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Banking Regulation

Prudential requirements

The European Union has implemented prudential requirements to enhance the stability of its financial sector and ensure its ability to support various end-users, such as households, firms, and other entities requiring financial services.
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EU's Actions and Goals: Post the global financial crisis, the EU introduced prudential requirements to ensure that banks can effectively manage liquidity shocks and absorb losses. These requirements are a crucial part of the EU single rulebook,, designed to bolster the resilience of the EU banking sector while facilitating banks' role in financing economic activity and growth.

Prudential Framework Components:
International Standards and Basel III:
  • The Basel Committee on Banking Supervision (BCBS), comprising central banks and supervisory authorities from 28 jurisdictions, establishes international banking prudential regulation standards.
  • Basel III, developed by the BCBS, sets non-binding international standards, primarily targeting "internationally active banks".
  • The EU has adopted these standards into binding EU law, applying them to all EU banks and investment firms. This approach aims to build a strong single market for banks within and across the 27 EU Member States, as well as on a global scale.

EU's Adaptation of Basel III:
  • The EU has actively participated in developing BCBS standards on capital, liquidity, and leverage.
  • The rules implemented in the EU align with Basel III objectives but are tailored to accommodate the diversity of the EU's banking system. This includes addressing proportionality concerns for smaller and domestically-oriented banks, ensuring that regulations are fit for purpose at both EU and national levels.

The prudential requirements are a key step in the EU's efforts to create a more robust and resilient banking sector, capable of sustaining financial stability and supporting economic growth.

Legislation

  • Capital Requirement Directive V
  • ​Capital Requirement Directive IV
  • ​Capital Requirement Directive II
  • ​​Capital Requirement Directive
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​he Banking Prudential Requirements Directive (CRD V) governs the access to deposit-taking activities. It establishes rules on
  • corporate governance of banks
  • powers and responsibilities of national authorities (e.g. authorisation, supervision, capital buffers and sanctions)
  • requirements on internal risk management that are tied to national company laws
Basic informationTransposition by EU Member StatesLegislative history
The Regulation on Prudential Requirements for Credit Institutions and Investment Firms (CRR II) establishes the prudential requirements that institutions need to respect. It sets out
  • the rules for calculating capital requirements
  • reporting and general obligations for liquidity requirements
Basic informationLegislative history

Bank recovery and resolution

​The European Union has established a comprehensive framework to effectively manage bank failures, ensuring financial stability and minimizing the impact on public funds and depositors.

Bank Resolution Strategy:
Bank resolution occurs when authorities decide that a resolution, instead of normal insolvency proceedings, would better safeguard financial stability and depositor interests, and minimize reliance on public funds.

The resolution tools used by authorities aim to:
  • Ensure the continuity of the bank's critical functions.
  • Maintain overall financial stability.
  • Restore the viability of parts or all of the bank or facilitate their transfer to another entity.
  • Parts of the bank that cannot be made viable undergo normal insolvency proceedings.

Post-Financial Crisis Measures:
​Following the global financial crisis of 2007-2009, the EU adopted numerous measures to harmonize and enhance tools for addressing bank crises. These measures include legislative proposals and directives aimed at reforming bank crisis management and deposit insurance frameworks.

​Policy Making Timeline:
Bank Resolution Cases:
This framework reflects the EU's commitment to ensuring the resilience of the banking sector, protecting depositors, and maintaining financial stability, especially in times of crisis.

Deposit guarantee schemes

​Deposit guarantee schemes (DGS) reimburse up to a certain amount to compensate depositors whose bank has failed. A fundamental principle underlying DGS is that they are funded entirely by banks, and that no taxpayer funds are used.

Under EU rules, deposit guarantee schemes
  • protect depositors' savings by guaranteeing deposits of up to €100 000
  • help prevent the mass withdrawal of deposits in the case of a bank failure, which can create financial instability

The EU has gradually increased the level of deposit protection since the first directive for DGS was introduced in 1994.

On 18 April 2023, the European Commission has adopted new proposals aimed at revising and fortifying the existing EU bank crisis management and deposit insurance (CMDI) framework. These proposal are designed to ensure orderly market exits for failing banks of all sizes and business models, including smaller institutions.

  1. Proposed amendments to the Bank Recovery and Resolution Directive
  2. Proposed amendments to the Single Resolution Mechanism Regulation
  3. Proposed amendments to the Deposit Guarantee Schemes Directive
  4. ​Proposed amendments to the Daisy Chain Act


Key Enhancements of the Proposals:
  • The proposals are based on insights gained from the initial years of implementing the CMDI framework.
  • They aim to provide resolution authorities with more effective tools to handle crises while ensuring financial stability.
  • A primary focus of the proposals is to guarantee uninterrupted access to deposits for individuals, businesses, and public entities during a banking crisis.

Industry-Funded Safety Nets:
  • The proposals introduces measures to utilize industry-funded safety nets in crises.
  • This includes facilitating transfers from failing banks to stable ones, providing a protective shield for depositors in such scenarios.

​Implications:
  • The revised framework aims to maintain financial stability and protect both taxpayers and depositors.
  • It seeks to enhance the efficiency and effectiveness of the crisis management framework, benefiting the overall economy.


Winding-up of credit institutions

In the European Union, a unified bankruptcy procedure is established for credit institutions (primarily banks) operating across multiple EU countries, as per Directive 2001/24/EC This directive ensures the application of a single bankruptcy process in all involved EU countries when such institutions face failure.

Key Elements of the Directive:
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  • Application of Home Country Laws: The directive mandates that the bankruptcy and winding-up proceedings of a credit institution follow the laws of the EU country where it is registered (the 'home country').
  • Notification and Impact on Creditors: It is required to inform creditors about the bankruptcy proceedings and reorganisation measures. The directive also addresses how bankruptcy proceedings affect contracts and certain legal rights.
  • Scope of Application: Directive 2001/24/EC is specifically applicable to credit institutions with branches in other EU countries. However, it does not extend to banking groups as a whole.

This directive streamlines the bankruptcy process for cross-border financial institutions within the EU, ensuring consistent application of rules and procedures based on the home country's laws.

Covered Bonds

The European Union is working to integrate and enhance the efficiency of the covered bonds market, which is a crucial element in long-term financing across many EU Member States. Covered bonds are vital instruments for channeling funds into the property market and public sector entities.

Key Characteristics of Covered Bonds:
  • Covered bonds are debt obligations issued by credit institutions.
  • They offer double-recourse protection to bondholders, meaning if the issuer fails, bondholders have a direct, preferential claim against certain earmarked assets, as well as an ordinary claim against the issuer's remaining assets.

Market Status:
  • By 2014, the covered bond outstanding volume in the EU reached approximately €2.5 trillion, positioning European credit institutions as global leaders in these markets.
  • However, the market remains fragmented along national lines, with varying performance across Member States. This fragmentation hinders standardization in underwriting and disclosure practices and poses challenges to creating deep, liquid, and accessible markets, especially cross-border.

EU Framework for Covered Bonds:
  • As a key component of the capital market union action plan, the Commission aims to develop an integrated European framework for covered bonds, rooted in high-quality standards and market best practices.
  • In March 2018, the Commission proposed a dedicated EU framework for covered bonds, including both a directive and a regulation.
  • The European Parliament endorsed this legislation in April 2019, establishing the foundation for a capital markets union that includes the EU framework for covered bonds. in 2013, the EU Council is still discussing the Proposal for a Regulation.

Legislative Developments and Consultations:
  • The new regulatory framework proposed by the Commission comprises a directive and a regulation, intending to streamline the covered bonds market.
  • A public consultation launched in September 2015 by the Directorate-General for Financial Stability, Financial Services and Capital Markets Union assessed the feasibility of a future integrated European covered bond framework.

​The EU's initiative to enhance the covered bonds market reflects its commitment to facilitating long-term financing and creating a more integrated and efficient capital market within the Union.