Banks may face fines or extra capital requirements if their remuneration policy for managers and traders is too risk-prone, according to draft EU rules put forward by the European Commission to stabilise financial markets after the worst crisis since the 1930s.

Brussels yesterday (13 July) proposed a comprehensive review of capital requirements for banks, aimed at limiting risks related to directors' bonuses, re-securitised products and trading books.

The proposal will need approval from both the European Parliament and EU governments before becoming law, with officials predicting that the process will take at least two years to be concluded. 

A report on the financial impact of the measures proposed is expected by the end of the year, and "could lead to a few modifications," an EU official explained.

Clamp-down on managers' fees

The most striking measures relate to the regulation of banks' remuneration policies, which stand accused of being disconnected from companies' performances and having encouraged excessive risk-taking. 

Managers, it is argued, were taking home massive bonuses even when their banks were making losses.

The new standards proposed by the Commission are in line with guidelines already issued by the group of EU national regulators for the banking sector (CEBS) and by the Financial Stability Forum (FSF), which oversees vulnerabilities of the global financial markets.

However, Brussels went a step further by proposing to strengthen national supervisors' ability to tackle future misconduct. According to the draft directive, supervisors "may impose sanctions such as fines" or request "capital add-ons" in more extreme cases.

However, the Commission refrained from proposing that supervisors be allowed to claw back the bonuses of managers who were deemed too risk-prone. The measure was suggested before the draft directive was published, triggering a fierce debate. It was likely one of the reasons for which the proposal was delayed (EurActiv 01/07/09).


Brussels also proposed to amend existing rules in order to increase capital requirements for banks dealing with re-securitised financial products. These are complex instruments linked to asset-backed securities, which multiply banks' risk and losses. They were at the root of the current financial crisis.

In order to discourage banks from investing in these complex and often misunderstood instruments, the proposed new rules raise capital requirements for re-securitisation. The capital a bank would be required to hold as protection against the risks of re-securitised products "can be three times higher than for securitisation positions," explained an EU official.

In the best credit-rating conditions, capital requirements for securities are set at 7% of the value of the assets. For a re-securitised product, the requirement can reach 20%. In the worst credit scenario, capital requirements can go above 100%, making investment in these complex products totally unattractive.

Critics, however, say that the proposals come after these instruments have already seriously damaged global financial markets. The new standards are set to reduce the size of the sector, partially reflecting what has already happened as a result of the crisis.

Trading books

The draft directive requires banks to hold additional capital to offset risks coming from their trading books, which consist of all positions in financial instruments and commodities held by a bank for trading reasons.

If adopted, the new requirements would oblige banks to hold enough capital to protect themselves not only from a default risk, as is foreseen now, but also from risks related to the deterioration in credit quality of the assets held, as was the case in the current crisis, during which many assets quickly turned from very safe to impaired.