Implementation of the new capital requirement directive in hungarian banks

Hegedûs, Gyula

Keywords: Basel Committee, Basel Capital Accord, Capital Adequacy Framework, Capital Requirement Directive, CRD

The key conclusions were that the new rules will in general reduce capital requirements for EU credit institutions by around 5% compared to present levels.

Furthermore, the outcomes for the different approaches are in line with objectives – particularly combining capital neutrality with appropriate incentives for institutions to move towards more sophisticated approaches. Finally, smaller domestic credit institutions adopting the simple approach will face slightly reduced capital charges; larger internationally active credit institutions adopting the more advanced approach will face substantially unchanged capital charges; smaller but specialised and sophisticated EU credit institutions adopting the advanced approach might face substantially lower capital requirements than at present. Importantly, the main source of reduction in capital requirements is the ‘retail’ portfolio, which is mostly composed of loans to Small and Medium Enterprises (SMEs) below EUR 1 million and residential mortgage loans. The new operational risk capital charge is the main source of offset of this decrease in capital requirements for credit institutions. (EC, 2004) In addition, at the request of the Barcelona European Council the Commission commissioned a study on the consequences of the draft proposed new capital requirements for credit institutions and investment firms in the EU. The final report, prepared by PricewaterhouseCoopers, is positive about the impact (with only two areas of criticism – investment firms and venture capital - both of which have been addressed in the Commission’s proposals). The key conclusions are that the new capital requirements framework should be positive for the EU, and for prudential regulation in the EU. EU credit institutions’ capital requirements should decrease by ± 5% (€ 90 billion) and translate into an annual increase in profits of ± € 10-12 billion. There is no disadvantage for smaller credit institutions and no indication that the new regime will force mergers or consolidation. The decision to cover all credit institutions in the directive will not put EU firms at a competitive disadvantage, nor is the US decision to apply only advanced approaches to some 20 big credit institutions a significant competitive factor. Implementation costs for EU credit institutions are not solely driven by Basel II and many of these investments (perhaps as high as 80%) would have happened anyway, although over a longer period. Importantly, there will be no negative impact on the availability and cost of finance for SMEs in most EU Member States (‘procyclicality’ effects are less - and less damaging - than the present rules). The macro-economic effects of Basel II on the EU-economy are small - there could be a benign supply-side shock to the economy reducing the cost of capital to firms and generating an increase of 0.07% in EU GDP. In general the new capital framework will reduce the banking system’s vulnerability through greater awareness of risk, improved risk management, and a more efficient allocation of capital should have beneficial long-run consequences for the EU economy. (EC, 2004) It is very important for a financial institution in an EU country to begin the preparation for CRD in time. One of the key decision is to choose a method planned to use. It is important to know a voluntary return to the Standardised or Foundation Approach shall be permitted only in extraordinary circumstances and shall be approved by the competent authority. The more sophisticated methods are more expensive. But with more sophisticated methods there is a lower equity requirement commonly. So before the financial institutions make decisions for methods, they have to calculate as follows...