The European Commission’s proposed amendment of the Capital Requirements Directive comes ahead of the Basle Committee On Banking Supervision’s guidance on counter-cyclical capital, reinforcing the impression that it is trying to establish ‘facts on the ground’ to force the debate over bank capital.
Responses are due by September 4, and the European Commission plans to publish a directive in October.
Its proposals on mortgage risk weights are likely to prove equally controversial, penalising loans in a currency other than the borrower’s income and high loan to value loans.
The consultation offers a small concession to banks reeling from the flurry of new capital requirements by suggesting an overall impact assessment of all the proposed initiatives.
"This goes to the previous proposals, such as the IRC [incremental risk charge] and the stressed VaR," said Simon Gleeson, a partner at Clifford Chance in London. "IRC and stressed VaR were the subject of a Basle quantitative impact study, so at least some work had been done in that direction.
"But there are a lot of banks that are seriously worried about the cumulative impact on their balance sheets, mostly because it’s proving to be very hard to model.
"If it had been suggested that there wouldn’t be some sort of impact study at some point there would have been a lot of extremely unhappy banks...
"Policy makers are at least starting to recognise that they are in slightly uncharted territory here in terms of what the consequences of their policy choices will be."
The proposed capital buffer is based explicitly on the formula used by the Bank of Spain. It is offered in two forms, depending on whether the International Accounting Standards Board moves from an incurred loss model for impairments to an expected loss model.
Under the first approach, two co-efficients determined by national regulators based on historical statistics are applied to six generic risk categories.
These are alpha — the historical average estimate of credit loss through the credit cycle — and beta — the historical average specific provision. The buffer applied in each period for a given risk category is the sum of loan growth times alpha and the difference between beta and the proportion of provisioned loans, times the loan stock.
The second approach, to be taken if banks move to an expected loss impairment model, removes alpha and makes the buffer simply beta times loan stock, minus value adjustments and provisions.
The remaining amendments are designed to discourage banks from riskier lending in both residential and commercial mortgages, and to remove many of the areas of national discretion included in the original CRD.
For foreign currency residential mortgages, the portion of the loan below a 50% LTV will have the ordinary risk weight, while the portion above will be accorded a risk weight rising to 1,250% at an LTV of 100%.
Similarly, for all residential mortgages the preferential risk weighting of 35%, which applies under the standardised approach for loans with an LTV of up to 80%, will only apply to the portion of the loan below a loan to market value of 40%. For commercial mortgages, the maximum LTV for a 50% risk weight will also 40%.
"This is something that wouldn’t really have much impact in Europe outside the UK and Ireland and one or two other places," said Gleeson.
Chris Dammers