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EU Version of Basel III Summary

Core Content

The document discusses the challenges faced by the EU's implementation of Basel III, specifically through the Capital Requirements Directive (CRD IV), which was under consideration during the May 2nd meeting of the Council of EU finance ministers. It highlights the UK's opposition to certain aspects of the proposal, emphasizing the tension between European integration and the preservation of the single market's principle of free competition.

Main Points

• CRD IV Overview:
  CRD IV is a key post-crisis regulatory measure aimed at improving prudential supervision of the EU banking sector. It introduces stricter capital definitions, a minimum Tier 1 capital requirement, and additional capital buffers. However, it does not establish an absolute minimum level of core capital, instead allowing member states to set their own minimum risk-weighted capital requirements with a ceiling.

• UK's Position:
  The UK finance minister opposed the Commission's proposal, arguing that it weakens Basel III. The UK has also requested four exemptions, contributing to the perceived dilution of the rules. The UK's stance is based on the principle of free competition within the single market, as long as minimum standards are respected.

• Risk-Weighting Concerns:
  The document criticizes the use of risk-weighting to determine capital requirements, which allows banks to manipulate capital levels through internal models or low-risk weightings for certain asset classes like government debt and mortgage loans. This could lead to inconsistencies and reduced effectiveness of the regulation.

• Leverage Ratio Absence:
  A leverage ratio, which measures core capital relative to total assets and is more transparent and easier to understand, was not included in the CRD IV proposal. The UK and other critics argue that such a ratio is essential to ensure a consistent and robust implementation of Basel III across the EU.

• Council Compromise:
  The Council compromise proposed to decide on a leverage ratio by 2015, with implementation from 2018. However, this delay is seen as problematic, as it leaves the regulation vulnerable to further loopholes and inconsistencies.

• Capital Definition Issues:
  The current definition of capital in CRD IV allows for the proportional consolidation of minority interests and double counting of capital in insurance undertakings, which deviates from the Basel III framework and could lead to regulatory arbitrage.

• Comparison with US Practice:
  The US has implemented a leverage ratio as part of its regulatory framework, and is likely to criticize the EU for not fully adhering to Basel III. The US approach is more principles-based, while the EU favors a rules-based approach to accommodate its diverse financial markets.

Key Information

• Date of Publication: 11 May 2012

• Author: Karel Lannoo, CEO and Senior Research Fellow at CEPS

• Document Type: CEPS Commentary

• Focus: Critique of the EU's approach to implementing Basel III, particularly CRD IV

• Main Criticisms:

  • Lack of an absolute minimum capital requirement
  • Risk-weighting mechanisms that allow for regulatory manipulation
  • Absence of a leverage ratio
  • Inconsistent capital definitions compared to Basel III
  • Potential for regulatory arbitrage due to differences in national implementation

• Implications:
  The document raises concerns about the adequacy and consistency of the EU's regulatory approach, questioning whether a one-size-fits-all model is suitable for the region's diverse financial landscape. It suggests that a more principles-based approach, similar to the US, would better align with the original intent of Basel III.