Extensibility of COREP and Compatibility between Basel II agreement and the future Directive An external analysis. Andrés Álvarez (University of Oviedo) Francisco Flores (University of Huelva)

Introduction Basel II will be implemented in the EU by a Directive. Nowadays the European Commission has published a proposal for Directive (COM(2004) 486 final), henceforth the Directive, where Directive 2000/12/EC relating to the taking up and pursuit of the business of credit institutions and Directive 93/6/EEC on the capital adequacy of investment firms and credit institutions are recast. European Banking organisations believe that it is very important for the delivery of the EUs economy to consistently implement the new capital adequacy framework across the Union and so to be flexible in order to adapt to changes in risk management practices, following the indications of the new Accord.

Preliminary differences (I) We have started the study of the Basel II Accord and the Proposal for Directive 486/2004 examining the Introduction, Scope of Application paragraphs and other parts, and we have found some differences that we will try to explain. The first one regards to the organisations to which they are applied, and the second one refers to the availability and nature of the capital recognised in capital adequacy measures. Even if our work has just started and upcoming studies are necessary to write any conclusion, it seems that the European Union is not going to be as strict as Basel II.

Preliminary differences (II) First of all, Basel II provides that the Accord must be applied on a consolidated basis to internationally active banks and also, on a fully consolidated basis, to any holding company that is the parent entity within a banking group and to all internationally active banks at every tier within a banking group. There are no exceptions mentioned in the Accord related to its scope of application for credit institutions. However, Directive 486/2004 does not seem to be as strict as the Accord at this point: on its previous considerations, the Directive reflects that it cannot be applied in the case of certain credit institutions. Notwithstanding the above, the Accord assumes that there may be some cases where it is not desirable to consolidate certain securities or other regulated financial entities specifying those cases and providing the instructions to follow if any majority-owned security or other financial subsidiary are not consolidated for capital purposes: all equity and other regulatory capital investments in those entities attributable to the group will be deducted, and the assets and liabilities, as well as third-party capital investments in the subsidiary will be removed from the banks balance-sheet.

Preliminary differences (III) Reading the first paragraphs of both the Accord and the Directive we have noticed that there is another difference between them regarding to the requirements for the protection of depositors. Basel II specifies that it is essential to ensure that capital recognised in capital adequacy measures must be readily available for the depositors, due to one of the main objectives of supervision, which is their protection. None the less, if we take a look on the Directive, it just provides that credit institutions should ensure that they have internal capital enough in quantity, quality and distribution, according to the risks to which they are or might be exposed, but there are no indications about the availability. Instead of that, the Directive just designates competent authorities as the responsible entity to make sure that credit institutions have good organisation and adequate own funds, having regard to the risks they are or might be exposed to.

Preliminary differences (IV) We have found differences in the terms that appear in the structure of regulatory capital:

Questions Is possible to link COREP with Basel II agreement text? How the compatibility is? Is possible to link COREP with Basel II agreement text? How the compatibility is? Is possible to more completely extend COREP to Pillar II and III? Is possible to more completely extend COREP to Pillar II and III? Is possible to extend COREP to other geographic spaces? Is possible to extend COREP to other geographic spaces?

Is possible to link COREP with Basel II agreement text? How the compatibility is? Hipotheses: We think that COREP could be easely extended to Pillar II and III (adding more templates to the actual set), and to other geografical spaces (linking legal references in templates to Basel II agreement text). We think that exist a strong relationship between Basel II agreement and the future European Directive, which support the link between COREP, Basel II Pillars and other geografic frameworks.

Extensibility. Legal aspects. Basel II agreement Future Directive COREP The legal structure permits the link between COREP and Basel text.

To other Basel Pillars COREP Templates Today Pillar I Pillar II Pillar III Future Templates

To other geografic frameworks European Union European Directive COREP Templates Basel II Agreement New Templates Other countries

Objetives Make a direct comparison between legal references of a COREP template and the Basel II agreement text. (First question). We have been working on the Reference lists provided in the coreptest.xls files. As you know, legal references to fill the templates are linked to Directive 2000/12 and Council Directive 93/6, which will be applicable just in the EU. But what would happen if non-EU countries decide to join pure Basel II Accord? The aim of our work has been to find legal references from Basel II and to show them beside the legal references from Directives 2000/12 & 93/6. As you can see in the document almost all references to Directives 2000/12 & 93/6 have their Basel II reference, but not all of them have been founded by us (yellow coloured cells). And whats more, there are two lists (MKR- IM and MKR-IM Daily) that havent been filled, due to the fact that some of the current references are set to some articles that we were not able to found (i.e. art 10 of annex 5 in Directive 93/6). Finally, we must say that you will notice that in some templates we have included legal references related no to Basel II but to the Basle Committee on Banking Supervision (January 1996, modified in September 1997) document Amendment to the capital accord to incorporate market risks

Preliminar Conclusions We could link the templates with Basel II text. We could link the templates with Basel II text. We should make any conciliations. We should make any conciliations. We could adapt the templates (adding more measures and dimensions and using the existing set) and/or add more templates in order to complete the disclosing requirements of Pillars II and III (this is a future work to do). We could adapt the templates (adding more measures and dimensions and using the existing set) and/or add more templates in order to complete the disclosing requirements of Pillars II and III (this is a future work to do).

Annex Please, view the templates references in the BaselIIReferences file. Please, view the templates references in the BaselIIReferences file. Thank you for your attention. Thank you for your attention.