EU mulls fining banks for risky bonus policy
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.
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.
The overhaul of the Capital Requirements Directives was set to honour a pledge made by the G20 group of industrialised and emerging market countries in April 2009 to give banking supervisors powers to intervene if they think bonuses encourage too much risk-taking. This came in the wake of the worst global financial and economic crisis in decades.
Many of the EU's member states, such as Britain, France and Germany, are G20 members who signed up to the pledge. There was widespread outrage over public money being used to rescue banks, some of whose top executives walked away with huge payouts or pensions.
The proposal was aimed at reviewing the Capital Requirements Directives (CRDs), in order to introduce tighter standards to assess the impact on capital requirements of remuneration and re-securitisation in the banking sector. Re-securitised products are at the core of the US sub-prime mortgage market, which is widely believed to have been the root of the crisis.
A first revision of the CRDs, launched before the financial crisis, was recently approved by the European Parliament (EurActiv 07/05/09).
- Autumn 2009: Commission expected to present third review of Capital Requirements Directives in order to tighten loans in positive conjunctures (EurActiv 08/07/09).