On 20 July 2011 the European Commission (the Commission) published its legislative proposals for a regulation and a directive (referred to together as CRD IV) to implement the Basel III capital and liquidity standards into EU law and to replace the existing directives that comprise the Capital Requirements Directive (CRD). CRD IV also introduces a number of EU-specific reforms to the CRD, in particular the introduction of a single EU rule book.

In line with Basel III, the Commission is proposing that banks and investment firms (that fall within the scope of the Markets in Financial Instruments Directive (2004/39/EC)) will be required to hold:  

  1. (a minimum of 4.5% of Common Equity Tier 1 capital (common equity);
  2. a minimum of 6% of total Tier 1 capital (common equity and other financial instruments with enhanced loss absorbency criteria (Additional Tier 1 capital)); and
  3. a completely new capital conservation buffer of 2.5% (to be met with common equity) above these minimum regulatory requirements.

With the capital conservation buffer, such institutions will be required to hold 7% of common equity and 8.5% of Tier 1 capital. However, systemically important financial institutions may be subject to additional common equity requirements above these minimum regulatory requirements (to be decided at the G-20 meeting in Cannes on 3 – 4 November 2011).  

Failure to meet these requirements will restrict an institution’s ability to pay dividends. If a crisis forces an institution to write down bad loans it can eat into the buffer, but this brings extra regulatory oversight and the institution will also be prevented from paying dividends and making discretionary bonus payments.

In addition, a further countercyclical capital buffer will be introduced at a national level which will be within a range of 0%-2.5% of common equity and will be in addition to the minimum regulatory requirements.  

CRD IV represents a significant change in the EU regulatory framework for banks and investment firms. For most of them, the major impact of it will be higher capital requirements (which will be progressively introduced from 2013 to 2019). The Commission has estimated that this will ultimately result in banks needing to hold an additional €460 billion of Common Equity Tier 1 capital by 2019. The next stage for CRD IV is political agreement at EU level. Although the Commission has not indicated when this is expected to be reached, it has stated that it intends to comply with the Basel III deadline of 1 January 2013.  

Meanwhile, on 12 September 2011, the UK Independent Commission on Banking (IBC) issued its Final Report containing recommendations for reform of the UK banking sector. As part of this, the ICB recommends capital requirements for the larger UK retail banks which are higher than those required by Basel III and CRD IV. This has raised some concern that these proposals are out of step with the global banking regulations, could create regulatory arbitrage and could disadvantage UK corporates by increasing the cost of borrowing. It remains to be seen whether any of these recommendations will be implemented by the UK Government and, if so, the effect they may have.