IARCP
General Manager, ComplianceLLC
1200G Street NW Suite
800,Washington DC
20005,USA
Tel: (202) 449-9750
Email: lekatis@risk-compliance-association.com
Web: www.risk-compliance-association.comHQ:
1220N. Market Street Suite804,
Wilmington DE 19801,USA
Tel: (302) 342-8828

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CRD IV/ CRR
FrequentlyAsked Questions
Thefinancial crisisrevealed vulnerabilitiesin the regulationand
supervision of the bankingsystem at European and global level.
Thepackage agreedby Council and Parliament buildson thelessons
learnt from the recent crisisthat hasshownthat lossesin thefinancial
sectorcan beextremelylargewhenadownturnisprecededbyaperiod of
excessivecredit growth.
An overview
Guidance on Leveraged Lending
TheOffice of theComptrollerof the
Currency, the Board of Governorsof the
Federal Reserve System, and the Federal Deposit InsuranceCorporation
(collectively, the agencies) have jointlyissued the attached supervisory
guidanceon leveragedlending, whichappliesto all national banks,
federal savingsassociations,andfederal branchesandagenciesof foreign
banks(collectively, banks).
This guidancewaspublished in the Federal Register on March
22, 2013,and replacessimilar guidanceissued in April 2001(2001
guidance).

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Statement on the Proposed Framework for
Reorganization of PCAOB Auditing
Standards
JamesR. Doty, Chairman
PCAOB Open Board Meeting, Washington, D.C.
It should come asnosurprise toany professional
person that auditingliteratureis extensive.
This reflectstheevolution of businessprocesses,globalizationof
economies,technological changes.
Public consultation on Guidelinesrelated to the
preparation for Solvency II
The European Insurance and Occupational Pensions
Authority (EIOPA) launched a public consultation on
Guidelinesrelated tothepreparationfor Solvency II.
The purpose of the Guidelines is to support both National
Competent Authorities (NCA‘s) and undertakings in their
preparation for the SolvencyII requirements.
TheGuidelinescover the areasthat EIOPAconsiders fundamental to
ensure effectivepreparation for SolvencyII: system of
governance, includingrisk management; forwardlookingassessment of
theundertaking‘sownrisk(basedontheOwnRiskandSolvency
Assessment (ORSA) principles);submission of informationtoNational
Competent Authorities(NCA‘s); pre-applicationof internal models.

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Supervisory framework for measuring and
controlling large exposures
Oneof the keylessonsfrom thefinancial crisisis
that banksdid not alwaysconsistently
measure,aggregate and control exposuresto
singlecounterparties acrosstheir books and
operations.
And throughout historytherehavebeeninstancesof
banksfailing due toconcentrated exposuresto
individualcounterparties(egJohnsonMattheyBankersin theUK in 1984,
theKorean bankingcrisisin the late 1990s).
Largeexposuresregulation hasarisen asa tool for containingthe
maximum lossa bank could facein the event of a sudden counterparty
failure to a level that doesnot endanger thebank‘ssolvency.
ChairmanBen S.Bernanke
Monetary Policy and the Global Economy
At the Department of Economicsand STICERD
(Suntoryand Toyota International Centresfor
Economicsand RelatedDisciplines)Public Discussion inAssociation
withtheBank ofEngland, LondonSchoolofEconomics,London, United
Kingdom
―For me, perhapsthecentral insight isthat the recent crisis, despite its
manyexotic features, wasin fact a classicfinancial panic--asystemwide
run of "hot money" awayfrom assetswhosevaluessuddenlybecame
uncertain.‖

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CIMA signsMoU with Successor Entitiesto
the UK‘sFSA
On 1 April, 2013, the United Kingdom‘s Financial
Services Act 2012 enters into force, and functions
previouslyexercisedby the Financial Services
Authority (FSA) will now be exercised by three separate entities.
Thesearethe Prudential RegulationAuthority (PRA), the Financial
Conduct Authority (FCA) and the Bank of England.
CIMA has signed Memorandaof Understanding (MoU) withthe PRA
andtheFCA, successoragenciestotheFSA.
ThePRA– a subsidiaryof the Bank of England – will be responsiblefor
prudential supervision of deposit takers,insurersand significant
investment firms.
Recent economic and financial
developmentsin Iceland
Speechby Mr Már Guðmundsson, Governor of
theCentral Bank of Iceland, at the 52ndAnnual
GeneralMeetingof theCentral Bank of Iceland,
Reykjavík
―As weconvenefor the52ndAnnual General
Meetingof the Central Bank of Iceland, the domestic economicrecovery
that began in mid-2010continues, although it hassloweddown in recent
months.
At least to a degree, the slowdownis due to developments
internationally.‖

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Toward a stronger financial market
infrastructure for Canada – taking stock
RemarksbyMsAgathe Côté, DeputyGovernor
of the Bank of Canada, to theAssociation for
Financial Professionalsof Canada (Montreal
Chapter)
―I am going to takeadvantageof this audienceof financial professionals
totalk about financial market infrastructure, a subjectthat affects every
singleperson in onewayor another – you, becauseof the nature of your
work,more than others.‖
Financial regulation – Australia in the
global landscape
Address by Mr Glenn Stevens,Governor of the
ReserveBank ofAustralia, totheAustralian
Securitiesand InvestmentsCommission (ASIC)
Annual Forum, Sydney
―It is alsoimportant to remember that
Australia, along with all other jurisdictionsthat
sign up to
international standards, will be evaluated by our peers.
Soit‘s worthspellingout our approach tosome keyissues.‖

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CRD IV/ CRR
FrequentlyAsked Questions
1. CONTEXT
Whya revision of the Capital requirementsdirective is
necessary?
Thefinancial crisisrevealed vulnerabilitiesin the regulationand
supervision of the bankingsystem at European and global level.
Thepackage agreedby Council and Parliament buildson thelessons
learnt from the recent crisisthat hasshownthat lossesin thefinancial
sectorcan beextremelylargewhenadownturnisprecededbyaperiod of
excessivecredit growth.
Institutionsentered the crisiswith capital of insufficient quantityand
quality.
Tosafeguard financial stability, governmentshad to provide
unprecedentedsupport to thebankingsector in many countries.
Theoverarchinggoalof thenewrulesistostrengthentheresilienceofthe
EU banking sector soit wouldbe better placed to absorb economic
shockswhile ensuringthat bankscontinue to financeeconomicactivity
and growth.
What lessonshave welearnt from the crisis?
First and foremost the crisis revealed an absolutenecessityof enforcing
thecooperationof monetary, fiscaland supervisoryauthoritiesacrossthe
globe.
Crossborder developmentswereobserved toolate, crossborder impacts
wereverydifficult toanalyse.

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Secondly, some institutionsin the financial system appearedtobe
resilient and readytoabsorb alsoenormousmarket shocks.
Other institutions,evenwithsimilarcapital levels,appeared tobeunable
toprotect themselves.
Thecrucial differencesbetweenthe twowerefound in: the qualityand
thelevel of the capital base, the availabilityof the capital base, liquidity
management and the effectivenessof their internal and corporate
governance.
Theselessonsjustifiedamending the Basel agreement, and accordingly
replacingthe CRD with a new regulatoryframeworkincluding a
Regulation (CRR hereinafter) and a Directive (CRDIV hereinafter).
Thirdly, cross border failures of international financial groups appeared
an insurmountable challenge for nationally accountable authorities; as a
consequence, several banks needed the intervention of the state in order
tostayafloat.
Theknowledgethat bankscould havebeen resolved, alsoin a cross
border context, wouldhave changed thebalanceof powerbetweenpublic
authoritiesand banks, withtheformer having more toolsat their disposal
than just thepublic purse and the bail-out option, and the latternot being
able toenjoythe best of all worlds:privatizegains, socializelosses.
This wouldhave put a dent on bank's risk appetite.
This justifiesthe Commission'slegislativeproposal for bank recovery
and resolution adoptedon June 6, 2012.
And this alsoexplainswhy, during thenegotiations,at the initiativeof
theEP, rules on remuneration werestrengthened.
Why did existing rules (including Basel 1/Basel 2) not stop the
crisisfrom happening?
Thecurrent EU bank capital frameworkis represented by the Capital
RequirementsDirective(CRD) comprising Directives2006/48/EC and
2006/ 49/ EC and reflectingtheproposalsof the Basel Committeefor the
Basel II Framework(Basel II) and TradingBook Review.

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It coversboth credit institutionsand investment firms and stipulatesthe
minimum amountsof ownfinancial resourcesthat banksmust have in
order to cover the risksto whichtheyareexposed.
Thefinancial crisishasunveileda number of shortcomingsof Basel II
andnecessitatedunprecedentedlevelsof publicsupport in order to
restore confidenceand stability in the financial system.
In particularsthe followingdrawbacksof theexistingframeworkwere
identified:capital that wasactuallynot loss-absorbing, failing liquidity
management, inadequategroup widerisk management and insufficient
governance.
In this regard, theG-20Declarationof 2April 2009conveyed the
commitment of theglobal leaderstoaddressthe crisiswith
internationallyconsistent effortsto, among others,improve thequantity
andqualityof capital in thebanking system, introducea supplementary
non-risk based measure tocontain the build-up of leverage, develop a
frameworkfor stronger liquiditybuffersat financial institutionsand
implement therecommendationsof the Financial Stability Board
(FSB)20tomitigatethepro-cyclicality.
In responseto themandategiven by theG-20, in September 2009the
GroupofCentral Bank GovernorsandHeadsofSupervision(GHOS), the
oversight bodyof theBaselCommittee(seebelowsection2), agreedona
number of measuresto strengthen theregulation of the bankingsector.
Thesemeasureswereendorsedby FSB and the G-20leadersat their
PittsburghSummit of 24-25September 2009.
In December 2010,the BaselCommitteeissueddetailed rulesof new
global regulatory standardson bank capital adequacyand liquiditythat
collectivelyare referred to asBasel III.
2. BASEL III, CRD IV AND IN TERNATIONAL LEVEL
PLAYING FIELD
What is the Basel Committee?
TheBasel Committeeon Banking Supervision(BCBS) hasthetask of
developing international minimum standardson bank capital adequacy.

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It is basedat the headquartersof the Bank for International Settlements
(BIS) in Basel, Switzerland.
Thememberscome from
Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany,
Hong Kong
SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico,the
Netherlands,Russia, SaudiArabia, Singapore,South
Africa, Spain, Sweden,Switzerland, Turkey, theUnited Kingdom and the
UnitedStates.
TheEuropean Commission and theEuropean Central Bank are
observers.
What is "Basel III"?
TheBCBS developsminimum standardson bank capital adequacy.
Thesehave evolved over time.
Followingthefinancial crisis, the Basel Committeehasreviewedits
capital adequacystandards(seeabovesection 1).
Basel III is theoutcome of that review, with thenumber threecoming
from it beingthethird configuration of thesestandards.
What is"Basel III" proposing to make banks stronger?
Better and more capital
Several banksappeared tohave a capitalbaseon their balancesheet
meetingthe regulatorystandards, which, however, turned out to benot
alwaysavailablewhen needed for lossabsorption. Some contracts
restrictedtheabsorption of lossesor there weresimplyno liquid assets
mirroring thebalancesheet capital figure.
Basel III now prescribesstrict criteriaiii that must be met by ownfunds
instruments, in order toensure that theycan effectively absorb banks‘
lossesalsoin timesof stress.

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More balanced liquidity
Amajor problem wasthe lack of liquid assetsand liquid funding during
thecrisis– referred toas"themarket driedup".
BaselIII requiresbankerstomanagetheir cashflowsand liquiditymuch
more intensethan before, topredict theliquidityflowsresultingfrom
creditors' claimsbetter thanbefore, and tobe ready for stressedmarket
conditionsby havingsufficient "cash" available, both in theshort term
and in the longer run.
Leverage back stop
Just in casethe calculatedrisk weightsof Basel 2 and 2.5contain
errors,modelscontain errors,or new productsare developed and risk
weightsare not measured preciselyyet, a traditional back stop
mechanism limitsthegrowthof thetotal balancesheetascomparedto
availableownfunds.
Amaximum leverageof 12used to be a ruleof thumb in thedays that
bankswerenot regulatedyet.
Today, given the sophistication of risk weight determination, the
leverageratiowill be an additional checking tool for supervisors.
Asthistool is new for theinternational framework, it wasagreed that data
and experience must be gathered before an effective leverage ratio can be
introduced asa bindingrequirement in each jurisdiction.
Capital requirements for derivatives(Counter party credit risk)
Basel III alsoenhancesthe existingcapital requirementsfor bank
derivativetransactionsand the so-calledcounterpartycredit risk that
stemsfrom them.
Aderivativeis an instrument whosevaluedependson another
instrument, underlying it.

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Derivativesareusedforgoodreasonsin banks‘riskmanagement, but the
crisisrevealed that exposuresand lossescould be material, and that a
review of the treatment in the supervisory frameworkwasjustified.
Theframeworkalsoincludesthe treatment of bank exposuresto central
counterparties(CCPs).
CCPisanentitythat interposesitselfbetweenthetwocounterpartiestoa
transaction, becoming the buyer toeveryseller and the seller toevery
buyer.
ACCP's main purposeis tomanage therisk that could ariseif one
counterpartyis not ableto make the required paymentswhenthey are
due– i.e. defaultson thedeal.
Capital Buffers (see section 10below)
Do CRD IV and CRR fully implement "Basel III"?
The EU has actively contributed to developing the new capital, liquidity
and leverage standards in the Basel Committee on Banking
Supervision, while making sure that major European banking
specificitiesand issuesare appropriatelyaddressed.
Thenew rules thereforerespect thebalanceand level of ambition of
Basel III.
However, there are tworeasonswhyBasel III cannot simplybe
copy/ pasted intoEU legislation.
First, Basel III is not a law.
It is thelatest configuration of an evolving set of internationallyagreed
standardsdeveloped by supervisorsand central banks.
That hasto now gothrough a processof democratic control asit is
transposedintoEU (and national) law.
It needsto fit withexistingEU (and national) lawsor arrangements.
Furthermore, while theBasel capital adequacyagreementsapplyto
'internationallyactivebanks', in theEU it hasalwaysappliedtoall banks
(more than 8,300) aswell asinvestment firms.

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This wide scope is necessary in the EU where banks authorised in one
Member State can provide their services across the EU's single market
and assuch aremore than likely toengagein cross-borderbusiness.
Also, applying theinternationallyagreedrules only toa subset of
European banks wouldcreatecompetitivedistortionsand potential for
regulatoryarbitrage.
TheEU hashad totake theseparticularcircumstancesintoaccount
whentransposingBasel III intoEU law.
What is Europe adding to "Basel III"?
As explained above, themost fundamental changeisthat, in
implementingthe Basel III agreement within theEU, wemove from an
uni-dimensional type of worldwhereyou have onlycapital asa prudential
reference,to multi-dimensional regulation and supervision, whereyou
havecapital, liquidityand theleverageratio– whichis
important, becausethiscoversthewholebalancesheet of thebanks.And
even within capital, thereis a much cleaner definition and more realistic
targets.
In additiontoBaselIII implementation, theproposal introducesa
number of important changestothebanking regulatory framework.
In the Directive:
Remuneration.In order totackle excessiverisk takingthe
remuneration frameworkhasbeen further strengthenedwith
regard to therequirementsfor the relationship betweenthe
variable (or bonus) component of remunerationand thefixed
component (or salary).
From 2014onwards,thevariablecomponent of thetotal
remuneration shall not exceed 100% of thefixed component of the
total remuneration of material risk takers.

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Exceptionally, and under certainconditions,shareholder can
increasethismaximum ratio to 200%.
Enhanced governance: CRDIV strengthensthe
requirementswithregard to corporategovernancearrangements
andprocessesand introducesnew rulesaimed at increasingthe
effectivenessof risk oversight by Boards, improvingthe statusof
theriskmanagement function and ensuringeffectivemonitoring
bysupervisorsof risk governance.
Diversity. Diversity in board composition should contribute
toeffectiveriskoversight byboards,providingfor a broader range
of viewsand opinionand thereforeavoidingthe phenomenon of
group think.
CRDIV thereforeintroducesa number of requirements,in
particular asregardsgender balance.
Enhanced transparency. CRDIV improvestransparency
regardingthe activitiesof banks and investment fundsin different
countries,in particular asregards profits,taxesand subsidiesin
different jurisdictions.
This is consideredessential for regainingthe trust of EU citizens
in thefinancial sector.
Systemic risk buffer (seesection 10 below)
Global systemic institutionbuffer (seesection 10below)
Other systemic institution buffer (seesection 10 below)
Finally, the new rulesseek toreducetothe extent possible
relianceby credit institutionson external credit ratingsby:

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a)requiringthat all banks' investment decisionsarebasednot only
on ratingsbut alsoon their own internal credit opinion, and
b)that bankswith a material number of exposuresin a given
portfolio develop internal ratingsfor that portfolio instead of
relying on external ratingsfor the calculationof their capital
requirements.
In the Regulation:
A ―sin gle ru le b ook‖ : For the first time a single
set ofharmonisedprudentialrulesiscreatedwhichbanksthroughout the
EU must respect.
EU headsof stateand government hadcalled for a "singlerule
book" in the wakeof the crisis.
This will ensure uniform applicationof Basel III in all Member
States,it will closeregulatory loopholesand will thuscontributeto
a more effectivefunctioning of the Internal Market.
Thenew rules remove a largenumber of national optionsand
discretionsfrom theCRD, and allowsMember Statesto apply
stricter requirementsonlywheretheseare justifiedby national
circumstances(e.g. real estate), needed on financial stability
groundsor becauseof a bank'sspecific risk profile.
How is possible to ensure an international level playing field?
Thefinancial system is global in nature and it is not stronger than its
weakest link.
It is thereforeimportant that all countriesimplement international
bankingstandards, includingBaselIII.
TheEU hascontinuousand constructivediscussionswithits
international partners– most notablytheUS – regarding their

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implementationof theBasel agreementsin a proper and timely manner
and - more in general - on cross-border financial servicesregulatory
issues.
What‘sthe timeline and implementation of the legislative
proposalsand how it relatesto the timelines and
implementation in other G20 countries?
Theoriginal Commission proposal followedthetimelinesasagreedin
theBasel Committeeand in theframeworkof theG20: entryintoforceof
thenew legislationon 1January 2013,and full implementationon 1
January 2019,in linewith the international commitments.
Given the detailed discussionsduring thelegislativeprocess, thedate of
entryintoforce is now expected to be in [tobe confirmed], in order to
allowfor final technical legal checks and translationsin all EU official
languages.
Thedate of applicationwill be 1January 2014,withfull implementation
(in linewith the original Commission proposal) on 1January2019.
Todate, about half of themember jurisdictionsof the Basel Committee
haveadoptedthe final rulesimplementing(parts of) Basel III.
Theremainingjurisdictionsare expectedto adopt the final rules
sometime this year.
What the EU will do if other jurisdictionsdo not implement?
TheEU hasaninterestinincreasingtheresilienceof itsbankingsystem.
AsBaselIII aimstoachievethat objective,it isin principleinourinterest
toimplement it.
While there is alwaysa short term risk of regulatory arbitrageif one
jurisdictiongoesfurther than other jurisdictions,in the longer term it is
clearlybeneficial asmarket participantsbenefit from a stable, safeand
soundfinancial system.

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Even so, there may be areaswherean international level playing field is
more important alsoin the short run (e.g. thenew elementsof Basel III).
TheCommission is thereforecloselymonitoring the consistent
implementationof BaselIII acrosstheglobe and would need todraw all
thenecessaryconclusionsin due time should other key jurisdictionsnot
followsuit.
3. STRUCTURE OF THE NEW REGULATORY
FRAMEWORK
Whyare there twolegal instruments?Why also a regulation?
Theproposal dividesthe current CRD (Capital RequirementsDirective)
intotwolegislativeinstruments:a directivegoverning the accessto
deposit-takingactivities and a regulation establishingtheprudential
requirementsinstitutionsneed to respect.
While Member Stateswill have to transposethe directiveintonational
law,the regulation isdirectlyapplicable, whichmeansthat it createslaw
that takesimmediateeffect in all MemberStatesin the same wayasa
nationalinstrument, without anyfurtheractiononthepart ofthenational
authorities.
This removesthe major sourcesof national divergences(different
interpretations,gold-plating).
It alsomakestheregulatory processfaster and makes it easier toreact to
changedmarket conditions.
It increasestransparency, asone rule aswrittenin the regulation will
applyacrossthesinglemarket.
Aregulationissubject tothesamepoliticaldecision makingprocessasa
directiveat European level, ensuringfull democraticcontrol.
Last but not least, this proposal marksa thorough review of EU banking
legislationthat hasdeveloped over decades.
Theresult is a more accessibleand readablepieceof legislation.

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What goes in which instrument?
Areas of thecurrent CRD wherethe degreeof prescriptionis lowerand
wherethe linkswithnational administrativelawsare particularly
important will stay in the form of a directive.
This concernsin particular thepowersand responsibilitiesof national
authorities(e.g. authorisation, supervision, capital buffers and
sanctions), the requirementson internal risk management that are
intertwinedwithnational company law aswell asthe corporate
governanceprovisions.
By contrast, thedetailed and highly prescriptiveprovisionson
calculatingcapital requirementstake theform of a regulation.
4. SINGLE RULE BOOK
What is the single rule book?
In June 2009, the European Council called for theestablishment of a
"European singlerulebook applicabletoall financial institutionsin the
SingleMarket."
Thesinglerulebook aims toprovidea singleset of harmonised
prudential ruleswhichinstitutionsthroughout the EU must respect.
This will ensure uniform applicationof Basel III in all MemberStates.
It will closeregulatory loopholesand will thuscontributetoa more
effectivefunctioningof theSingleMarket.

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TheCommission suggestsremoving national optionsand discretions
from theCRD, and achievingfull harmonisation by allowingMember
Statestoapplystricter requirementsonlywheretheseareneededon
financial stabilitygroundsor becauseof a bank's specificrisk profile.
Whyisthe single rule book important?
Today, European banking legislationis based on a Directivewhich
leavesroom for significant divergencesin national rules.
This hascreated a regulatorypatchwork, leadingto legal
uncertainty, enablinginstitutionsto exploit regulatory
loopholes,distortingcompetition, and makingit burdensome for firms
to operate acrosstheSingleMarket.
For example:
- Securitisation was at the core of the financial crisis. Previous global
and EU standards(Basel II, CRD I) addressed some of the risks by
specific capital requirements(includingfor all liquidityfacilities).
However,many MemberStatesdid not follow,benefitingfrom a
transitional opt-out.
In a fullyintegratedmarket such assecuritisation, it waseasyfor
cross-bordergroupstoissuetheir securitisationtitlesin those
Member Statesthat opted out rather than in Member Stateswhich
applied thestandards.
- Followingtheexperiencewith securitisation in thefinancial
crisis,CRD II introducedharmonised rulestotighten the conditions
under whichinstitutionscould benefit from lowercapital
requirementsfollowinga securitisation (includinga harmonised
notion of significant risk transfer).
But several Member Stateshavenot transposedthis by the end of
2010asrequired.
- Thefinancial crisishasshown that reliableinternal risk models are
important for institutionsto anticipatestressand hold appropriate
capital.

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However,requirementsfor, and accordinglytheimplementation
of, internal ratingsbased risk models vary from one Member State to
another.
As a result, capital requirementsfor comparable exposures
differ, leadingpotentiallytoan level playing field and regulatory
arbitrage.
- Atough definitionof capital is a keyelement of Basel III.
However,experiencewithCRD I hasshownthat Member States
introducedenormousvariationswhen transposingthe directive
definitionintonational law.
Even wherethe requirementsof the directive wereclear, some
MemberStatesdid not correctlytransposethem.
In some cases,theCommission had toopeninfringement
proceedings,taking manyyears, in order to force theseMember
Statestocomplywiththedirective.
- Asinglerulebook basedon a regulation will addressthese
shortcomingsand will therebylead toa more resilient, more
transparent, and more efficient European banking sector:
- Amore resilient European banking sector:Asinglerulebookwill
ensure that prudential safeguardsarewhereverpossibleapplied
acrosstheEU and not limited to individual Member States.
Thecrisishighlightedtheextent towhichMemberStates'economies
are interconnected.
TheEU isa sharedeconomicspace.
What affectsone country could affect all.
It is not realistic tobelievethat unilateral action bringssafetyin this
context.
If a Member State increasesthe capital requirementsfor domestic
institutions,institutionsfrom other Member Statescan continueto
providetheir serviceswithlowerrequirements– and at a competitive
advantage- unlessother countriesfollowsuit.
This givesalsorisetoregulatory arbitrage.

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Institutionsaffected by the higher capital requirementscould
relocatetoanother Member Stateand continuetoprovidetheir
servicesin theoriginal Member State by meansof a branch.
- Amore transparent European banking sector:Asinglerulebookwill
ensure that institutions' financial situationis more transparent and
comparable acrosstheEU - for supervisors, deposit-holdersand
investors.
Thefinancial crisishasdemonstratedthat the opaquenessof
regulatoryrequirementsin different MemberStateswasa major
causeof financial instability.
Lackoftransparencyisanobstacletoeffectivesupervisionbut alsoto
market and investor confidence.
- Amore efficient European banking sector:Asinglerulebookwill
ensurethat institutionsdonot havetocomplywith27differingsetsof
rules.
Will Member Stateshave the possibility to require a higher basic
capital requirement?
TheEU in generalandtheeuroareain particularhaveaveryhighdegree
of financial and monetary integration.
Decisionson the level of capital requirementsthereforeneed tobe taken
for thesinglemarket asa whole, asthe impact of such requirementsis
felt by all MemberStates.
FinancialstabilitycanonlybeachievedbytheEU actingtogether;not by
each MemberState on itsown.
For example, if EU capital requirementsare set toolow, an individual
MemberStatecannot escaperisksto financial stabilityby simply
increasingrequirementsfor itsown institutions.
Unlessother Member Statesfollowsuit, foreign institutions' branches
can continuetoimport risk.
Higher levelsof capital requirementsin one MemberState wouldalso
distort competitionand encourage regulatoryarbitrage.

P a g e | 24
For example, institutionscould be encouragedto concentrate risky
activitiesin MemberStateswhich onlyimplement the minimum
requirements.
Therefore, capital requirementsneedtobe set at a level that is
appropriatefor theEU asa whole.
That is why, accordingto thepoliticalagreement, thecapital
requirementscannot be increasedbynational authorities(e.g. 6% CET 1
insteadof 4,5%), unlessa specificadd-on is justified followingan
individual supervisory review or based on systemic risk or
macro-prudential concerns(Systemic risk, Global systemic institutions
andOther systemic institutionsbuffersand Pillar 2, seesection10
below).
Will Member Statesstill retain some flexibility under the Single
Rule Book?
MemberStateswill retain some possibilitiestorequire their institutions
tohold more capital (seebelow a tableincludingall possibleflexibility
options– detailed description of variouscapital buffersisprovidedin
section 10below).
For example, Member Stateswill retain the possibilityto set higher
capitalrequirementsforrealestatelending, therebybeingabletoaddress
real estatebubbles.
If theydo, thiswill alsoapplytoinstitutionsfrom other Member States
that do businessin that Member State.
Moreover,each MemberStateis responsiblefor adjustingthelevel of its
countercyclical buffer toitseconomic situation and to protect
economy/ banking sector from anyother structural variablesand from
theexposure of thebankingsector toany other risk factorsrelatedto
risks to financial stability.
Furthermore, MemberStateswouldnaturallyretain current powers
under "pillar 2", i.e. the abilityto imposeadditional requirementson a
specific bank followingthe supervisoryreview process

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TheCommission toowill have the power toincreaseprudential
requirementsin all areassubject to specific conditions(seetablebelow)

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What is "Pillar 2"?What will change?
Pillar 2 refers tothepossibilityfor national supervisorsto imposea wide
rangeof measures- includingadditionalcapital requirements– on
individual institutionsor groupsof institutionsin order toaddress
higher-than-normal risk.
Theydosoon the basisof a supervisoryreview and evaluation
process, during whichthey assesshow institutionsare complying with
EU bankinglaw,the riskstheyfaceand theriskstheypose to the
financial system.
Following this review, supervisors decide whether e.g. the institution's
risk management arrangements and level of own funds ensure a sound
management and coverageof the riskstheyfaceand pose.
If the supervisor findsthat the institutionfaceshigher risk, it can then
requirethe institutionto hold more capital.
In taking this decision, supervisors should notably take into account the
potential impact of their decisions on the stability of the financial system
in all other MemberStatesconcerned.
The proposal clarifies that supervisors can extend their conclusions to
types of institutions that, belonging to the same region or sector, face
and/ orposesimilar risks.
How will thisaffect those Member Statesthat have already
decided to gofurther than Basel III or are planning to do so?
SomeMember States(e.g. Spain) have alreadydecided to goabovethe
minimum levelsof capital foreseen by Basel III.
Some(e.g. Sweden, Cyprus) have indicatedtheir intention to start doing
so.
Others (e.g. UK) have national processesunder waythat consider
requiringalevel of ownfundsaboveBasel III from parts oftheir banking
sector.

P a g e | 27
In some instances,Member Stateshave alsodecided to introducemore
quicklythechangesforeseen under Basel III that increasethequalityof
capital aswell.
According to the political agreement, MemberStatesare free to
anticipatethe full implementation of Basel III and hencemove to the
capital requirementsforeseen for 1January 2019already today, should
theysowish.
While Member Stateswill not be able toexceedthe level of own funds
requirement set by the political agreement, theycan usethe instruments
of flexibilityforeseen by that agreement, namely thecounter-cyclical
buffer, the systemic risk buffer, the global and other systemic institution
buffers,and Pillar 2.
5. CAPITAL
What is bank capital?
Capital can be definedin different ways.
Theaccountingdefinition of capital is not the same asthe definition
used for regulatory capital purposes.
For bankingprudential requirementspurposes,capital is not obtained
simplybydeductingthevalueof an institution's liabilities(what it owes)
from itsassets(what it owns).
Regulatorycapital ismore conservativethan accountingcapital.
Onlycapital that is at all timesfreely availableto absorblossesqualifies
asregulatory capital.
Additional conservatism is added by adjustingthis measure of capital
further by e.g. deducting assetsthat may not have a stablevalue in
stressed market circumstances(e.g. goodwill) and not recognisinggains
that have not yet been realised.

P a g e | 28
What is the capital adequacy requirement?
It is the amount of capital an institutionis required to hold comparedto
theamount of assets, to cover unexpected losses.
In the CRD, this is called'minimum own fundsrequirement' and is
expressedasa percentage.
Whyiscapital important?
Thepurposeof capital istoabsorb thelossesthat abank doesnot expect
tomake in thenormal courseof business(unexpectedlosses).
Themore capital a bank has, the more lossesit can suffer before it
defaults.If a firm owesmore than it owns(itsassetsare worthlessthan
itsliabilities),it cannot pay itsdebt and is therebyinsolvent.
If a bank haslesscapital than the requirement amount, supervisorscan
take measurestoprevent insolvency.
How is it calculated?
It is thevalue of a bank's capital asa percentageof its riskweighted
assets(RWA).
Theformula issimple:capital / RWA> 8%.
What are risk-weighted assets?
When assessinghow much capital an institutionneedsto
hold, regulatorsweigh an institution's assetsaccording to their
risk.
Safeassets(e.g. cash) are disregarded;other assets(e.g. loansto other
institutions)are consideredmore risky and get a higher weight.
Themoreriskyassetsaninstitutionholds,themorecapitalit hastohave.
In additiontorisk weighingon balancesheet assets,institutionsmust

P a g e | 29
havecapital alsoagainst risksrelatedtooff balancesheetexposuressuch
asloan- and credit card commitments.
Thesearealsoriskweighed.
What is the difference between Tier 1and Tier 2 capital?
Capital comesin different formsthat servedifferent purposes.
There aretwotypesof capital:
- Going concern capital:this allowsan institutiontocontinueits
activitiesand helpstoprevent insolvency. Thepurest form is
Common EquityTier 1(CET1) capital. Goingconcern capital is
consideredTier 1capital.
- Goneconcern capital:this helps ensuringthat depositorsand senior
creditorscan be repaid if the institutionfails. One exampleof this
kind of capital is institutiondebt. Gone concern capital isconsidered
Tier 2 capital.
-
What wasthe problem with capital during the crisis?
Banksand investment firmsdid not all havesufficient amountsof capital
andthecapital theyhad wassometimesof poor qualityasit wasnot
readilyavailable toabsorb lossesastheymaterialised.
Toprevent institutionsfrom defaulting, public fundshad to be used to
prop up institutions.
How do you proposeto increase the quality and quantity of
capital?
In line with Basel III, the proposal strengthens institutions' capital base
by increasing the amount of own funds institutions need to hold and by
restrictingwhat countsasown funds.

P a g e | 30
Today, banks and investment firms need to have a total capital of at least
8% of risk weightedassets.
Tomorrow, while the total capital an institution will need to hold remains
at 8%, the share that hastobe of the highest quality– common equitytier
1(CET1) – increasesfrom 2% to4.5%.
Thecriteria for each instrument will alsobecome more stringent.
Furthermore, theproposal harmonisestheadjustmentsmade to capital
in ordertodeterminetheamount ofregulatorycapitalthat it isprudent to
recognisefor regulatorypurposes.
This new harmonised definition would significantly increase the effective
level of regulatory capital institutionswouldbe required to have.
One unit of Basel II capital is therefore not the same as one unit of Basel
III capital.

P a g e | 31
Is the political agreement only going to increase the former
minimum level of capital?
No, thebasicownfundsrequirement staysat 8% orrisk-weightedassets.
However,in linewith Basel III, theproposal alsocreatesfive newcapital
buffers:thecapital conservationbuffer, thecounter-cyclical buffer, the
systemic risk buffer, the global systemic institutionsbuffer and the other
systemic institutionsbuffer (seesection on capital buffers).
Naturally, on top of all theseown fundsrequirements,supervisorsmay
add extra capital to cover for other risksfollowinga supervisoryreview
(seequestion on Pillar 2 above) and institutionsmay alsodecidetohold
anadditional amount of capital on their own.
How can institutions increase their capital ratio tomeet the new
requirements?
Institutionscan increasetheir capital ratio in twoways:
- Increasecapital:An institution can increaseitscapital by either
issuingnew sharesand/ or not pay dividendsto itsshareholders,i.e.
toretain profits.
Thesenew sharesand retainedprofitsbecomeincludedin itscapital
base.Providedtheydonot increasetheir risk-weightedassets
(RWAs), this increasestheir capital ratio.
- Reduceassetsand their risk weight:An institutioncan alsocut back
on lending, sell loanportfoliosand/ or make lessrisky loansand
investments,therebyreducing itsRWAs, whichhastheeffect of - for
agiven amount of capital - increasingitscapital ratio (capital/ RWA).
When will these provisionsstart to apply?
Basel III foreseesa substantial transitionperiodbeforethenew capital
requirementsapply in full.

P a g e | 32
This is toensurethat increasingthe resilienceof institutionsdoesnot
undulyaffect lendingtothe real economy (i.e. to ensure that institutions
donot cut back on lendingand investments).
Theprovisionsrelatedto the level of own fundswill accordinglybe
phased in asof [the 1January2014.
Capital instrumentsthat will not meet thenew, stricter eligibility criteria
will be phased out over 10years in order tohelp to ensure a smooth
transitionto thenew rules.
Do the new rulesallow Member States to implement Basel III
faster than foreseen by the Basle timetable?
Basel III foreseesa gradual transition to the stricter standards, with full
implementationasof 1January 2019.
The political agreement proposal foresees the same transition period but
allows Member States to implement the stricter definition and/ or level of
capital more quicklythan is required byBasel III.
Do the new rulesdepart from the Basel III definition of capital?
No. The Regulation takesexactlythe same approach asBasel III by
imposing14strict criteria that any instrument wouldhave tomeet to
qualify, withappropriate adaptationtothecriteriafor instrumentsissued
bynon-joint stock companiessuch asmutuals, cooperativebanksand
savingsinstitutions.
Thefull substanceof Basel III is perfectlytranslated intotheEuropean
laws.
Becauseof the absenceof a common EU concept of ―common
shares‖,the legal form of thehighest qualityform of capital isnot
restrictedto "ordinary shares".
This doesnot affect the substanceasCET1must meet 14 strict criteria.

P a g e | 33
What are the conditions capital instruments have to meet to
qualify asCommon Equity Tier 1instruments?
Article 26 of the CRR states that capital instrument can only qualify as
Common Equity Tier 1 instruments if a number of conditions are met.
Thesecan be summarisedasfollows(for full details, seearticle):
theyare issued directlyby theinstitution;
they are paid up and their purchase is not funded by the
institution;
they meet a number of conditions as regards their
classification (e.g. they qualify as capital for accounting and
insolvencypurposes);
they are clearly and separately disclosed on institutions'
financial statementsbalancesheet;
theyare perpetual;
theprincipal amount of the instrumentsmay not be reduced
or repaid unlesstheinstitution ise.g. liquidated.
Moreover, the provisions governing the instruments should not
indicate that the principal amount of the instruments would or
might be reduced or repaid other than in the liquidation of the
institution;
the instruments meet a number of conditions as regards
distributions (e.g. no preferential distributions in
time, distributions may be paid only out of distributable
items, the conditions governing the instruments do not include a
cap or other restriction on the maximum level of
distributions, the level of distributions is not determined on the
basis of the amount for which the instruments were
purchased, etc…);

P a g e | 34
compared to all the capital instruments issued by the
institution, the instruments absorb the first and proportionately
greatest share of losses as they occur, and each instrument absorbs
losses to the same degree as all other Common Equity Tier 1
instruments;
the instruments rank below all other claims in the event of
insolvencyor liquidationof the institution;
the instruments entitle their owners to a claim on the
residual assets of the institution, which, in the event of its
liquidation and after the payment of all senior claims, is
proportionate to the amount of such instruments issued and is not
fixed or subject to a cap;
the instrumentsare not secured, or guaranteed by any entity
in the group (e.g. the institution, its subsidiaries, the parent
institution or itssubsidiaries, etc);
the instruments are not subject to any arrangement that
enhances the seniority of claims under the instruments in
insolvencyor liquidation.
Theseconditionsensure that only the highest qualitycapital
instrumentsqualify asCET1.
Do the new rulesrecognise only ordinary sharesas Common
Equity Tier 1or could other instruments be recognised aswell?
Towarrant recognitionin thehighest qualitycategoryof regulatory
capital, a capital instrument must be of extremelyhigh qualityand must
absorb lossesfullyasthey arise.
The14 criteria for Common EquityTier 1capital agreed in Basel III are
extremelystrict bydesign. Onlyinstrumentsof thehighestqualitywould
becapableof meeting them.

P a g e | 35
Provided an instrument met thosestrict criteria - includingin respect of
itslossabsorbency–it wouldqualify asCommon EquityTier 1capital.
What are minority interests and what amount of minority
interestscan be recognised?
Minorityinterestsare capital in a subsidiarythat is ownedbyother
shareholdersfrom outsidethe group.
Theyare particularlyimportant in the EU, asEU banking groupsoften
havesubsidiariesthat are not fullyowned by theparent company but
haveseveral other owners.
Basel III recognisesminorityinterestsand certain capital instruments
issuedby subsidiaries(e.g. hybridsand subordinateddebt) tobe
includedin the capital of thegroup only wherethosesubsidiariesare
banks(or are subject to thesame prudential requirements) and up tothe
level of thenew minimum capital requirementsand the capital
conservation buffer.
Thepolitical agreement recognisesminority interestsup to and
includingthe Pillar 2 requirement. This is a simpleresult of the fact that
theEU legislationdoesput at the disposal of SupervisoryAuthority
several additional buffers(seesection 10).
What will be the treatment of significant holdingsin insurance
companies?
Basel III requiresbanks todeduct significant investmentsin
unconsolidatedfinancial entities, includinginsuranceentities,from the
highestqualityform of capital (CET1).
Theobjectiveis toprevent thedouble counting of capital, i.e. toensure
that the bank is not bolsteringitsown capital withcapital that is also
used to support the risks of an insurancesubsidiary.
Thepolitical agreement allowsan updated version of the Financial
ConglomeratesDirective(FICOD) approach, whichallowsconsolidation

P a g e | 36
ofbankingandinsuranceentitiesin agroup, tocontinuetobeusedasan
alternativeto theBasel III deductionapproach.
What are Deferred TaxAssets (DTAs) and what will be their
treatment?
Deferred TaxAssets(DTAs) areassetsthat may beused toreducethe
amount of future tax obligations.
Basel III treats DTAsdifferentlydependingon how much theycan be
relied upon whenneeded to help a bank toabsorblosses.
Where their valueis lesscertain to be realised, theymust be deducted
from capital.
However,Basel hassubsequentlyclarifiedthat DTAs that are
transformedon amandatory and automatic basisintoa claim on the
Statewhen an institutionmakes a losswouldbe one of the forms of
DTAs for which deduction would not be warranted.
Thepolitical agreement implementstheaboveBasel rules.
What is the Basel I floor and will its application be prolonged?
Basel II requiresmore capital to be held by banks for riskier business
than wouldbe requiredunder Basel I.
Forlessriskybusiness, BaselII requireslesscapitaltobeheldthanBasel
I. This is what Basel II wasdesigned to do: to be more risksensitive.
Toensure banksdonot hold toolittleregulatorycapital, Basel II set a
flooron the amount of capital required, whichis 80% of thecapital that
wouldbe required under BaselI.
While the floor required bythe original CRD expired by theend of
2009,the CRD III reinstatedit until end-2011.
In the light of the continuingeffectsof thefinancial crisisin thebanking
sectorand the extensionof the BaselI flooradopted by theBasel
Committeeon BankingSupervision in July2009, thepolitical agreement
reinstatesthe floorin 2014,to be applied until 2017.

P a g e | 37
However,national authoritieswouldbe ableto waivethe requirement
under strict conditions.
It alsointroducesa requirement for a continuousrevision of theneed for
such a floor sinceit should not be maintainedin placelonger than is
strictlynecessary.
What will be the cut-off date for recognising instruments that do
not meet the eligibility criteria?
ToensureasmoothtransitiontothenewBaselIII rules,instrumentsthat
are currentlyused that donot meet thenew rules have to be phased out
over a 10-year period, providedtheywereissued prior tothe date of
agreement of thenew rules by Basel(12September 2010). Under Basel
III, instrumentsissuedafter thecut-off date wouldneed to comply with
thenew rulesor wouldnot be recognisedfrom 1January2013.
Thepolitical agreement setsthecut-off date at 31December 2011.
What will be the treatment of instruments no longer eligible as
CET1?
Thepolitical agreement phasesthem out over a 10-year period. For
instrumentsinjectedbya government prior tothedateof entryintoforce
of the regulationthepolitical agreement is tofullyrecognisethem in
CET1capital for a 5-year period.
Thenew rules require institutionsto hold more capital against
investmentsinhedgefunds,realestate,venturecapitalandprivateequity
than theyhave done toup now.
Why isthat?
Thecurrent CRD (points66-67ofAnnex VI, Part 1)statesthatcompetent
authoritiesmay applya 150%risk weight to"exposuresassociatedwith
particularlyhigh riskssuch asinvestmentsin venturecapital firms and
privateequityinvestments".
However,what 'particularlyhigh risks' arehas not been defined.

P a g e | 38
Thelackofobligationcombinedwiththelackofacleardefinitionhasled
todifferent assessmentsand risk weightsgranted to thesame type of
exposures.
On thebasisof an advicefrom CEBS(Committeeof European Banking
Supervisors,thepredecessorof EBA), the Commission now proposesto
requirebankstoassign a 150%risk weight tothesetypes of exposures
(investmentsin venture capital firms, alternativeinvestment fundsand
speculativerealestatefinancingaswellas"exposuresthat areassociated
with particularlyhigh risks").
The proposal now also clearly defines the criteria that supervisors should
use when an exposure is associated with such risks and requires EBA to
develop guidelinesin that respect.
What is the role of contingent capital in the new framework?
TheCRR requires all instrumentsrecognised in theAdditional Tier 1
capital of a credit institutionor investment firm tobe writtendown, or
convertedintoCommon Equity Tier 1instruments, whenthe Common
EquityTier 1capital ratioof the institutionfallsbelow 5.125%.
Thenew rules donot recognise other formsof contingent capital for the
purposesof meetingregulatory capital requirements.
What is hybrid capital?What role does it play?
Hybrid capital is aterm used todescribeformsof capital instrument that
havefeaturesof both debt and equityinstruments.
Such instrumentsin issue during thecrisis proved not to be sufficiently
lossabsorbent.
Thenew rules buildsupon theimprovementsmadeunder CRD II to the
qualityof hybrid Tier 1capital instruments,introducingstricter criteria
for their inclusion in Additional Tier 1capital.
As explainedabove, thisincludesa requirement for all such instruments
toabsorblossesbybeing written down, or converted intoCommon
EquityTier 1instruments,whenthekeymeasureof acredit institutionor

P a g e | 39
investment firm'ssolvency- the Common Equity Tier 1capital ratio-
fallsbelow 5.125%.
6.LIQUIDITY
What Rulesdoesthe Regulation establish on liquidity buffers?
Thecrisishasshownthat institutions' did not hold sufficient liquid
means(e.g. cash). Whenthecrisishit, manyfirmswereshort of liquidity.
This contributed to the demiseof several financial institutions.
While a number of Member Statescurrentlyimposesome form of
quantitativeregulatorystandard for liquidity, noharmonised regulatory
treatment existsat EU level.
Basel III introducestwonew ratiosand foreseesin each casean
observation period in order toidentify and addresspossibleunintended
consequences.
TheBCBS will make thenecessarychanges,if any, before2015or
2018,respectively.
Thereforesubject to the observation period(seebelow) theRegulation
establishestwonew liquiditybuffers:
- First, toimprovetheshort-term(overathirtydayperiod) resilienceof
theliquidityrisk profileof financial institutions,there isa Liquidity
Coverage Requirement (LCR).
- Second, toensure that an institution hasan acceptableamount of
stablefunding to support the institutionsassetsand activitiesover
themedium term (over a one year period), there is a Net Stable
FundingRequirement (NSFR);
How will the liquidity coverage ratio (LCR) be introduced?
The observation period will start immediately after adoption of the
Regulation and institutions will be required to report to national

P a g e | 40
authoritiestheelementsthat areneededtoverify that theyhaveadequate
liquiditycoverage.
Theywill dothis in a uniform way, with standard reportingformatstobe
developed by the EBA.
On thebasisof thesereports,EBA will prepare reportsfor submission to
theCommission.
The Commission will have a delegated power to specify the detailed
liquiditycoveragerequirement for implementationin 2015.
What istheimpact of the Basel Committee decision thisJanuary
on the LCR?
Many observersincludingthe Commissionwereconcernedthat the
original calibrationof the LCR wastoosevere.
In a time of economic difficulty, there wereconcernsthat
implementationof theLCR asoriginallyforeseen by theBasel
Committeein December 2010could have an adverse impact on the real
economybypromotinga shift from lending(loanassets) tomore liquid
assets(e.g. cash, central bank deposits) asinstitutionsprepared tomeet
thenew LCR requirements.
For thisreason theCommission attachesmuch importancetothe
observation period after whichthedetailedLCR will be specified.
Theseconcernswerealsorecognised by theBasel Committee.
On 7 January2013,the BaselCommitteeissuedthetext of a revised
LiquidityCoverageRatio(LCR) whichhad been endorsedby the
governingbody of the Basel Committee, namely, the Group of Central
Bank Governors and Headsof Supervision (GHOS).
This text includedarevisedtimetablefor thephase-in of thestandard.
Thesame day, CommissionerMichel Barnier alsoissueda pressrelease
welcomingtherevisedagreement unanimously reachedby theBasel
Committee.

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The package of amendments to the LCR as originally formulated in 2010
including its phasing-in, addresses concerns previously identified by the
Commission.
However,thefinal formulation of the LCR is still not completeand
important work is still continuingunder the BaselCommittee.
Thereforethe approach for the final adoption of theLCR under EU law
in 2015ismaintained, namely full use of the observation periodand
adoption of the detailedLCR bythe Commission taking account of the
EBA Reportsand international developmentssuch asthe final Basel
LCR standard.
What will be the time schedule for implementation of the LCR?
Becauseof concernsthat toorapid implementationof theoriginal LCR
couldhavedetrimentalimpact onthereal economy,thetext publishedby
theBasel committeeon 7th January2013,proposed a minimum
phasing-in of the LCR over 5years starting with60% of the LCR in
2015,rising progressivelytoreach 100% in 2019.
However,given the important role liquiditymismatchesplayed in the
financial crisis,the Union legislatorsconsidered it more appropriateto
havea somewhat faster implementationschedulethan Basel.
TheRegulation thereforesetsthe followingschedulefor LCR
implementation:
60% in 2015
70% in 2016
80% in 2017,and
100%in 2018.
In other wordsunder the Regulation 100% LCR implementation will be
reached in 2018,i.e. one year earlier than Basel.

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But whydoesthe Regulation phase in the LCR oneyear faster
than Basel?
Thefinancial crisisthatstartedin2007showedthat liquidityisabsolutely
key for the resilienceof institutionsin stresssituations.
Thetreatment of liquidityisfundamental, both for the stabilityof banks
aswell asfor their rolein supportingwidereconomicrecovery.
Therefore,tohighlight this importance,theUnion co-legislatorsdecided
toadvancefull implementationof the LCR by one year sothat a 100%
LCR will already applyin 2018.
However,if appropriate and in the light of a report tobe preparedby
EBA taking intoaccount the economicsituation aswell asEuropean
specificitiesand international regulatorydevelopments, the Commission
is empoweredtodefer the 100% phase-in of the LCR until 1January 2019
and apply in 2018a 90% LCR, in linewith the Basel schedule.
Is an institution alwaysobliged to have a LCR ratio above 100%?
No.
In a stressed situation an institution may be obliged to make use of its
liquid assets with the result that its LCR ratio (temporarily) falls below
100%.
This point hasbeenspecificallyrecognisedin the text publishedby the
Basel committee on 7th January 2013.
However,it should be noted that even in this situation, under the
Regulationaninstitutionisrequiredtoimmediatelynotify thecompetent
authoritiesand submit a plan for the timely restorationof the LCR ratio
above100%.
Doesthat mean there are no new liquidity rulesuntil 2015?
No. Again tounderlinetheimportanceofavoidingliquidity
mismatches,from thedate of adoption, the Regulation already
establishesa general

P a g e | 43
requirement that institutionsneed tohold liquid assetstocover their net
cashoutflowsin stressed conditionsover a thirtyday period.
However,thisis a general requirement and not a detailed ratio
requirement aswhenthen LCR entersintoforcein 2015.
Will it be possible to accelerate the implementation of the LCR
at national level?
Yes. Before the LCR becomes a binding minimum standard in
2015, Member States may maintain or introduce binding minimum
standards for liquidity coverage requirements and require LCR levels
up to 100% beforethe LCR is fullyintroducedat a rate of 100% in 2018.
How doesthe Regulation implement the 7 January 2013revised
Basel agreement regarding an extended definition of liquid
assetsand revised outflow rates?
TheCommissionattachesaspecial importancetotheobservationperiod
in order to properlyassesstheimpact of thenew liquidityrequirements
on institutionsand financial marketsand ensure requirementsare
definedand calibratedin the most appropriate manner.
ThisiswhytheRegulationdoesnot fix at thisstageaclosedlist of liquid
assets.
Instead, it specifiesa minimum list of itemsthat shall be considered as
liquid, while theEBAshall report to theCommission by 31December
2013on appropriateuniform definition of high and extremelyhigh
liquidityand credit qualityof liquid assets.
In its report, the EBAshall consider a variety of assets, includingRetail
MortgageBacked Securities(RMBS) of high liquidityand credit
quality, localgovernment bonds, commercial paper, equities listed on a
recognisedexchange, corporatebonds, and soon.
Pendingtheuniform definitionof liquidassets,institutionsshall identify
and report themselvesin a givencurrency, assetsthat are respectivelyof
high and extremely high liquidityand credit quality.

P a g e | 44
At the same time, competent authorities may provide general guidance
that institutionsshall followin identifying thoseassets.
In the same manner, the EBAshall report to the Commissionon the
calibration of inflowand outflow rates.
It should benoted that EBA shall in particularreport on theneed for any
mechanismsto restrict thevalue of liquidityinflows, e.g. by establishing
anappropriateinflowcap;aswellasreport onanymechanismstorestrict
thecoverage of liquidityrequirementsbycertain categories of liquidity
assets,e.g. by establishinga minimum percentagefor liquid assetsof
extremelyhigh liquidityand credit quality.
Note that in itsreport, the EBAshall takedue account of international
regulatorydevelopments.
TheCommission isempoweredtospecifythedetailed liquiditycoverage
requirements.
When will the net stable funding requirement come into force?
Thesame basic approach will be followedfor theNSFR, namelya long
observation period beforeadoption of thestandard intoUnion law.
However,workon the NSFR hasnot progressed asfar asthat on the
LCR andthereisstill averyconsiderableamount ofdevelopment workto
becarried out by theBasel Committee.
Thereforein thelight of theresultsof theobservation period and reports
tobe preparedby EBA, theCommission will prepare, if appropriate,a
legislativeproposal by 31December 2016to ensurethat institutionsuse
stablesourcesof funding, takingfull account of the diversity of the
European banking sector.
Doesthat mean there are no NSFR rulesuntil 2018?
No. Several years before any bindingminimum standards for net stable
fundingrequirementsmay be specifiedunder Union law,theRegulation
already establishesthe general rulefrom 1January2016that institutions
shall ensure that long term obligationsare adequately met witha

P a g e | 45
diversityof stablefunding requirementsunder both normal and stressed
conditions.
What is the role of covered bonds in the composition of the
liquidity buffer?
For theLCR, a particular focusof the observation period will be set on
thedefinition of liquid assets.EBA will test different criteriafor
measuringhow liquid securities areunder stressedmarket conditions.
Thiswill preparethegroundforadecisionbefore2015that willultimately
determinetheeligibility criteria for the twotiersof the liquiditybuffer.
For theNSFR, the Commissionwill analyse how such a structural
requirement plays out acrossthediverseEU banking sector, notablyas
regards itsabilitytoprovidelong-term funding to support thereal
economy.
7. LEVERAGE
Whyreducing leverage in the banking sector?
Leverage is an inherent part of bankingactivity; assoon asan entity's
assetsexceeditscapital baseit islevered.
TheCommission doesnot proposeto eliminateleverage, but to reduce
excessive leverage.
Thefinancial crisishighlightedthat credit institutionsand investment
firmswerehighly levered, i.e. theytook on more and more assetson the
basisof an increasinglythin capital base.
What is the Leverage Ratio?
In linewithBasel III, theCommission thereforeproposestostart the
processof introducinga leverageratio.

P a g e | 46
Theleverageratio is definedasTier 1capital divided by a measureof
non-risk weightedassets.
What purpose doesthe Leverage Ratio serve?
Thepurposeof the leverageratio is tohave a simpleinstrument that
offersa safeguard against the risksassociatedwith the risk models
underpinningrisk weightedassets(e.g. that the model is flawedor that
data ismeasuredincorrectly).
Theultimateaim is alsotoconstrain leverageand tobringinstitutions'
assetsmore in linewith their capital in order to help mitigate
destabilisingdeleveragingprocessesin downturn situations.
Will institutions be required to have a Leverage Ratio above a
certain value?
Sincethe LeverageRatiois a new regulatory tool in the EU, there isa
lack of informationabout the effectivenessand the consequencesof
implementingit asa binding (Pillar 1) measure.
It is thereforeimportant to gather more information before makingthe
leverageratioa bindingrequirement.
In linewithBasel III, theCommission thereforeproposesa step by step
approach:
- Initiallyimplement the LeverageRatio asa Pillar 2 measure;
- Data gatheringon thebaseof thoroughlydefinedcriteria asof 1
January 2014;
- Publicdisclosureasof 2015;
- Report bythe end of 2016including, whereappropriate, a legislative
proposaltointroducethe leverageratio asa binding measureasof
2018.

P a g e | 47
Whyinstitutions should disclose their leverage ratio asof 1
January 2015?Doesthat not effectively make it a binding
requirement in view of market pressure?
Requiring the disclosure of the Leverage Ratio isin line with the EU's
push to introduce more transparency in the financial sector in
general, and thebanking sector in particular.
It is alsofullyin linewithBasel III rules.
Even in the absenceof such a requirement, the market wouldalmost
certainlydemand institutionstodisclosetheinformation on their
Leverage Ratioand punish thoseinstitutionsthat wouldnot discloseit
bymeansof raisingtheir cost of capital.
How dothenewrulesaddresstheconcernsthat theintroduction
of the Leverage Ratio would have significant negative impacts
on trade finance and lending to small and medium
enterprises, to name just two areas?
There isn‘t currentlysufficient informationin order toestimate the
preciseimpact of theLeverageRatio.
That is whythe LeverageRatio will not be introduced outright asa
bindingmeasure, but rather asa Pillar 2 measure (i.e. the judgement on
whetherornot theleverageratioof aparticularinstitutionistoohigh and
whetherthat institution should hold more capital asa consequencewill
beleft to thesupervisorof that institution).
Furthermore, that is whytheproposal foreseesan extended observation
period during whichthenecessarydata will be gathered, and a review to
estimatetheimpact oftheLeverageRatiobasedonthosedatathat would
then inform thedecision on the introduction of the LeverageRatioasa
bindingmeasure.
TheRegulation applies lowerconversion factorsto trade related
off-balancesheet itemsthanthoseinitiallyprovided in theCommission's
initial proposal.

P a g e | 48
This intendsto mitigate the impact of theleverageratioon trade finance
operationsand lendingto SMEs.
How dothenewrulestake into account variousbusinessmodels
throughout the Union and addressthe issue of low-risk type of
businessprofiles?
Thereview of the leverageratiowill includethe identificationof
institutions‘businessmodels and whetherthe level of theleverageratio
should be the same for all types of businessmodels.
If deemed appropriate, several levelsof theleverageratiomay be
introduced in order toreflect the overall risk profile, the businessmodel
and size of institutions.
8. COUNTERPARTY CREDIT RISK
What will be the treatment of counterparty credit risk arising
from derivatives?
Buildingon theRegulation on OTC derivativesand markets
infrastructures(EMIR) (IP/10/1125), the new rulesincreasethe own
fundsrequirementsassociatedwithcredit institutions' and investment
firms' derivativesthat are traded over-the-counter("OTC
derivatives", for furtherdetails see MEMO/ 09/ 314and
MEMO/ 10/ 410) and securitiesfinancingtransactions(e.g. repurchase
agreements).
The new rules also amend the current treatment of institutions' exposure
to central counterparties (CCPs)iv stemming from those transactions, as
well asexchange-tradedderivativestransactions,in the followingway:
- Unlike under existingrules, exposurestoa CCP will be subject to an
ownfundsrequirement.
Thesizeof the requirement will depend on the type of exposure:trade
exposurestoa CCP (e.g. exposuresduetocollateral postedtothe
CCP) will be subject to a substantiallysmallerown fundsrequirement
thanexposuresduetocontributionstotheCCP'sdefault

P a g e | 49
fund. This is becausedefault fund contributionscan be usedfor
mutualisinglossesdue to thedefault of another clearingmember.
- Compared toexposuresfrom bilaterallycleared
transactions, exposurestoCCPs will be subject to lowerown funds
requirementsaslong asthe CCP will meet certain requirements(in
thespecific, they will need tomeet the requirementslaid down in
EMIR or besubject toequivalent rules,in caseof a third-country
CCP).
If the CCP will not meet thosecriteria, thentrade exposureswill be
subjecttothebilateral treatment and default fund contributionswill
besubject to a high ownfundsrequirement.
How will the new rulesaffect non-financial corporatesand their use of
non-centrallycleared OTC derivatives?
Thepolitical agreement reachedby the co-legislatorsexempts
non-centrallycleared OTC derivativetransactionsbetweenbanksand
non-financialcorporatesfromthenewBasel3capitalrequirement forthe
so-calledCredit ValuationAdjustment risk, whensuch transactionsdo
not exceed relevant thresholdsthat arespecified in EMIR.
9. SUPERVISION
How do the new rulesstrengthen supervision?
Regulation, nomatter how good, cannot overcome poor supervision.
Thefinancial crisisbrought thispoint on theagenda.
As a result, the EU hasalreadytaken stepsto strengthen
supervision, notablywiththe creationof the three European Supervisory
Authoritiesand theEuropean System of Financial Supervision
(MEMO/ 10/434).
Thenew rules strengthen banking supervisionfurther by requiringthe
annual preparation of a supervisoryprogramme for each supervised
institutionon thebasisof arisk assessment;greaterand moresystematic
useof on-sitesupervisoryexaminations;more robuststandardsandmore
intrusiveand forward-lookingsupervisoryassessments.

P a g e | 50
10.CAPITAL BUFFERS
What the new rulesprovide for asregardsthe capital buffers?
On thebasisof theBasel provisionsthe followingcapital buffersare
introduced
Capital conservation buffer
Thecapital conservation buffer is a new prudential tool introducedby
Basel III.
It is a capital buffer of 2.5% of total exposures of a bank that needs to be
met with an additional amount of the highest qualityof capital (i.e. CET1
capital).
It sitson top of the4.5% CET1 capital requirement (seeSection 5 on
capital above).
As itsname indicates,thebuffers objectiveis toconservea bank‘s
capital.
When a bank breachesthe buffer, i.e. whenitsCET1capital ratiofalls
below7%, automatic safeguardskick inandlimit theamount of dividend
andbonuspaymentsa bank can make.
Thefurtherthebank ―eats‖intothebuffer,thestricterthelimitsbecome.
This preventsthe bank‘scapital tobe further eroded by suchpayments.
Countercyclical buffer
Thecountercyclical buffer is another new prudential tool introducedby
Basel III.
As the name indicates,thepurposeof this buffer is tocounteract the
effectsof theeconomiccycle on banks‘lendingactivity, thusmakingthe
supplyof credit lessvolatileand possiblyeven reducetheprobability of
credit bubblesor crunches.

P a g e | 51
It works asfollows: in good times, i.e. where an economyis booming and
credit growth is strong, it requires a bank tohave an additional amount of
capital (asin thecaseof thecapital conservation buffer, CET1capital).
Thispreventsthat credit becomestoocheap(thereisacost tothecapital
that a bank must have) and that bankslend toomuch.
If a bank doesnot haveenough capital tofill this buffer, thesame
restrictionsasin thecaseof the capital conservation buffer kick in.
When theeconomic cycle turns, and economic activityslowsdownor
even contracts,this buffer can be ―released‖ (i.e. thebank isnolonger
requiredto havetheadditional capital).
This allowsthebank tokeep lendingtothe real economy or at least
reduceitslendingby lessthanwouldotherwisebethe case.
Global systemic institution buffer
FollowingEP proposedamendmentsthepolitical agreement includesa
mandatorysystemic risk buffer of CET1capital for banksthat are
identifiedby the competent authorityasgloballysystemically important.
Theidentificationcriteria and the allocation intocategoriesof
―SIFI-ness‖ are in conformitythe G-20agreedG-SIFI criteriaand
includesize, crossborder activitiesand interconnectedness.
Themandatory surcharge will be between1and 3.5% CET 1and apply
from 1January 2016onwards.
TheG-SII a"surcharge" reflectsthecostofbeingsystemicallyimportant
andprovidesand reducesthemoral hazard of implicit support and
bail-out by taxpayer money.
TheFinancial StabilityBoard‘sprovisional list of 28global
SIFIs,includes19 European global SIFIs.

P a g e | 52
Other systemic institution buffer
In additiontothe mandatoryGlobal SII buffer the politicalagreement
providesfor a supervisoryoption for a buffer on ―other‖ systemically
important institutions.
This includesdomesticallyimportant institutionsaswell asEU
important institutions.
In order toprevent adverseimpactson theinternalmarket there is
framingin the form of thecriteria usedtoidentify O-SIIs, anotification/
justificationprocedure and an upper limit of 2% CET1.
TheO-SII buffer is applicablefrom 2016onwardsbut MemberStates
wantingtoset higher capital for certain banksearlier can use the
systemic risk buffer.
Theoptional O-SII buffer CET1capital is recognisedfor meeting the
consolidatedmandatory G-SII buffer requirement.
In additiontothese capital buffersthe new rules provide for a:
Systemic risk buffer
Each Member State may introducea Systemic Risk Buffer of Common
EquityTier 1for thefinancialsector or oneor more subsetsof the
sector, in order toprevent and mitigatelong term non-cyclical systemic
or macroprudential riskswiththepotential of seriousnegative
consequencesto the financial system and thereal economyin a specific
MemberState.
Until 2015,in caseof buffer ratesof more than 3%, MemberStateswill
need prior approval from theCommission, whichwill take intoaccount
theassessmentsof the European Systemic RiskBoard (ESRB) and the
EBA.
From 2015onwardsand for buffer ratesbetween3 and 5 % the Member
Statessettingthebuffer will have to notify theCommission, the
EBA, and theESRB.

P a g e | 53
TheCommission will providean opinionon the measure decidedand if
thisopinion isnegative, the MemberStateswill have to "complyor
explain".
Bufferrates above 5% will need tobe authorized by the Commission
through an implementingact, takingintoaccount the opinionsprovided
bytheESRB and by the EBA.
11. CORPORATE GOVERNANCE
How doesCRD IV improve corporate governance?
Thenew Directive introducesclear corporate governance arrangements
andmechanismsfor institutions.
Theserulesconcern the compositionof boards, their functioningand
their rolein risk oversight and strategy in order toimprovethe
effectivenessof risk oversight by Boards.
Thestatusandtheindependenceoftheriskmanagement function isalso
enhanced.
Supervisorswill play an explicit role in monitoring risk governance
arrangementsof institutions.
Themeasuresadopted should help avoid excessiverisk-takingby
individual institutionsand ultimatelythe accumulationof excessiverisk
in thefinancial system.
Theprincipleof proportionality, taking intoaccount the size and
complexityof theactivitiesoftheinstitutionaswellasdifferent corporate
governancemodels, appliesto all measures.
Corporate governance – Does CRD IV impose diversity?
Diversityin board composition shouldcontributetoeffectiverisk
oversight by boards,providing for a broader rangeof viewsand opinion
andthereforeavoidingthe phenomenon of group think.

P a g e | 54
What doesCRD IV do to improve transparencyregarding the
activities of banks and investment fundsin different countries?
Increasedtransparencyregarding the activitiesof institutionswhich
operateon a multi-national basis, and in particular asregards
profits,taxesandsubsidiesindifferent jurisdictions,isessential for
regainingthetrust of EU citizensin the financial sector.
Under CRD IV, MemberStateswill have to ensurethat institutions
disclosethis type of information, by MemberState and by third country
in whichtheyhave operations.
TheCommission will, however, first assessthepotential impact of some
of thesedisclosureobligationsand, if appropriate, make a proposal to
amend the scope and/ or modalitiesof disclosure.
Whyreforming only CRD IV (banks and investment firms) and
disregarding other sectors(insurance, investment funds)?
This may lead toinconsistenciesbetweendifferent sectorsand it is
difficult to justify whyin banksthere should be a limitationof the
number of board mandates, separation betweenCEO/ Chair
functions,boarddiversity, and not in insurancecompaniesor
investment funds.
Thecorporate governancefailings whichcontributedtothe financial
crisisoccurred mostlyin banks.
Also, existingrulesin thebanking sectorare of a very general nature as
comparedtoinsuranceor investment fund legislationwhereruleson
internalorganisationand risk management aremuch more detailed and
precise.
That is whywestart with reforming corporate governancein credit
institutionsand investment firms.
However,for thesake of consistencyand in order toavoid regulatory
arbitragebetweensectors, it will be necessarytoreview the existing
legislationin other sectors(Solvency II, UCITSDirective) toalign
it, whennecessary, tothe outcome of the final text of the CRD IV
package.

P a g e | 55
Nevertheless, thespecificitiesof each sector should be taken into
account, and therulesshouldnot necessarilybe identical for
banks,insurancecompaniesand investment funds.
12.REMUNERATION
What are the existing rulesregarding remuneration?
In order toensure that remunerationpoliciesdonot give incentivesto
take riskswhichundermine sound and effectiverisk management and
whichexacerbateexcessiverisk-takingbehaviour,CRD III introducedin
2010a number of technical criteria underpinningthe total remuneration
policies(includingsalariesand discretionarypension benefits) of credit
institutionsand investment firms in relation tocategoriesof staff whose
professional activitieshave a material impact on their risk profile
(‗material risk takers‘).
Theseincluded in particular the followingrequirementsregardingthe
structure of remuneration:
- a substantial portion, and in any event at least 50 %, of any variable
remuneration should consist of equity-linked instruments;and
- a substantial portion of the variable remuneration component, and in
anyevent at least40 % to 60 % (the latterin thecaseof a variable
remuneration component of ―a particularlyhigh amount‖) should be
deferred over a period of not lessthan three to five years.
While providing that fixed and variable components of total
remuneration should be appropriately balanced and that the fixed
component should represent a sufficiently high proportion of the total
remuneration (allowing the possibility to pay no variable
remuneration), it was left to the institutions to set the appropriate
ratios between the fixed and the variable component of the total
remuneration.
CRD III did not set any maximum ratio between the fixed and the
variablecomponent.

P a g e | 56
Institutions also have an obligation to disclose to the public information
regarding the remuneration policy and practices for material risk
takers[iii].
What are the new, additional rules introduced by CRD IV?
CRD IV essentially carries over the existing provisions of CRD III
relatingtoremuneration.
It also introduces additional transparency and disclosure requirements
relating to the number of individuals earning more than EUR 1million
per year.
Furthermore, in order totackle excessiverisk takingthe remuneration
frameworkhasbeenfurther strengthened withregard to the
requirementsfor therelationship betweenthevariable(or bonus)
component of remuneration and the fixed component (or salary).
Thekey elementsof thenew rule, whichwill apply toremuneration
awardedfor servicesand performancefrom 2014onwards,are the
following:
- Thevariablecomponent of the total remuneration shall not exceed
100%of the fixed component of thetotal remuneration of material
risk takers;
- Theshareholders,ownersor membersof the institutionmay, witha
qualified majority involvingeither a minimum representation
requirement for sharesor equivalent ownershiprightsof 50 % and a
voting majorityof twothirdsor nominimum representation
requirement and a 75 % voting majority, approve a higher maximum
level of thevariablecomponent provided that this level doesnot
exceed200%ofthefixedcomponent ofthetotalremuneration. In this
context, forthepurposesofcalculatingthemaximum ratio,theuseof
deferred and bail-in-ableinstrumentsis specifically
encouraged through the applicationof a notional discount factor to
up to25% of total variable remunerationprovided that it is paid in
instrumentswhichare deferred for more than fiveyears; and
- Thecompetent authoritiesaretobeinformedof recommendationsto
shareholdersandof theresult ofanyshareholdervote, whichshall not

P a g e | 57
conflict with institutions' obligationsto maintaina sound capital
base.
TheEBA iscalledupon toprovidefurther technicalguidanceasregards
thenotional discount factor and the Commission will review the
application and the impact of the new rulesin due course.
Do the new rulesapply to the remuneration of all staff?
No. The rules apply only for categories of staff whose professional
activities have a material impact on their risk profile, such as senior
management, risk takers, staff engaged in control functions and any
employee receiving total remuneration that takes them into the same
remuneration bracket assenior management and risk takers.
The EBA is called upon to develop draft regulatory standards with
respect to qualitative and appropriate quantitative criteria to identify
thesecategoriesof staff.
Do the new rulesapplyto all institutions andinvestment firmsin
the EU?
Yes.Moreover, the rulesalsoapplyto
i)subsidiariesestablishedoutside the EEA of institutionswhichhave
their head office in the EEAand
ii)subsidiariesestablished insidetheEEAof institutionswhichhave
their head office outsidethe EEA.
CRD IV providesthat "[t]heapplicationof the [remunerationprovisions]
shall be ensured by competent authorities for institutionsat group, parent
companyandsubsidiarylevels,includingthoseestablishedin offshore
financial centres".
This provision already existed in CRD III. TheCommission will review
theapplicationand theimpact of this rule in due course.

P a g e | 58
13.SANCTIONS
What exactly the new rules provide for regarding sanctions? The
proposalwill require Member Statesto providethat appropriate
administrativesanctionsandmeasurescanbeappliedtoviolationsofEU
bankinglegislation.
For thispurpose, theDirectivewillrequirethem tocomplywithcommon
minimum standardson:
- typesand addresseesof sanctions,
- thelevel of fines,
- thecriteriato betakenintoaccount by competent authoritieswhen
applying sanctions,
- thepublication of sanctions,
-themechanism toencourage reportingof potential violations.
Theseprovisionsarewithout prejudicetotheprovisionsof national
criminal law.
Whythe introducing provisionson sanctions in the revision of
the CRD?
The"CRD IV" packagefundamentallyoverhaulsthesubstantive
prudential rulesapplicabletoinstitutions.
But theserules will onlyachievetheir objectiveif theyare effectivelyand
consistentlyenforcedthroughout the EU.
This requiresthat competent authoritieshave at their disposal not only
supervisorypowersallowingthem toeffectivelyoversee credit institutions
but alsosufficientlystrictandconvergent sanctioningpowerstorespond
adequatelyto theviolations(which may neverthelessoccur), and prevent
future violations.
However,thebanking sector is one of theareaswherenational
sanctioningregimesare divergent and not alwaysappropriateto ensure
deterrence.
For example, in thebankingsector themaximum amount of fines
provided for in caseof a violation is unlimitedor variablein five Member

P a g e | 59
States,more than 1million euro in nineMember States, and lessthan
150000euro in seven Member States.
Thosemaximum levels,in thelatter group in particular, appear tobe
rather small, especiallyin view of the largesize of thebankinggroups
operatingin several of theseStates. For more examplessee
MEMO/ 10/660
Therefore, thenew frameworkprovidesfor the introduction of rules to
reinforceand approximate national sanctioningregimes.
Banking supervision is based on supervisory measures to
prevent violations and restore banks' viability – whywould
sanctions be necessary?
When a bank is in distress, the first priority is in fact to save and not to
sanctionit.
In fact, the new rules are not introducing harmonised sanctions for
violationsof minimum capital requirements.
But sanctionsare key to ensure other rules are respected – for example if
banks don't report to supervisors as required, and thereby make
supervision ineffective,or if banksact without authorisation.
What it is planned to ensure that breachesare actually
prosecuted and that appropriate sanctionsare actually handed
down?
The new rulesmake sure that all supervisors have the possibility, that is
tosayare empowered, to imposeeffectivesanctions.
National supervisors remain mainly responsible for the actual
application of sanctions.
In order to ensure that breaches are actually prosecuted and ensure
convergence for sanctions handed down, we require supervisors to put in
place whistle blowing programmes to improve detection of
violations, and propose convergence on the factors to be taken into
account whenimposingsanctionsin each individual case.

P a g e | 60
Prosecution is highly case specific and in the realm of national
authorities (with the exception of Credit Rating Agencies), so the reach
of EU legislativeaction is limited.
Therefore, peer reviews conducted by the ESAs (Art 30(2)(d) of the ESA
Regulations explicitly refers to sanctions) are an important tool to ensure
further convergence, and once the legislative framework in all Member
States on what supervisors can do will have converged following our
initiative, weplace big hopeson them.
What hashappened to the initial idea of criminal sanctions?
Criminalsanctionscanhaveanimportant deterrent effect inparticularon
individuals,and can thereforebe appropriatein certain instances.
UnderArt 83(2) TFEU, theEU cantakeactiononcriminalsanctionsbut
onlyunder limitedcircumstances.
We will further assess whether EU action on criminal sanctions is
necessary for the financial services area as a whole and will decide about
appropriatefurther action on that basis.
List of violationsfor whichsanctioning powersshould be
available:
- unauthorisedbanking services;
- requirementsto notify authoritiesin case of acquisition of qualifying
holdings;
- governancerequirements;
- reportingrequirementson capital, liquidity, leverage, largeexposure;
- limitson largeexposures;
- retention requirementson securitisation;
- general liquiditycoveragerequirements;
- public disclosurerequirements(Basel Pillar III).

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14.RELIANCE ON RATINGS
What is the issue?
Capital requirements are meant to be risk-sensitive and therefore require
measuresof credit riskasinputs.
Such measures can either be developed by each bank itself or by a
specialised institution whose job is to evaluate risk (credit rating
agencies- CRAs).
The financial crisis highlighted that banks had taken on risk without
really understanding it and that they relied too much on the risk
assessmentsof external rating agencies,of whichthere are onlya few.
Once the crisisstarted, many of the risk assessmentsin the securitisation
fieldproved tobe wrong.
Rating agencies then adapted their risk assessments as a result of which
banks tried to exit the markets in question at the same time. This
adjustment, while desirable, was so violent that it undermined financial
stability.
The Financial Stability Board (FSB) endorsed in October 2010 principles
to reduce authorities‘ and financial institutions‘ reliance on CRA ratings
in standards, law and regulation.
The G20 approved the FSB's principles on reducing reliance on external
credit ratings(Seoul Summit, 11-12November 2010).
TheFSB principlescover five typesof financial market activity:
1) prudential supervisionof banks;
2) policiesof investment managers and institutional investors;
3) central bank operations;
4) private sector margin requirements;and
5) disclosurerequirementsfor issuersof securities.
The goal of the principles is to reduce the cliff effects from CRA ratings
that can amplify procyclicalityand causesystemic disruption.
Theprinciplescall on authoritiesto do this through:

P a g e | 62
removing or replacingreferencesto CRAratingsin lawsand
regulations, wherever possible, with suitable alternative standards
of creditworthinessassessment;
expecting that banks, market participants and institutional
investorsmake their own credit assessments, and not rely solely or
mechanicallyon CRAratings.
The Basel Committee on Banking Supervision is working toward
achieving compliance with the G20 and FSB objectives of reducing
mechanistic reliance on external ratings, focusing first on the
securitisationframework,wheresuch relianceis predominant.
Hasalsoproposed toreduce relianceon credit rating agenciesratingsin
theregulatory capital framework.
How doesthe new framework will reduceover-reliance on
external ratings?
This problem hastwofacets.
First, and from ageneralviewpoint, whenit comestoestimatingtherisk
of instrumentsand activities.
Second, when it comestocalculatingtheamount of regulatory capital.
As regardsthe first, institutionsneed tounderstand the risksof the
activitiestheyundertake.
Howeverconvenient, they should not outsourcethat judgement fullyto
an external partysuch asa credit ratingagency.
Themost problematic overrelianceon ratingstakesplacewhen
institutionsinvestin rated securitieswithout understanding therisksof
thesesecurities.
Misguided investment decisionsmay create bubbles.
Themost blatant caseof such overreliance,in thefield of
securitisation, hasalreadybeen addressedby CRD II, whichrequired
institutionsto carryout a rangeof analysisfor their securitisation
investments,even if they areAAA rated.
On top of that, credit institutionsand investment firmsare required to
havetheir own sound credit granting criteria and credit decision
processesin place.

P a g e | 63
Thisapplies irrespectiveof whetherinstitutionsgrant loanstocustomers
or whethertheyincur securitisation exposures.
External credit ratingsmay beused asone factor among othersin this
processbut shall not prevail.
In particular, internal methodologiesshall not rely solely or
mechanisticallyon external ratings.
As regards the role of ratingsin calculating the amount of regulatory
capital, avoiding overreliance in this field does not mean making no
referencesto ratingswhatsoever.
Such referencesmay sometimesbethe best availablealternative.
Thesystems that arenecessaryto produceinternalratingsare not only
costlytoimplement but alsotosupervise.
Moreover,developing internal ratingsmay sometimesbe impossiblefor
aninstitutioninisolation(e.g. whenaninstitutiononlyhasafewmaterial
counterparties).
Thenew rules will thereforerequire institutionsthat have a material
number of exposuresin a givenportfolio to develop internal ratingsfor
that portfolio.
ThisexpressestheEU's preferenceforusinginternalratherthanexternal
ratingswherepossible.
Thenewframeworkwillalsorequire institutionsusingexternalratingsto
benchmark the resultingcapital requirementstotheir internal credit
opinions.
If that comparisonshowsthat thecapitalrequirementsaretoofavourable
comparedtotheinternal credit opinion, thenthe institutionwill be
requiredunder Pillar 2 tohold additional capital.
In addition, theEuropean BankingAuthority (EBA) should every year
publish informationon what banksand supervisorshavedone to reduce
overrelianceon external ratingsand report onthe degreeof supervisory
convergencein this regard.

P a g e | 64
WhydoestheEU gofor a half-measure; wouldit not bebetter to
prohibit any reliance on external ratingsasdone by the US? Risk
sensitivecapital requirementsrequire a measure of credit risk.
Sometimesexternal ratings– howeverimperfect – remain the best
solution available.
Thealternatives(e.g. country based method for banks,internal ratings)
may misguidemarkets, betoocostlyor lack objectivity.
Moreover,internal ratingsare not a panacea.
For instance, for securitisation, giventhe lack of reliable internal
approachesand theincentivesfor the banks tounderestimate
risk, allowinginternal risk measureswouldcome withconcernsof its
own.
Rather than scrapping ratingsaltogether, the proposal encouragestheuse
ofinternalratingsandstrengthensprovisionsonhowexternalratingscan
beused.
TheUS examplehighlightsthedifficultyof eliminatingratings.
FollowingtheDodd FrankAct, US authoritieshave been forced to do
awaywithreferencesto ratings,absent workablealternatives.
15.OTHER ISSUES
The new ruleswill strengthen banking regulation. Will that not
encourage activity to migrate to the non-regulated ―shadow
banking‖ sector?
Banks are at the heart of theEU financial system.
It is accordinglyof vital importancethat they are safeand sound.
That is whythe new frameworkinvolvesan overhaul of EU banking
legislation.
At the same time, it is important toensure that, asa result of this, risk
doesnot simplymigrate to other lessregulated areasof thefinancial
system.
While thisisnot areasonfor refrainingfrom raisingtheregulatorybar for
banks,it is a strong reason for closely monitoring any potential
migration.

Risk management presentation April 8 2013

Risk management presentation April 8 2013

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Risk management presentation April 8 2013