EU to tighten bank lending to offset risks

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European Union finance ministers agreed yesterday (7 July) to tighten bank loans during periods of economic growth in order to boost liquidity and make funds available for when recession hits. The agreement came as national regulators proposed to build a bank liquidity buffer to guarantee a “survival period of at least one month”.

Under the agreed plan on long-term rules, which the European Commission will use to draft legislation in October, banks would be required to build sizeable reserves of capital in good times so that they can act as a buffer during downturns.

This would prevent financial institutions from ruthlessly opening the credit market during periods of economic boom, while easing lending during difficult times.

The scheme is intended to ensure the 27-nation EU is better prepared for any repeat of the global financial crisis, which was triggered by bad loans in the United States which spread quickly throughout the world’s economies.

“The Council agrees that further work is necessary to mitigate pro-cyclicality by creating counter-cyclical capital buffers, i.e. to be raised in good times and to be drawn in downturns,” the ministers said in a statement after their monthly meeting in Brussels. Pro-cyclicality is an aspect of economic policy that could magnify economic or financial fluctuations.

“We need to see stronger buffers in banks in good times. It is important that we mend the banking system so that credit gets running again. We need stronger regulation, more efficient regulation,” said Swedish Finance Minister Anders Borg, whose country holds the EU’s rotating presidency.

The Council statement was echoed by draft guidelines on liquidity buffers published yesterday by EU banking regulators brought together in the Committee of European Banking Supervisors (CEBS).

“A survival period of at least one month should be applied to determine the overall size of the liquidity buffer under the chosen stress scenarios. Within this period, a shorter time horizon of at least one week should also be considered to reflect the need for a higher degree of confidence over the very short term,” CEBS said.

The committee also described the type of assets that could be accepted in a liquidity buffer: they must be money or assets that can be turned into cash quickly with a predictable value. Over-reliance on one type of asset, whose rapid sale to raise cash could disrupt the broader market and trigger problems for other banks, should also be avoided, CEBS said. The committee carefully avoided spelling out an absolute figure for the reserve, as this will vary from bank to bank.

Disagreement on German proposal

Countries rejected Germany’s proposal to relax the Basel II rules on capital requirements for a limited period so that credit supply does not dry up to such an extent that firms are put at risk. But the plan gave rise to little enthusiasm.

“There was a very broad majority of countries that did not have exactly the same view [as Germany],” Borg told a news conference. He said the Commission would look at the issue and report back to the ministers.

“What I’m not in favour of is that some are thinking about chucking out Basel II. A crisis that arose on the back of debts can’t be solved by making it easier to run up debts,” Austrian Finance Minister Josef Proell said. German Finance Minister Peer Steinbrueck said his country would press on with its plans. 

(EURACTIV with Reuters.)

EU rules on capital requirements are designed to protect savers and investors from the risk of the failure or bankruptcy of banks. They ensure that these institutions hold a minimum amount of capital. 

The Capital Requirements Directive, adopted in 2006, has just been amended by the EU institutions (EURACTIV 07/05/09) and is currently under a review again following the financial crisis.

Specifically, the European Commission is working on a legislative proposal aimed at introducing tighter standards to assess the impact on capital requirements of remuneration and securitisation in the banking sector. The plan is currently being held up by disputes between member states (EURACTIV 01/07/09).

  • Oct. 2009: Commission to present legislative proposals on new capital requirements for banks.

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