Institute Seminar on the Impact of Basel II A European Perspective on Basel II implementation Institute of International Bankers New-York Danièle Nouy | 11 December 2007

New York, 11 December 2007 | Danièle Nouy 2 Outline 1.Moving from Basel 1 to Basel 2 2.Key challenges raised by the implementation of Basel II in Europe 3.CEBS responses: -Phase I: Guidelines, -Phase II: Shift to implementation.  Objective : Create a virtuous circle for a smooth, efficient and consistent implementation of Basel II

New York, 11 December 2007 | Danièle Nouy 3 CEBS’ role Main tasks: Advice the Commission on banking policy issues, Promote consistent implementation of the EU legislation and convergence of supervisory practices, Exchange information and enhance supervisory cooperation. Objectives: Promote cross-border supervisory cooperation and safety and soundness of the EU financial system through: Effective regulation, Efficient and cost-effective approaches to supervision of cross-border groups, Good supervisory practices, Level playing field and proportionality.

New York, 11 December 2007 | Danièle Nouy 4 1- Moving from Basel I to Basel II - What’s new? Three pillars with checks and balances; Complex in detail but clear purpose and architecture; Based on the best practices of the industry => It is an efficient regulation from an economic perspective; Flexible framework for both small and big banks: “Proportionality” is the magic word. 3 pillars Minimum Capital Requirements Regulatory view Supervisory review and evaluation (SREP) + Banks’ internal view (ICAAP) Market discipline Market view Credit risk Market risk Operational risk Supervisory judgment Disclosure requirements

New York, 11 December 2007 | Danièle Nouy 5 2- Key challenges in the implementation of Basel II 1) Potential divergence in national implementation Options and national discretions; Additional layers of national rules (“goldplating”); Different interpretations. 2) Complex and fragmented supervisory process Misalignment between legal and operational structures in banking groups  challenge to supervisory process; Validation and Art. 129 of the CRD; Supervisory review process for Pillar 2. 3) Administrative costs for compliance

New York, 11 December 2007 | Danièle Nouy 6 3- Efforts to address implementation issues Phase I: Guidelines Supervisory disclosure, for enhanced transparency of the process and outcome; validation of advanced approaches for credit and operational risk (high level principles not enough to achieve convergence); Common (but not fully harmonised) reporting frameworks (COREP and FINREP); Structured use of supervisory judgment: Supervisory Review Process (Pillar 2).  Joint effort from CEBS and Commission to ensure consistent interpretation of Basel 2 in Europe.

New York, 11 December 2007 | Danièle Nouy 7 3- Efforts to address implementation issues A CRD Transposition Group Joint effort of CEBS and European Commission to ensure a consistent interpretation and implementation of the CRD provisions and to enhance transparency. Answers are published on the websites of CEBS and the European Commission. Statistics Questions received so far: 287 Responses published as of mid October: 261

New York, 11 December 2007 | Danièle Nouy 8 3- Efforts to address implementation issues Example: Guidelines on validation Need for common approaches allowing both institutions and their supervisors to make appropriate preparations and pave the ground for final decision; Extensive involvement of supervisors from all Member States.  A common understanding on how supervisory authorities can deal with IRB or AMA applications.

New York, 11 December 2007 | Danièle Nouy 9 3- Efforts to address implementation issues Example: Guidelines on Pillar 2 Set of guidelines covering: The application of the Supervisory Review Process -SREP- under Pillar 2, Concentration risk, interest rate risk in the banking book and stress testing. … And work in progress on some specific points including: The practical aspects of home-host cooperation in SREP, The methodologies for assessing claimed diversification benefits and Capital allocation…

New York, 11 December 2007 | Danièle Nouy Efforts to address implementation issues Phase II: The shift to implementation Enhanced coordination and cooperation obtained by: –Operational networking: e.g. networks of supervisors, –Developing new tools, in particular delegation of tasks, joint EU examinations, mediation, common training, staff exchanges … to promote a common EU supervisory culture. Market pressure: –Supervisory disclosure, as a tool for market pressure, –Peer review.

New York, 11 December 2007 | Danièle Nouy Efforts to address implementation issues Operational networking: What do we mean? The implementation of the CRD into day-to-day practices and supervisory decision give rise to a number of issues: Technical issues, Consistency issues. Operational networking is about creating a stable connection between national supervisors to address practical issues: Colleges of supervisors, supported by: A line function: connection between colleges of supervisors, A support function: network of experts on specific topics (e.g. reporting, validation etc). Industry proposal for the “Lead supervisor model”.

New York, 11 December 2007 | Danièle Nouy 12 Operational networking Line function: SON The target is to establish an operational network of line supervisors in charge of day-to-day supervision of cross-border groups Objective: identifying and addressing Basel 2 implementation issues in a bottom-up fashion, First areas of attention: working of colleges, identification and prioritisation of IRBA and AMA validation issues, Pillar 2 cross border issues,… Deliverables: –A best practices paper on the functioning of colleges of supervisors, –Templates for written arrangements for banking groups, –Analyses on the practical implementation of article 129 of the CRD, –As well as collection of Pillar 2 cross-border processes and issues.  Dialogue with the Industry “Operational Network Platform”.

New York, 11 December 2007 | Danièle Nouy 13 Operational networking Support function: NOVI – Validation and reporting networks For example : validation experts, two strands: credit risk, and operational risk. Tasks: follow-up work resulting from the guidelines on validation: Exchange information on technical validation issues, Suggest areas where further input from CEBS is deemed necessary, And, where necessary, conduct surveys of good practices on validation issues. Similar approach in the area of reporting (FINREP and COREP networks).

New York, 11 December 2007 | Danièle Nouy 14 New tools - Supervisory disclosure Links to national websites for more detailed information

New York, 11 December 2007 | Danièle Nouy 15 New tools - Peer pressure: a new mechanism … Benchmarking based on objective assessment criteria, A comply or explain approach, Transparency.

New York, 11 December 2007 | Danièle Nouy 16 … To create a virtuous circle 2-Practical application in Member States 3- Monitoring and updating 1-CEBS Guidelines Consistent implementation

New York, 11 December 2007 | Danièle Nouy 17 Strengthening the EU dimension Debate under way on the “review of the so-called Lamfalussy process” CEBS issuing proposals for strengthening the Lamfalussy approach by improving: –Regulatory convergence (for example “sunset clauses for national options and discretions), –Supervisory convergence, as well as –The role and working procedures of EU committees.

New York, 11 December 2007 | Danièle Nouy 18 Strengthening the EU dimension Supervisory convergence Ex ante definition of convergence targets: -”Soft convergence”: converge on principles, with some flexibility, - “Vertical convergence”: group specific convergence, for cross-border groups, -”Hard convergence”: country-neutral approach, complete uniformity. … And assessment of the outcome vis à vis the selected convergence target.

New York, 11 December 2007 | Danièle Nouy 19 Strengthening the EU dimension The role and working procedures of EU committees Reviewing the mandates: EU and national, Possibility of majority voting, coupled with peer review and the “comply or explain principle”, No EU-wide legally binding tool at supervisory level, but guidelines, standards and recommendations linked to different convergence targets. Learning from the US model: the Federal Financial Institutions Examination Council - FFIEC.  A decentralised, but integrated system.

New York, 11 December 2007 | Danièle Nouy 20 Conclusion A lot of efforts to create the tools, Feedback from market participants rather positive but room for improvement, Need to translate the convergence efforts into the day-to-day practices, Global perspective, beyond EU, Increased need for effective and regular dialogue with market participants who should stay fully involved in the process.