The European Commission has put forward a revision of EU rules on capital requirements for banks that is designed to reinforce the stability of the financial system, reduce risk exposure and improve supervision of banks that operate in more than one EU country. The proposals may be useful for strengthening market confidence and institutional resilience in more stable periods, but they will be way too late to have any impact on the current meltdown of the financial system, as they will come into effect in about two year's time.

Under the new rules, banks will be restricted in lending beyond a certain limit to any one party, while national supervisory authorities will have a better overview of the activities of cross-border banking groups. The proposal for capital requirement rules, which amends the existing Capital Requirements Directives, reflects extensive consultation with international partners, Member States and industry. It now passes to the European Parliament and the Council of Ministers for consideration.

Internal Market and Services Commissioner Charlie McCreevy hihlighted that "these new rules will fundamentally strengthen the regulatory framework for EU banks and the financial system. I believe that they are a sensible and proportionate response to the financial turmoil we are experiencing. Basic rigour, transparency and prudence are key to a healthy and stable banking system."

Proposed amendments to the Capital Requirements Directives

The purpose of the Capital Requirements Directives (2006/48/EC and 2006/49/EC) is to ensure the financial soundness of banks and investment firms. Together they stipulate how much of their own financial resources banks and investment firms must have in order to cover their risks and protect their depositors. This legal framework needs to be regularly updated and refined to respond to the needs of the financial system as a whole. The main changes proposed are as follows:

• Improving the management of large exposures: banks will be restricted in lending beyond a certain limit to any one party. As a result, in the inter-bank market, banks will not be able to lend or place money with other banks beyond a certain amount, while borrowing banks will effectively be restricted in how much and from whom they can borrow.
• Improving supervision of cross-border banking groups: 'colleges of supervisors' will be established for banking groups that operate in multiple EU countries. The rights and responsibilities of the respective national supervisory authorities will be made clearer and their cooperation will become more effective.
• Improving the quality of banks' capital: there will be clear EU-wide criteria for assessing whether 'hybrid' capital, i.e. including both equity and debt, is eligible to be counted as part of a bank's overall capital – the amount of which determines how much the bank can lend.
• Improving liquidity risk management: for banking groups that operate in multiple EU countries, their liquidity risk management – i.e. how they fund their operations on a day-to-day basis – will also be discussed and coordinated within 'colleges of supervisors'. These provisions reflect the on-going work at the Basel Committee on Banking Supervision and the Committee of European Banking Supervisors.
• Improving risk management for securitised products: rules on securitised debt – the repayment of which depends on the performance of a dedicated pool of loans – will be tightened. Firms (known as 'originators') that re-package loans into tradable securities will be required to retain some risk exposure to these securities, while firms that invest in the securities will be allowed to make their decisions only after conducting comprehensive due diligence. If they fail to do so, they will be subject to heavy capital penalties.

The proposed amendments are, in the main, a direct follow-up to the Roadmap for the current financial turmoil agreed by EU Finance Ministers. In part, they are also a response to the recent recommendations of the G-7 Financial Stability Forum. The European Council has expressed a strong sense of urgency emphasising that the measures should be adopted by April 2009.