EU members split over solvency ratio

Date: 11/01/1996

AMENDMENTS to a key piece of banking legislation are being delayed because of member states' differences over how to ensure against excessive bank exposure to losses on mortgage lending.

A routine review of the 1989 Solvency Ratio Directive (SDR), which sets a minimum amount of core capital that banks and securities houses must hold to back up different types of lending, has prompted an argument between member states.

The original directive established a common rule that a credit institution's funds must be at least 8&percent; of its assets and 'off balance sheet' transactions - types of borrowing not required to appear on balance sheets - once adjusted for perceived risk.

This allows institutional solvency to be measured flexibly because it distinguishes between different types of risk. For example, a loan by a bank to its home government is less risky than to a single individual and to assign each the same amount of risk or capital cover is inappropriate.

Under the Solvency Ratio Directive, risk weightings of zero are assigned to loans in cash or to leading central banks, 20&percent; to claims on development banks and 50&percent; on loans secured on residential property.

For off balance sheet items, a risk weighting is applied along with that of the other party in the deal.

The Commission urged a review of the workings of the directive both to check on how it was operating and also to incorporate rules agreed in April 1995 by the multilateral Committee on Banking Regulations and Supervisory Practices in Basle.

As a result, three amendments to the directive have been drafted and are due to be agreed later this month.

The first will allow banks - and securities companies now that the Investment Services (ISD) and Capital Adequacy Directives (CAD) have come into force - to 'net' their exposures to each other automatically then have this assessed for capital risk.

This means that banks carrying out operations between themselves do not need to draw up new contracts for net liabilities, which are then assigned a piece of capital to cover their risk.

“This issue must be settled soon,” said a diplomat involved in negotiating the amendments. “It is crucial because, at the moment with the CAD and the ISD, there are investment firms caught under the SDR which are not allowed to do this kind of netting where they previously could.”

This issue is uncontroversial, as is a proposal to extend the coverage of the rules to off balance sheet exposures with maturities up to five years as well as some commodities contracts.

However, the question of mortgage cover caused so much controversy that the Commission decided to split the amendments into three separate drafts so that they would not scupper the whole proposal.

Under the 1989 directive, all member states' authorities were told to assign 100&percent; weightings to a loan granted by a mortgage on commercial properties. However, Germany, Denmark and Greece were allowed until 1 January 1996 to keep their 50&percent; weightings.

Now this has come up for renewal, they are being allowed another five-year derogation, with other member states permitted the same option.

The UK government is totally opposed to this, partly due to its bad experience of speculative property lending in the Eighties.

“We think it is outrageous,” claimed a UK official.

“When it was introduced, it was a temporary measure until they increased their capital backing up to 100&percent;.”

Similarly, a proposal to allow supervisory authorities to assign 50&percent; risk weightings to mortgage-backed securities worried some member states.

These instruments are created when a lender gathers together a number of mortgages and pools them into a special 'vehicle' company.

This company then issues floating-rate notes or bonds to investors, thus recouping the money originally lent to the borrowers.

The payments of interest and capital by these home buyers provide for the interest on the notes and their repayment, so mortgage loans are changed into tradable securities.