Report from the Commission to the European Parliament and the Council – Second report on effects of Directives 2006/48/EC and 2006/49/EC on the economic cycle

The minimum capital requirements for banks under the EU Capital Requirements Directive (CRD), based on the Basel II framework, are risk sensitive. In consequence, as credit and market risk increases in a downturn, minimum capital requirements for banks will also increase to meet those higher risks. Banks may need to raise additional capital to meet these higher requirements at a time when their capital resources are being eroded by losses and opportunities for raising capital are scarce and costly. This may constrain banks' lending capacity into the economy, amplifying the downturn. Similarly, during an economic upturn when prices steadily rise and defaults decrease, the apparent reduction in risk may reduce capital requirements and increase lending, boosting the economy further. If the regulation has such an effect it is described as 'pro-cyclical'.

The possibility that the CRD may contribute to the pro-cyclicality observed in the financial system under the predecessor Basel I framework led to the inclusion in the CRD of Article 156 which requires the European Commission to periodically examine whether the CRD has 'significant effects on the economic cycle' and to submit a biennial report to the European Parliament and the Council together with any appropriate corrective measures. The Commission prepared its first report on pro-cyclicality in 2010.

This second report is again based on the analysis of the ECB, which was supported by the Impact Study Group (ISG) that was set up jointly by the ESCB Financial Stability Committee (FSC) and the European Banking Authority (EBA) in 2011 as a successor of the Joint Task Force on the Impact of the new Capital Framework (JTFICF). The focus of the ECB report was a quantitative analysis of IRB bank data, although there is brief discussion of the likely pro-cylicality of the Standardised Approach, included in this report.

In July 2011, the Commission proposed a legislative package for the reform of banking regulation, including a directive (CRD IV) and a regulation (CRR). The Commissions' proposal includes some measures that may mitigate pro-cyclicality. This report concludes with an outlook on the extent to which these counter-cyclical policy measures may mitigate the pro-cyclical impacts of the CRD on the financial and economic cycle.

EUR-Lex: COM(2012)400: Follow the progress of this document through the decision-making procedure http://eur-lex.europa.eu/legal-content/EN/HIS/?uri=COM:2012:400:FIN

European Commission: SWD(2012)218: Charts http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=SWD:2012:0218:FIN:EN:PDF

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