Regulation of Credit Institutions
Credit institutions authorised in one EU state may provide services in other EU states. An institution established in one state which wishes to establish a branch in another state must notify the authorities of its home state giving details of the program of operations and detailed plans.
The home state must provide this to the host state. The refusal must be justified on the grounds of the lack of capacity or the administrative structure of the credit institution. There is a right to appeal to the court.
They may use their original name provided it does not give rise to any doubt as to which national law their parent undertaking is subject. There may be a requirement for explanatory particulars such as “branch.”
The home state’s regulator must ensure that all credit institutions have sound administrative and accounting procedures and adequate controls.
There are essential requirements for the taking up and authorisation of credit institutions.
- there is a requirement for separate funds with a minimum capital of €5 million;
- at least two persons of sufficient repute to direct the business of the credit institution;
- a requirement for notification of the regulator of significant shareholders, direct or indirect.
There are detailed criteria for the prudential assessment of shareholders and management in the event of an acquisition. An adjustment must be made as for the suitability and soundness of the acquirer.
Capital Adequacy
There are two consultative bodies which advise the Commission with regard to banking. The European Banking Commission is an advisory body. The Committee of European Banking Supervisors liaises between the Commission and national public authorities that oversee community measures.
The CEBS deals with cooperation between national authorities. It fosters cooperation and convergence of supervisory practices. It evaluates developments of the banking sector and reports to the commission on risks and vulnerability.
European Union directives provide for the capital adequacy of credit institutions and investment firms. The rules are intended to implement the Basel II requirements in a consistent manner. They are a key part of the prudential framework.
The framework establishes different approaches to capital adequacy for different types of risks. It is designed to enable firms to put in place risk management systems which best suit their risk profile in their areas. Supervisory activities assess the amount of capital which investment firms must have at their disposal to cover their risks.
The quantity of the capital required is assessed by reference to credit risk, market risk, and operational risks. A separate directive deals with credit risks. Directive relating to market risk covers investment firms and credit institution.
Prudential Requirements
Under a 2013 Regulation, banks have to hold a total amount of capital that corresponds to at least 8% of their assets measured according to their risks. Safe assets (e.g. cash) are disregarded; other assets (such as loans to other institutions) are considered riskier and get a higher weight. The more risky assets an institution holds, the more capital it has to have.
Liquidity measures. To ensure banks have sufficient liquidity means (e.g. cash or other assets that can be quickly converted into cash with no or little loss of value), the regulation introduces liquidity buffers:
- the liquidity coverage ratio which aims to ensure that banks have enough liquidity means in the short term;
- the net stable funding requirement which aims to ensure that banks have an acceptable amount of stable funding to support their assets and activities over the medium term.
The regulation introduces a the leverage ratio. Its aim is to limit banks from incurring excessive debts on financial markets. From 2015, banks have to publicly disclose their leverage ratio. If appropriate, the Commission will propose legislation to make this new ratio binding for banks as of 2018.
Additional Capital Protections
The 2013 Directive on Access to the Activity of Credit Institutions and the Prudential Supervision of Credit Institutions and Investment Firms seeks to further strengthen requirements on bank governance and capital in order to make them more robust.
It builds on the regulations making provision for taking up a banking business, prudential supervision of banks and investment firms, freedom of establishment, freedom of movement of services provided by banks. It provides for enhanced sanctions.
The Directive provides for additional capital requirements. They are known as capital buffers and are to be of the highest quality (Common Equity Tier 1).
Under the capital conservation buffer, the bank should hold 2.5% of their total exposures in order not to face restrictions on distribution and bonuses.
Countercyclical buffers apply to periods of excess lending activities which might lead to a credit bubble. National authorities can require banks to hold up to 2.5% of their total risk-weighted asset exposure.
Another buffer is the global systematic institution buffer which applies to major banks identified as globally systemically important. The additional capital, under the buffer, may go up to 3.5% of the bank’s total risk-weighted asset’s exposure.
A State may also apply additional capital requirement to mitigate systematic and macro-prudential risks that may have important negative impacts on the financial system and its national economy. In order to be applied, the systematic risk buffer is subject to certain conditions depending on the percentage of capital added.
The Directive seeks to prevent banks from taking excessive risks through giving their staff incentives. It fixes a maximum ratio between fixed and variable remuneration for all material risk takers. The bonus cannot exceed the identified staff member’s actual fixed remuneration, unless the shareholders decide, subject to certain concessions to allow bonuses that amount to up to twice the fixed remuneration. The rules make requirements on bonuses that promote a long-term approach to risk.
The Directive introduces binding rules to ensure effective oversight by the bank’s management bodies and improve risk management. From January 2015, banks must disclose information on a country by country basis, including profits, tax, public subsidies, revealed.
Restructuring and Bank Rescue
The European Commission produced State aid rules to assess public support of financial institutions during the financial crisis. The framework provides common conditions at EU level for access to public support and requirements for such aid to be compatible with the internal market. The Commission may approve State support to remedy a serious disturbance in the economy of a State.
The post-crisis changes provide that
- Banks may not receive recapitalisations or asset protective measures before the restructuring plan is approved by the Commission;
- In the case of capital shortfalls, bank owners and junior creditors will be required to fully contribute as a first resort before injection of public money;
- Failed banks are subject to strict executive remuneration policies.
Financial Institutions Accountants
European Union directives lay down accounting provisions for banks and other financial institutions. They prescribe the form of balance sheet layout, assets and liabilities presentation. Certain balance sheet entries must be shown in particular ways. There are two standard profit and loss account layout. There are special provisions in relation to on certain types of item in the profit and loss account.
There are valuation rules for assets, securities, loans, advances, and liabilities. There is detailed prescription in relation to the notes which must be appended to the balance sheet.
There are special provisions for consolidated accounts. Where the domestic law does not require accounts to be published, the copies must be available at a price which does not exceed their administrative cost.
There are provisions for publication of accounts by branches of a foreign credit institution. Annual accounts reports and consolidated accounts must be published and audited in accordance with the law of the head office. The former requirements for branch accounts have been phased out.
There are requirements for documents to be published by branches of institutions whose head office is outside the EU. If their rules do not conform, with EU accounting rules, states may require the branches to publish annual accounts of their own activity.
From 2005 all EU companies including banks and insurance companies must prepare a consolidated statement in accordance with international accounting standards. States may permit or require companies to apply the system to their annual accounts as well as consolidated financial statements. They may require the application of the rules to non-publicly traded companies. The legislation supplements the requirements of accounting directive.
The IAS standards should reflect an accurate image of the company’s financial situation and performance. It must correspond with EU public interest requirements and meet the required level of information quality.
Bank Resolution Funds
The EU has indicated that resolution funds should contribute to the orderly resolution of distressed banks. This may be done by
- financing a bridge bank;
- financing a total or partial transfer of assets from the entity in distress;
- financing a good bank/bad bank split.
The commission is of the view that agreements for a fund should procure necessary resources while not incentivising inappropriate behaviour. The commission has considered criteria which may be used for the financing of resolution funds. This would include levies measurable by reference to criteria of size or profitability.
Bank resolution funds should be separated from the national budget and entrusted to authorities responsible for resolution acting as independent agents. They should respect EU state aid rules.
Reorganisation and Winding up of Credit Institution
There is an EU directive on the reorganisation and winding up of credit institutions. The purpose is to ensure a single unified winding up and reorganisation on the basis of home country control.
The reorganisation and winding up measures must be published in third-party states affected. It must be published in the official journal of the EU and national newspapers in each EU state.
Creditors in other states must be informed in good time in the official language of the home state. The heading of the form must be in all the official languages and creditors may submit claims in the official language of their member state. Members have rights to be informed of the progress of the winding up.
The administrative and judicial authorities of the home state must notify the regulators of the other states without delay of the opening up or winding up proceedings. The law of the home state applies.
There are some exceptions to the principle that the home state law applies in respect for example of employment contract, immovable property, and other such methods.
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