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European Parliament approves bonus cap and stronger capital requirements for banks

Stricter capital requirements and more stringent supervision will apply to European banks from the start of next year after the European Parliament voted through a "comprehensive" programme of banking reform.17 Apr 2013

Once in force the new Capital Requirements Directive (CRD4) will bring European banks into line with the Basel III international banking agreement, although member states will have some flexibility to impose more stringent requirements if they wish. A new Capital Requirements Regulation (CRR) will introduce the first single set of prudential rules for banks across the EU.

The package of measures will also introduce a cap on bankers' bonuses to "curb speculative risk-taking". Bonuses will be limited to 100% of salary in any given year, or 200% of salary with the agreement of shareholders. A minimum of 25% of any bonus exceeding 25% of salary will have to be deferred for at least five years to encourage bankers to "take a long-term view", the European Parliament said.

EU President José Manuel Barroso said that the rules would ensure a "dynamic and responsible financial sector".

"[CRD4] is the foundation for the single rulebook for banks and will ensure that banks across the EU build up the necessary capital to absorb future shocks themselves, without asking the taxpayer for help," he said. "The rules will put an end to the culture of excessive bonuses, which encouraged risk-taking for short-term gains."

"This is a question of fairness. If taxpayers are being asked to pick up the bill after the financial crisis, banks must also make a contribution," he said.

Member states must now formally approve the legislative text, which is due to be published in the Official Journal of the European Union by 30 June. The majority of the provisions will come into force on 1 January 2014.

Under the new regime, banks will be required to set aside good quality capital amounting to a minimum of 8% of their risk-weighted assets. Just over half of this, amounting to 4.5% of assets, must be in the form of 'tier one' capital; up from the current 2% requirement. This capital must be reasonably liquid, meaning readily convertible into the cash needed to pay depositors and creditors in an emergency. Tier one capital mainly consists of shareholders' equity, disclosed reserves and other high quality assets.

The rules also provide for two further capital 'buffers' above the minimum requirements. Banks will have to maintain a 'capital conservation buffer' to absorb losses and protect their capital, and a 'counter-cyclical buffer' specific to the institution to prevent excessive lending. Member states will also be given the flexibility to impose stricter requirements than set by the legislation, for example to cushion them against property price crashes.

The package also includes measures to encourage banks to lend to smaller companies and the 'real economy'. These loans will be assigned a lower risk profile, meaning that banks will not need to set aside so much capital to cover them. Banks will also be required to disclose profits made, taxes paid and subsidies received on a country by country basis, as well as turnover and number of employees. These figures must be disclosed to the European Commission from 2014, and made public by 2015.

EU ministers and MEPs provisionally agreed a deal to introduce a bonus cap last month. At the time, experts from Pinsent Masons, the law firm behind, said that the proposal would create challenges for HR departments and that banks could face breach of contract issues. Although banks could raise annual salaries to compensate for the loss of large bonuses, this would not have the same incentivising effect, they said.

However, financial services expert Helen Farr of Pinsent Masons said last month that although certain bankers could threaten action for breach of contract as a result of the change, they would be unlikely to succeed.

"Given that this change is being introduced as a result of change in law and that most bankers do have a contractual right to participate in a discretionary bonus scheme which is likely to be subject to a variation clause, it should not be a risk that should concern those implementing the changes unnecessarily," she said.