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Policy
Response
Response to the European Commission’s public consultation on possible changes to the Capital Requirements Directive
Background 1. The Building Societies Association represents all 59 building societies in the UK. Building societies have total assets of just under £350 billion and, together with their subsidiaries, hold residential mortgages of £245 billion, more than 20% of the total outstanding in the UK. Societies hold about £215 billion of retail deposits, accounting for more than 20% of all such deposits in the UK. Building societies employ over 51,500 full and part-time staff and operate through more than 2,000 branches. General introduction 2. The purpose of the European Commission’s paper is to consult industry and other parties on potential changes to the Capital Requirements Directive with regard to large exposures, hybrid capital instruments, supervisory arrangements, the waivers for cooperative banks organised in networks and adjustments to certain technical provisions. The Building Societies Association’s response focuses on the first two areas, large exposures and hybrid capital instruments, with minor comment on other issues. 3. Given the tight timescale imposed by the Commission, which has limited our opportunity to engage, and exchange feedback, with our members, this response is of necessity a draft and possibly subject to further modification. A. LARGE EXPOSURES The Commission services are interested in learning stakeholders' views on the impact, if any, of the approach suggested above. With regard to inter bank exposures, a limit is suggested that represents the higher of 25% of a bank's own funds or Euro"X" million (the Committee of European Banking Supervisors has suggested that 'X' should be set at Euro 150 million). Stakeholders' views are sought on the appropriateness of a Euro 150 million limit for exposures to institutions, and on the impact of this suggestion for banks' funding requirements on a day-to-day basis as well as during a contingency. Introduction 4. The Building Societies Association has examined the response on the large exposures issue prepared jointly by the British Bankers’ Association, the London Investment Banking Association, the International Swaps and Derivatives Association and the European Securitisation Forum (“the joint associations”). Joint associations' response on LE part of consultationThe BSA has decided that this response reflects most of its own concerns and will not, therefore, be submitting a detailed response on this area of its own. This joint associations’ response identified six major policy worries: inter bank, intra-group, connected lending, credit risk mitigation, clarity and consistency with Lamfalussy principles. It is the first of these – inter bank – that has caused building societies the most concern. Inter bank exposures 5. Like the joint associations, building societies believe that the existing exemption for inter bank exposures should be retained – we too see no reason to remove the existing exemption, on theoretical or empirical grounds. Societies agree that the 25% limit may not be the most appropriate tool to meet regulatory expectations because it does not provide any incentives to change the risk management behaviour of firms. The main objective must be to reduce the risk of firm failure. As a result, liquidity is an important factor in determining the appropriate treatment. Unlike other entities, the absence of, or inability to access, liquidity is a more significant factor in firm failure. Therefore, any restriction that artificially restricts liquidity is likely to increase rather than decrease the incidence of firm failure. 6. We agree with the joint associations that there is no evidence that large exposures, much less those to other banks of less than one year, have been the cause of firm failure. The existing exemption of inter bank exposures under one year has been in place for over 15 years. Bank failures are more likely the result of internal control problems. Along with the joint associations, building societies oppose the proposed removal of the one year inter bank exposures exemption. 7. While building societies (and the joint associations) welcome the Commission’s attempt to mitigate the impact of its proposals on smaller credit institutions (an official interpretation of this would be helpful) by introducing a threshold - being the higher of 25% of a bank’s own funds or €150m - this may not provide effective help and could have unintended consequences. Building societies, like small banks in the UK, tend to collect retail deposits and can be net lenders to larger banks. Requiring them to split their deposits into smaller amounts and spread them between a greater number of credit institutions would require them to diversify their risks and lend to counterparties with a lower credit rating than they currently accept and may result in them receiving a lower return on their deposits because of their lower nominal amount. Smaller credit institutions have more limited numbers of counterparties with which they can deal, particularly during times of general economic uncertainty. The suggested limits may cause them some difficulty at a time of crisis. 8. The financial markets in Europe continue to seek consolidation. This has the potential to reduce the pool of available counterparties, particularly for smaller credit institutions. Consolidation could inadvertently cause an institution to breach its limit, for example, two large exposures merge thereby creating one large commitment. Sufficient time needs to be given for an institution to run down its exposure in such an event without forcing it to take inefficient or uneconomic remedial action. Conclusion 9. We support the joint associations’ call for a retention of the exemption of inter bank exposures of less than one year. However, if the Commission did decide to go ahead with the withdrawal of this exemption, the BSA would, somewhat reluctantly, support CEBS’ original proposal of the higher of 25% of a bank’s own funds or €150m as a starting point. We should like to see this limit reviewed after an appropriate period. We also disagree with the introduction of national discretion to allow lower thresholds as this would create an unlevel playing field in Europe. B. HYBRID CAPITAL INSTRUMENTS Background to consultation 10. In view of the lack of EU legislation on the treatment of hybrid capital instruments, the European Commission invited the Committee of European Banking Supervisors to consider whether convergence in this area could be achieved. CEBS’ advice was published in April 2008: CEBS advice on hybrid capital instruments11. CEBS did not wish to create a brand new definition for Tier 1 hybrids but to provide guidelines for a common and clear interpretation and implementation across the EU of the eligibility criteria that hybrids must meet using, as the starting point, the Basel Committee October 1998 Sydney Press Release. 1998 Sydney Press Release12. Building on CEBS’ advice, the Commission has stated that it wishes to achieve convergence by:
13. We understand that the Commission does not wish to make text that accommodates different instruments/ markets. Introduction to the building society sector 14. Building societies are mutual organisations. We believe that any future framework must take into account the structural differences inherent in building societies when compared to joint stock company based financial institutions (building societies are unable to raise common equity). 15. Permanent interest bearing shares are a statute based instrument and the only kind of issued membership capital available to absorb losses for UK building societies. The required features are that they are undated/ permanent with non cumulative interest payments. 16. Permanent interest bearing shares were the first and only form of external instrument introduced in the UK to count as Tier 1 capital for building societies under the terms of the Own Funds Directive. PIBS are perpetual and usually pay a fixed rate coupon, although in recent years building societies have issued them with step ups which may give the societies an incentive to repay. They rank on liquidation as the most deeply subordinated instrument in the capital structure. Payments cannot be made if this causes an issuer to become insolvent. Do stakeholders agree with: (i) the Commission services' suggested eligibility criteria and the principle-based approach suggested above? (ii) the recognition of dated instruments - with a predetermined minimum original maturity - in firms' original own funds? (iii) the quantitative limits suggested? In this respect, the Commission services are also interested in views whether an additional limit would be useful to improve even further the quality of capital e.g. by requiring firms' core capital (equity, reserves and retained earnings) to be higher than a pre-determined proportion (e.g. 50%) of minimum capital requirements? Discussion (i) Principle based approach 17. We welcome the Commission’s principle based approach and extend support to a regime that seeks to ensure that institutions have a level playing field on which to operate. The regime needs to be mindful that across the EC there are a range of different ownership models for operating financial institutions all with a variety of capital instruments, for example in the United Kingdom there is a vibrant building society sector that as a mutual sector does not issue ordinary shares. 18. The regime needs to ensure that provided its core requirements of absorbing losses in going concern situations and subordination to all other claims are met, different varieties of capital are not penalised because either they are not ordinary shares in a company and/or they have other features that are closer to hybrid capital than ordinary shares. 19. The principles of absorbing losses as a going concern and subordination to all other claims are ones that should be applied irrespective of the nature of the instrument. Were the EC to accept amendments to Article 57 (a) that imposed additional restrictions on capital instruments merely because they had hybrid features, despite the fact that they met the guiding principles of absorbing losses and subordination, these fundamental principles would be undermined. Moreover, it might lead to some forms of institutions being treated inequitably by comparison to others. Such restrictions could have implications for competition in some markets as access to capital for certain types of institutions is more limited. 20. Any instrument that meets the terms of core capital should have no further qualification. On this basis, the decision chart set out in the consultation paper, combined with Article 57 (a), should be the guiding principles. This would appear to be a balanced approach to applying the principles. (ii) Dated Instruments 21. We agree that dated instruments with a predetermined minimum original maturity should be included within the calculation of a firm’s own funds. All firms of whatever ownership structure have capital needs that can often be most appropriately funded by means of a dated instrument. 22. Moreover the fact that such instruments have a predetermined maturity does not of itself make them less permanent than the ordinary share capital issued by some firms. While ordinary share capital is an undated form of capital those firms that have access to this form of capital have significant opportunity to repurchase and then cancel ordinary share capital at any time. In some respects, the significant flexibility around the permanence, or otherwise, of ordinary share capital means there is little comfort to be gained from a capital ratio that includes ordinary share capital as opposed to one that includes dated instruments. 23. We acknowledge that dated instruments need to demonstrate some minimum term before they can be called or redeemed and believe that the proposed minimum timescales outlined in the consultation paper represent a balanced way forward for dated instruments. (iii) Limits 24. We have concerns about the limits should the principles based approach to capital not be adopted on the basis indicated in the consultation. Any instrument that meets the principles of absorbing losses in going concern situations and is the most subordinate claim in an insolvency, should be considered core capital even if it has hybrid features that would, in other circumstances (for example, it is not the most subordinate claim) mean it is captured by these hybrid limits. 25. Super-imposing the hybrid limits over capital that would meet the principles of absorbing losses and subordination fundamentally undermines the whole principles based approach and should be avoided if the principles based approach is to have any merit. In respect of instruments that do not meet the principles of core capital then the approach to set limits is recognised as appropriate for preserving the quality of capital. 26. We consider the 15% limit set on innovative instruments to be low. In many cases, markets only exist for these instruments because they have margin step-ups. If this is the only source of hybrid capital, the limit may impose restrictions on certain institutions’ ability to raise capital. 27. It must be remembered that not all institutions are capitalised with share capital and competition and diversity should not be sacrificed just to meet hybrid limits that are constructed around a share capital model of ownership. The Commission needs to set limits that balance the disparate needs for consistency, principles, level playing fields, adequate quality capital and competitiveness across Europe. With this in mind it may be appropriate to set innovative capital at a higher level. 28. We recognise the need to have quality capital and would support the overall limit requiring a minimum of 50% of capital to be core capital provided that:
The principles based approach should be paramount. C. SUPERVISORY ARRANGEMENTS The Commission services seek views on the proposed amendments relating to crisis management and home/host issues. In particular, views are sought on the definitionof a systemically relevant branch and an appropriate level for the threshold in Article 42(2). 29. We recognise the need for supervisors across different jurisdictions to be able to communicate about institutions that operate across the same jurisdictions, particularly in periods of financial crisis. We have no particular comments on the proposals for systemically relevant branches, which appear reasonable. In respect of the threshold, this will need to be set at a reasonable level which should involve discussion with the relevant institution by the two supervisors. D. WAIVERS FOR COOPERATIVE BANK NETWORKS AND OTHER TECHNICAL AMENDMENTS In your view should affiliates to networks meeting the eligibility criteria laid out in the CRD but set up after 15 December 1977 be allowed to make use of the same exemptions as the affiliates to networks set up before that date? Technical changes Do you agree with the proposed changes? 30. We have no views on the extension of exemptions for cooperative bank networks. 31. In respect of the technical changes, we do not see the logic in setting a minimum threshold for risk weighted exposure amounts where significant credit risk has been transferred that could exceed the risk weighted exposure amounts prescribed in Annex IX. This penalises organisations that have successfully transferred risk and have retained only a small exposure in the securitisation. This approach could easily charge more capital to the retained positions than they total exposure of these residual positions. 32. We have no comment on the further technical changes. |
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