EU expected to report on Cad 3 progress next week

The commission, the EU’s executive body, will show how its third capital adequacy directive, or Cad 3, should look, assuming the Basel II capital accord is introduced by 2007 with no significant changes to the shape currently proposed by global banking regulators. Commission officials declined to comment on the details.

But regulatory sources said Cad 3 proposals are likely to differ from Basel II in one or two respects, in particular on the question of the use of insurance to reduce operational risk capital charges. Cad 3 is expected to propose a more extensive use of insurance than does Basel II.

The Cad 3 proposals are also likely to differ slightly from Basel II on the more technical issue of preventing ‘cherry picking’ when banks move to the more complex internal ratings based (IRB) approaches to calculating capital charges against credit risk. Regulators said the Cad 3 rules want to give banks some latitude about the pace at which they move from the simpler standardised approach. But they do not want banks to be in a position to calculate charges against some loans under IRB and others under the standardised approach, depending on which approach comes up with the lowest capital charge.

Meanwhile, some bankers and political analysts strongly doubt the EU can bring the Cad 3 rules into law by late 2006 and keep pace with the Basel II timetable. Bankers fear that if the EU timetable slips much behind the Basel II schedule, then major European banks could be put at a competitive disadvantage to their North American, Swiss and Japanese rivals.

Basel II will replace the simpler Basel I capital accord that dates from 1988 and which has since been adopted by over 100 countries. The European Commission wants to apply Cad 3 to all banks and investment firms in the EU, which by late 2006 could comprise 25 nations compared with 15 at present.

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