Capital Requirements Directive Research Articles

CORPORATE GOVERNANCE REFORMS IN THE BANKING SECTOR: ENHANCING STABILITY AND PROTECTING DEPOSITORS& INTERESTS

The global financial crisis of 2008 exposed significant weaknesses in the corporate governance practices of banks, leading to excessive risk-taking, lack of oversight, and eventual failures. In response, corporate governance reforms have been implemented in the banking sector to enhance stability, restore public confidence, and protect the interests of depositors. Effective corporate governance ensures that banks are managed responsibly, aligning the interests of various stakeholders. Key areas of focus for these reforms include board composition and effectiveness, risk governance and management, remuneration policies, internal controls and auditing, transparency and disclosure, and stakeholder engagement. Reforms emphasize the importance of having a diverse and independent board, robust risk management frameworks, aligning executive compensation with long-term performance, strengthening internal controls and auditing processes, enhancing transparency and disclosure requirements, and engaging with stakeholders, including depositors. Initiatives such as the Basel Committee on Banking Supervision's guidelines and the European Union's Capital Requirements Directive IV (CRD IV) have aimed to strengthen governance frameworks and promote best practices within the banking industry. These reforms mandate the establishment of dedicated risk committees, stress testing practices, clawback provisions in remuneration structures, and the implementation of effective compliance and auditing functions. Effective implementation of corporate governance reforms is crucial for enhancing financial stability, mitigating systemic risks, and protecting depositors' interests. By promoting responsible and ethical practices, strengthening oversight mechanisms, and aligning incentives with long-term sustainability, these reforms aim to restore public confidence in the banking industry and contribute to the overall resilience of the financial system. Keywords: Corporate Governance, Banking Regulations, Risk Management, Transparency, Financial Stability

How Should Crypto Lending Be Regulated Under EU Law?

The collapse of Genesis is the latest in a cascade of failures of crypto lenders. The last year has seen numerous major crypto lenders, such as Celsius, Voyager and BlockFi, going out of business in domino-like fashion. The failures have revealed the vulnerabilities of crypto-market lenders’ business model, most notably the liquidity and maturity mismatches in their loan portfolios, and their markedly weak corporate governance. The present article explores avenues to regulate crypto lending within the framework of EU financial services regulation. It argues that crypto lenders should be taken as falling within the definition of credit institutions under EU law, and thus, as a result, should be subject to the stringent licensing and prudential requirements introduced by the Capital Requirements Directive and Regulation. Prudential regulation is one of the ways that have been suggested for the regulation of crypto-market operators, alongside the investor protection framework. Taking into account that crypto lenders easily operate on a cross-border basis and that prudential regulation is fully harmonized in the EU, we take an EU-wide perspective and focus our analysis on EU law, rather than member state laws. In addition, prudential regulation can deal with any systemic risk issues with which investor protection regulation cannot deal. However, in order to avoid moral hazard and not give investors the false impression that crypto lenders are safe too-big-to fail institutions, we suggest that crypto lenders should not enjoy the full protection of prudential regulations. In particular, they should not be offered lender of last resort support and they should not be allowed to subscribe into a deposit insurance scheme. Even though it is often said that crypto markets pose no risk to the regulated sector due to limited interconnectedness, it should be noted that due to the high leverage of crypto investors, the real risk to the regulated sector comes from the possibility of crypto investors massively liquidating their positions in other asset markets.

Issues when the parental and host country systemic institution buffers differ: the case of Czechia

The article analyses regulatory reforms in the EU to the capital buffers for mitigating risks associated with institutions' systemic importance in the Capital Requirements Directive (CRD). The Directive includes a buffer for other relevant institutions (O-SIIs) and limits its size to a general cap and a specific cap for subsidiaries. However, the specific subsidiary cap may limit national authorities' ability to set a sufficient buffer for domestic institutions that are members of European banking groups to cover risks to the domestic market. It also may lead to a situation where two institutions of similar systemic importance could be subject to different O SII buffer rates because their owners are of different systemic importance and have different O-SII buffer rates in different EU jurisdictions. The amended CRD V increases the general and subsidiary cap for the O-SII reserve by one percentage point. However, the cap for subsidiary institutions remained in force, which limits the setting of capital buffers, especially for banking sectors with significant foreign ownership. These include mainly countries of the former Soviet-aligned Eastern Bloc. This paper outlines shortcomings of the subsidiary cap, argues for a revision of it to ensure level playing field in these capital buffers and quantifies the impact of the subsidiary cap according to the CRD IV and CRD V on the capital requirement applied to the Czech banking sector.

Compensation regulation in banking: Executive director behavior and bank performance after the EU bonus cap

The regulation that caps executives’ variable compensation, as part of the Capital Requirements Directive IV of 2013, likely affected executive turnover, compensation design, and risk-taking in EU banking. The current study identifies significantly higher average turnover rates but also finds that they are driven by CEOs at poorly performing banks. Banks indemnified their executives by off-setting the bonus cap with higher fixed compensation. Although our evidence is only suggestive, we do not find any reduction in risk-taking at the bank level, one purported aim of the regulation.

Options and Discretions under the Capital Requirements Directive IV

Options and Discretions under the Capital Requirements Directive IV

Risk management practices and credit risk of the significantly supervised European banks

PurposeThis paper aims to examine the influence of risk management (RM) practices on the credit risk of significantly supervised European banks.Design/methodology/approachTo avoid regulatory and reporting discrepancies, this paper samples banks that come under the direct supervision of the European Central Bank. Significantly supervised European Banks are selected for the five years from 2013 to 2017. The RM and governance data is manually drawn (from annual reports, registration documents, governance and RM reports), and financial data sets are also used (from Moody’s BankFocus and ORBIS).FindingsThe results indicate that strong risk control and supervision by a powerful chief risk officer (CRO) reduces banks’ credit risk. Banks with sufficiently powerful and independent CROs tend to manage their risks effectively, therefore reporting lower credit risk.Research limitations/implicationsEuropean Union introduced Capital Requirement Directive IV in 2013 and new guidelines on the banks' internal governance in 2017, which were to be implemented in 2018. Thus, this paper limited the sample to five years (from 2013 to 2017) to avoid inconsistencies in the results. Future studies can extend the research and compare banks' credit risk before and after the implementation of regulatory guidelines.Practical implicationsSince the global financial crisis, the regulatory environment has sufficiently changed. Hence, this study reveals that not all RM practices but a few important ones reduce credit risk.Social implicationsEffective risk control and supervision at the bank level can lower credit risk, ultimately enhancing overall financial stability.Originality/valueMost existing studies focus on classic governance indicators to analyze banks’ credit risk; however, this paper considers risk governance indicators which include RM practices used by European banks. Moreover, existing studies in this line focus on the crisis period of 2007–2008. This paper considered the postfinancial crisis period, specifically after the implementation of the Capital Requirements Directive IV at the European level.

Fit and Proper Requirements in the EU Banking Sector. A Step Further

Prudential regulation has become increasingly important over time. In such a context, strict suitability requirements for members of the management body and key function holders are considered an adequate tool to safeguard the sound and prudent management of banks. In the years following the Great Financial Crisis in 2008–2009 and the Eurozone sovereign debt crisis in 2010–2012, the regulatory and supervisory approach to banks’ corporate governance has seen a significant evolution. The centralisation of banking supervision at the Eurozone level was complemented by the application of a single rulebook throughout the European Union which stated, in compliance with the Capital Requirements Directive, higher suitability requirements for being appointed as a member of a management body or as a key function holder at a bank. Furthermore, the choice to identify fit and proper requirements through standards attributes significant power to the decision maker, thus allowing greater public control over private choices, and is justified by the need to prevent negative externalities. This approach is open to debate. Against the background of the pursuit of public interest, the lawmaker confers discretionary power on the supervisory authorities (the European Central Bank and the national competent authorities), and sets restrictions on the job market for board member candidates. This paper is a contribution enriching the ongoing discussion about the existing regulatory and policy regime, with a special focus on the specific functions performed by the management body members and particularly by the chairs of the management body’s special committees.

Financial Transparency to the Rescue: Effects of Public Country‐by‐Country Reporting in the European Union Banking Sector on Tax Avoidance*

ABSTRACTWe analyze the effect of mandatory financial transparency on corporate tax avoidance. The effectiveness of comprehensive tax transparency, in the form of a public country‐by‐country reporting, to mitigate corporate tax planning is largely unknown. Capital Requirements Directive IV by the European Commission required multinational banks to publish key financial and tax data in the form of public country‐by‐country reporting. We examine tax avoidance of banks around the reform. Our focus is on multinational banks newly required to report activities in tax havens that had not been publicly disclosed before the country‐by‐country reporting mandate. We predict and find that these exposed banks increased their tax expense relative to multinational banks with no activities in tax havens to disclose, as well as relative to domestic banks unaffected by the new mandate. In additional tests, we compare our sample of exposed multinational banks to several control groups from the financial sector and other industries. Our results suggest that country‐by‐country reporting can serve as an additional policy instrument to curb corporate tax avoidance, but only when the reporting exposes the firms' tax sheltering activities to public scrutiny.

Italy

Macroprudential oversight in Italy combines local elements with the European framework. At a local level, financial stability is a shared responsibility between Banca d’Italia (BdI), which is the national central bank and the prudential authority for banks and other financial institutions, the markets authority, Commissione Nazionale per le Società e la Borsa (CONSOB), the insurance supervisor, Istituto per la Vigilanza Sulle Assicurazioni (IVASS), and the pension funds supervisor, Commissione di Vigilanza sui Fondi Pensione (COVIP).2 Each authority exercises its responsibility within a combination of sectoral and activity boundaries and the BdI plays a leading role in surveillance and coordination. Within the European framework, the BdI is both the national competent authority and the designated authority for the macroprudential tools considered under the Capital Requirements Regulation (CRR) and the Capital Requirements Directive IV (CRD IV), which are implemented and activated following the processes described in these regulatory texts and the guidelines provided by the European Central Bank (ECB) – within the competences assigned to it by the SSM Regulation - and the European Systemic Risk Board (ESRB). The ubiquitous role of the BdI on both fronts eases the challenges posed by the coexistence of these two frameworks.

CRD V/CRR II: A comprehensive synopsis of the first European step towards implementing Basel IV (Part II)

Two banking packages are needed in Europe to implement the Basel recommendations of the standard ‘Basel III: Finalising post-crisis reforms’ into European supervisory regulation. The Basel Committee on Banking Supervision (BCBS) and European supervision use the abbreviation ‘Basel III’ for the reforms. They thus give the impression to those unfamiliar with the subject that the supervisory authority is merely updating and expanding the approaches and ideas published in the Basel III papers of 2010 in response to the financial crisis of 2007/2008. In the overall picture, however, this is not the case. In addition to the usual updating of known standards, the supervisory authority is introducing a large number of entirely new approaches and regulations that did not exist in this form previously. Banking sector is rightly using the term ‘Basel IV’ instead of ‘Basel III’ for this regulatory change package, which is the most comprehensive ever at both the international and European levels. The first European banking package was adopted in June 2019 and is currently being implemented. It is also known as the ‘CRD-V-CRR-II package’, as it makes significant changes to the capital requirements directive (CRD) and capital requirements regulation (CRR) in particular. This paper — like Part I which appeared in Journal of Risk Management in Financial Institutions Vol. 13, 2 — analyses the remarkable changes that will pose notable challenges for many banks. We use a four-pillar concept to differentiate the most critical issues. The publication of the second European banking package for the full implementation of Basel IV is still pending. The contents of the ‘CRD-VI-CRR-III package’ will therefore only be analysed at a later date.

France

The Less Significant Institutions (LSI) sector in France is very small in terms of market share and is diversified by size and business model (Table 1). It proved itself resilient during the financial crisis and is not a source of systemic risk. The sector has a high cost structure and faces a number of competitive and other challenges. The regulatory framework, based on the Capital Requirements Regulation (CRR)/Capital Requirements Directive (CRD) IV, is the same as for Significant Institutions (SIs) but the supervisory framework under the Single Supervisory Mechanism (SSM) is very different. The French Prudential Supervision and Resolution Authority (ACPR) remains the direct supervisor of LSIs but it is now subject to the oversight of the European Central Bank (ECB), which also has full responsibility for certain common procedures. The ACPR has continued its comprehensive supervisory approach, both on-site and off-site, but reflecting the SSM’s emphasis on greater harmonization, it has had to become more procedural and may have lost elements of flexibility. In response to SSM initiatives, the ACPR has sharpened its focus on governance issues, although business model and profitability risk remains the main challenge for the LSI sector.

The AnaCredit regulation is in place — a reflection on data-driven reporting: What has been achieved by the banks and regulators, and what remains to be done?

By introducing the AnaCredit regulation, the European Central Bank (ECB) has taken the concept of data-driven regulatory reporting to an unprecedented level. In addition to an everincreasing burden of traditional template-based reports serving both supervisory and statistical purposes, credit institutions of the Euro area are requested to deliver micro-data on a loan-by-loan and borrower-by-borrower level on a monthly and quarterly basis. The data are compiled according to precise definitions and organised into an entityrelationship model. This innovative approach to data collection within the banking sector is premised on the following principles: any aggregated data can be obtained from granular data, but the reverse is not true — granular data enabling both drill-down and roll-up analysis; in order to be comparable, data need to be harmonised and standardised by way of common definitions and standards; data are of better quality when they are organised in a model reproducing business reality and input systems to the greatest extent possible; top-down indicators calculated from granular data are not necessarily known in advance as new indicators can emerge from correlations observed between the underlying data. This approach should alleviate the reporting burden put on credit institutions since it will be possible to compute new macro-prudential indicators from data that have already been collected. Ultimately, and to the extent that rules for data dissemination across the national and European authorities allow, it could also establish a bridge between statistical and supervisory needs, since numerous breakdowns required in templates forming part of the Capital Requirements Regulation (CRR)/ Capital Requirements Directive (CRD) IV package or in short-term exercises could be derived from AnaCredit data in a bottomup approach — or, AnaCredit data could be used as an analytical tool for supervisors. This paper explores, by illustrative examples, how some of the caveats of the AnaCredit regulation, from its conception to its application, may impede the fulfilment of its double objective with regards to the collection of high-quality granular credit data across the Euro area and to the reduction of the reporting burden. It concludes with a discussion of the necessity to break down the remaining silos within banks but also within national and European authorities, and to pursue the work initiated on a larger scale through initiatives such as the Banks’ Integrated Reporting Dictionary (BIRD) and the Integrated Reporting Framework (IReF).

Does Public Country-by-Country Reporting Deter Tax Avoidance and Income-Shifting? Evidence From Capital Requirements Directive IV

In this study, we examine the effect of increased tax transparency on the tax planning behavior of European banks. In 2014, the European Union introduced public country-by-country reporting requirements to the banking industry. Treating this new requirement as an exogenous shock, we find limited evidence consistent with a decline in income-shifting by the banks’ financial affiliates in the post-adoption period (starting from 2015). We do not, however, find robust evidence of a significant change in the consolidated book effective tax rates among the affected banks. Our findings suggest that increased transparency from public country-by-country reporting can deter tax-motivated income shifting but that it did not appear to materially influence the banks’ overall tax avoidance. Our findings have policy implications for the ongoing debate between the European Parliament, the Organisation for Economic Co-operation and Development, and accounting standard-setting bodies on whether to require multinationals to publish country-by-country reports.

Zapobieganie wystąpieniu kryzysu finansowego według zaleceń organów Unii Europejskiej

The latest global economic crisis showed inconsistencies in the implementation of micro-prudential policy by credit institutions and investment firms in the EU and outside it on the one hand, and on the other hand the lack of regulation in the field of macro-prudential policy. It was only in 2013 that decisions were made in the Capital Requirements Directive IV and Capital Requirement Regulation package. In the article we verify the research hypothesis that the prevention of the financial crisis depends on the proper construction and consistent implementation in practice of micro-prudential and macro-prudential policy as a part of institutional systemic risk management in the European Union. The verification of this hypothesis was carried out using methods of statistical analysis of secondary data, published by the European Commission and through the analysis of prudential requirements for credit institutions and investment firms included in the EU directives. The research hypothesis was confirmed.

Regulating Bank Governance and the EU Capital Requirements Directive

This article pays tribute to Professor Mads Andenas’s scholarly contribution to European banking law and regulation. The article addresses how EU banking law under the Capital Requirements Directive IV regulates private shareholder rights regarding their governance or control rights over banking corporations and the extent to which public law regulatory powers are constrained by EU constitutional law regarding the application of administrative sanctions on EU banks or bank shareholders who violate CRD IV governance principles and rules. The analysis will focus on the CRD IV’s sound and prudent governance principle and related regulatory technical standards adopted by the European Banking Authority. It will also analyse the extent to which EU administrative or regulatory sanctions can be applied to banks for violating the sound and prudent governance principle and related regulatory standards and how the principle of proportionality could apply to the exercise of such regulatory powers. The article builds on the fascinating body of work of Professor Andenas in analyzing EU banking law and the extent to which EU member state supervisory authorities are constrained by fundamental EU legal principles in imposing sanctions on banks for violating applicable law and regulatory rules.

Financial Transparency to the Rescue: Effects of Country-by-Country Reporting in the EU Banking Sector on Tax Avoidance

We analyze the effect of mandatory financial transparency on corporate tax avoidance. The effectiveness of comprehensive tax transparency, in the form of a public Country-by-Country Reporting, to mitigate corporate tax planning is largely unknown. Capital Requirements Directive IV by the European Commission required multinational banks to publish key financial and tax data in the form of public Country-by-Country Reporting. We examine tax avoidance of banks around the reform. Our focus is on multinational banks newly required to report activities in tax havens that had not been publicly disclosed before the Country-by-Country Reporting mandate. We predict and find that these exposed banks increased their tax expense relative to multinational banks with no activities in tax havens to disclose, as well as relative to domestic banks unaffected by the new mandate. In additional tests we compare our sample of exposed multinational banks to several control groups from the financial sector and other industries. Our results suggest that Country-by-Country Reporting can serve as an additional policy instrument to curb corporate tax avoidance, but only when the reporting exposes the firms’ tax sheltering activities to public scrutiny.

IFRS 9 for Financial Institutions The Case for IFRS and FINREP Taxonomies A Conceptual Gap Analysis

Main topic: A tsunami of regulations since the 2013 financial crisis is steering toward’s Europe’s financial service sector. At the same time the accounting standard for financial institutions core products the financial instruments will be changing. Whenever such new accounting and reporting standards are issued by the IASB (International Accounting Standards Board) and this includes also footnotes, those disclosures become increasingly relevant. The reason for that is that the footnote disclosure represent an important source of information to provide transparency and enable the investor to understand the ex-post implementation business impact. In this paper the focus will be on those new footnote disclosures. As disclosures according to IFRS 9 become compulsary by 2018, the existing IFRS Taxonomy for IFRS 9 already developed by the IFRS Foundation, represents a suitable and objective framework to assess IFRS 9 impact on disclosures at an early stage. The specific goal of this paper is to perform a conceptual gap analysis considering the IFRS 9 taxonomy issued by the IASB and the Financial Reporting (FinRep) taxonomy on IFRS 9 issued by the European Banking Authority (EBA). In general, the IFRS Taxonomy is not used very much in practice. This is not understandable as several advantages relate to the IFRS taxonomy: principle-based accounting standard does very often not define specifically disclosure rules for each and every topic, therefore to derive reporting elements would very difficult to accomplish. A robust taxonomy development and governance process leading to the IFRS taxonomy simplifies the task of interpretations and the actual expression of reporting elements.The IASB started to perform a review process of the XBRL Due Process in 2013. As a result the development of the IFRS taxonomy should become part of the general due process of the financial reporting standards. Due to these changes it is expected that the importance of the IFRS taxonomy will be growing. The FinRep taxonomy has become mandatory since 2014 for all banks within Europe, to fulfill the regulatory reporting requirements according to the Capital Requirements Directive (CRR) IV.Results: Even though the disclosures for external reporting and for regulatory reporting are based on the same accounting framework International Financial Reporting Standards Boards (IFRS), differences can be observed with regard to disclosures, which are partly material. These differences become transparent when analysing IFRS- and FinRep-taxonomy reporting elements. This is caused by the principle-based IFRS, which enable scope of interpretation and the different objectives of the IASB and the banking supervision. Whereas the IASB follows the objective to develop industry non-specific international financial reporting standards, the banking supervision core focus lies on the banking industry. The EBA follows specific information requests with the FinRep taxonomy in the role as banking supervisory. The IASB intends to provide decision useful information for investors. Nevertheless these two taxonomies provide the possibility for a starting point for the harmonization and the development of common practice disclosures, which could counteract against heterogeneous financial reporting and the issue of “information overload”.

Basel II and the Capital Requirements Directive: Responding to the 2008/09 Financial Crisis

This paper addresses factors which have prompted the need for further revision of banking regulation, with particular reference to the Capital Requirements Directive. The Capital Requirements Directive (CRD), which comprises the 2006/48/EC Directive on the taking up and pursuit of the business of credit institutions and the 2006/49/EC Directive on the capital adequacy of investment firms and credit institutions, implemented the revised framework for the International Convergence of Capital Measurement and Capital Standards (Basel II) within EU member states. Pro cyclicality has attracted a lot of attention – particularly with regards to the recent financial crisis, owing to concerns arising from increased sensitivity to credit risk under Basel II. This paper not only considers whether such concerns are well-founded, but also the beneficial and not so beneficial consequences emanating from Basel II’s increased sensitivity to credit risk (as illustrated by the Internal Ratings Based approaches). In so doing it considers the effects of Pillar 2 of Basel II, namely, supervisory review, with particular reference to buffer levels, and whether banks’ actual capital ratios can be expected to correspond with Basel capital requirements given the fact that they are expected to hold certain capital buffers under Pillar 2. Furthermore, it considers how regulators can respond to prevent systemic risks to the financial system during periods when firms which are highly leveraged become reluctant to lend. In deciding to cut back on lending activities, are the decisions of such firms justified in situations where such firms’ credit risk models are extremely and unduly sensitive - hence the level of capital being retained is actually much higher than minimum regulatory Basel capital requirements ?

Basel II and the Capital Requirements Directive: Responding to the 2008/09 Financial Crisis

This paper addresses factors which have prompted the need for further revision of banking regulation, with particular reference to the Capital Requirements Directive. The Capital Requirements Directive (CRD), which comprises the 2006/48/EC Directive on the taking up and pursuit of the business of credit institutions and the 2006/49/EC Directive on the capital adequacy of investment firms and credit institutions, implemented the revised framework for the International Convergence of Capital Measurement and Capital Standards (Basel II) within EU member states. Pro cyclicality has attracted a lot of attention – particularly with regards to the recent financial crisis, owing to concerns arising from increased sensitivity to credit risk under Basel II. This paper not only considers whether such concerns are well-founded, but also the beneficial and not so beneficial consequences emanating from Basel II’s increased sensitivity to credit risk (as illustrated by the Internal Ratings Based approaches). In so doing it considers the effects of Pillar 2 of Basel II, namely, supervisory review, with particular reference to buffer levels, and whether banks’ actual capital ratios can be expected to correspond with Basel capital requirements given the fact that they are expected to hold certain capital buffers under Pillar 2. Furthermore, it considers how regulators can respond to prevent systemic risks to the financial system during periods when firms which are highly leveraged become reluctant to lend. In deciding to cut back on lending activities, are the decisions of such firms justified in situations where such firms’ credit risk models are extremely and unduly sensitive - hence the level of capital being retained is actually much higher than minimum regulatory Basel capital requirements ?

Forbearance Incentives: Undermining the Distinction between Going and Gone-Concern Capital

In absolute terms Contingent Convertibles (‘CoCos’) and the bail-in power achieve the same goal: the conversion of debt into equity or the write-down of debt. CoCos are issued as part of bank capital requirements under the Fourth Capital Requirements Directive and its Regulations. On the other hand, bail-in is a power under the Bank Recovery and Resolution Directive that can be applied by a regulator as part of resolution. CoCos are part of bank capital rather than being a resolution power and therefore we would expect that a conversion or write-down of a CoCo would take place prior to a bank being placed into resolution. This paper argues regulatory forbearance incentives mean that a CoCo trigger might occur concurrently with a bail-in rather than before a bail-in.