Capital Requirements Directive (CRD)

The Basel Capital Accord (Basel II) has been implemented in the European Union via the Capital Requirements Directive (CRD).

The CRD is the common framework for the implementation of Basel II in the European Union. The CRD entered into force into The European Union on the 1th of January 2007. This directive is making significant changes to two existing directives that were implementing Base II:
1. The Banking Consolidation Directive
2. The Capital Adequacy Directive

Basel II / CRD

Directive 2006/48/EC, together with Directive 2006/49/EC, is the translation of the new Basel framework agreement for prudential supervision of credit institutions and investment firms (Basel II) into European legislation. The Directive is known as the Capital Requirements Directive (or CRD for short), but contains much more than just capital requirements.

Basel II and the CRD represent a fundamental change in the supervision of banks and investment firms. Under the old regime (Basel I), a standard capital buffer of eight percent of the risk-weighted assets (RWA) was required. There were only three types of assets, each having its own weighting, but this was also the limit of the distinction according to risk. Under the new regime, assets are weighted more according to their risk and there is an institution-specific capital buffer, which is more in keeping with the institution’s total risk profile. The determination of the capital requirements by reference to the extent of the risk is supplemented in the CRD by requirements governing the internal processes and the disclosure of financial data. In addition, the CRD regulates how supervision must be carried out and the cooperation between supervisors within the EU.

Implementation by the Netherlands
The CRD consists of over 150 articles and ten annexes. The articles of the Directive have been transposed into the Financial Supervision Act (Wet financieel toezicht) in Order in Council 5. The annexes have been incorporated in the form of supervisory rules. Provision has been made for a phased introduction of the revised rules. Institutions which opt to apply the simple approaches to credit risk and operational risk may switch to the new framework on 1 January 2007. The Directives also give institutions the possibility of continuing to apply the old rules based on Basel I during 2007. From 1 January 2008 institutions may apply the advanced IRB approach for credit risk and the advanced approach for operational risk. 1 January 2008 is also the last date by which institutions must have switched to the revised rules.
Most important parts of the CRD

Various levels of complexity
The CRD allows the institution to choose between different approaches to risk management and how capital requirements are calculated: simple, standardised approaches and more complex approaches on the basis of internal estimates. The principle applicable to all approaches is: the lower the risk, the lower the capital requirement. Special consideration is given to credit risk mitigation.

Three requirement pillars
pillar 1: the minimum capital requirements per risk type: credit risk, market risk and operational risk;
pillar 2: the internal processes for risk management and for the calculation of the internal capital requirements, the economic capital and how the supervisor views these internal processes: supervisory review
pillar 3: requirements for the disclosure of key financial data as calculated for pillar 1

Group perspective for international groups
The Basel Committee on Banking Supervision noted in the late 1990s that the existing supervision framework offered insufficient opportunities to control the growth of the cross-border activities of international financial groups. Moreover, the standard eight percent requirement left scope for arbitrage. The supervision legislation contained no equivalent to the manner in which the risk management in financial groups was managed centrally. However, this group perspective is provided for in Basel II.
The CRD also provides that cooperation between supervisors is obligatory. An entirely new feature introduced by the CRD is the power of the home supervisor to take a decision on the validation of the group risk models if the supervisors are unable to reach a joint decision.

Overview – Credit institutions

source: dnb