Committee Reports::Report No. 09 - Proposal for a Second Banking Directive::26 January, 1989::Report

1.The proposed Council Directive on the co-ordination of laws, regulations and administrative provisions relating to the taking up and pursuit of the business of credit and amending Directive 77/780/EEC (the 2nd Banking Directive) was examined for the Joint Committee by its Sub-Committee on Economic, Commercial and Financial Affairs.

This Report was prepared by Deputy M.J. Nolan, Chairman of the Sub-Committee. The Joint Committee is indebted to Deputy Nolan and colleagues on the Sub-Committee for their dedicated work.

2.Written submissions were received from the Central Bank of Ireland, the Department of Finance and the Irish Bankers Federation.

The Joint Committee gratefully acknowledges the assistance and co-operation of these bodies. It gratefully acknowledges also the assistance given to it and to the Sub-Committee by Mr. John Hogan in preparing this Report.

3.The Sub-Committee had consultations with the Central Bank of Ireland, Department of Finance and the Irish Bankers Federation.

These consultations provided a valuable opportunity for consideration and discussion of many points raised in the written submissions.

B. BACKGROUND

4.The Joint Committee considers that the removal of internal boundaries, the establishment of free movement of goods and capital, and the freedom to provide services are fundamental to the creation of the internal market.

5.The Commission’s White Paper on Completing the Internal Market of June, 1985 (endorsed by the Heads of State or Government and incorporated in the Single European Act) which was the subject of Joint Committee Report No. 26 of Fourth Joint Committee - marshalled the arguments in support of this proposition in the following terms:-

Greater liberalisation of capital movements in the Community should serve three aims.

First, the completion of a large internal market inevitably involves a financial dimension. The free movement of goods, services and persons must also mean that firms and private individuals throughout the Community have access to efficient financial services. The effectiveness of the harmonisation of national provisions governing the activities of financial intermediaries and markets would be greatly reduced if the corresponding capital movements were to remain subject to restrictions.

Secondly, it must be stressed that monetary stability, in the sense of the general level of prices and exchange rate relations, is an essential precondition for the proper operation and development of the internal market. In this regard, action to achieve greater freedom of capital movements would need to move in parallel with the steps taken to reinforce and develop the European Monetary System. Exchange-rate stability and convergence of economic policies help the gradual removal of barriers to the free movement of capital; conversely, greater financial freedom leads to greater discipline in the conduct of economic policies.

Thirdly, the decompartmentalisation of financial markets should boost the economic development of the Community by promoting the optimum allocation of European savings. The task is to set up an attractive and competitive integrated financial system for both Community and non-Community business circles.

A number of Member States have had to make use of the protective clauses provided for in the Treaty (Article 73 and 108(3) to maintain or reintroduce restrictions on capital movements which are in principle liberalised under Community law. From now on the Commission’s attitude towards the use of safeguard clauses will be governed by the following criteria:

-measures should be continually reviewed and gradually abolished as the difficulties which originally justified them diminish;

-agreement should be reached not to apply the protective clauses to capital movements which are so short term as to be classified speculate and which are most directly linked to the free movement of goods, services and persons.

Generally speaking, however, capital now moves more freely in the Community than at the end of 1970s. The United Kingdom removed all exchange controls in 1979 and the arrangements applied in Denmark now comply with the Community rules in force. In December, 1984, the Commission authorised France, Italy and Ireland to retain, according to the above criteria, in varying degrees, restrictions on certain capital movements. These decisions took into account the measures taken on this occasion by the French and Italian authorities to relax such restrictions. These derogations have been renewed for a limited period.

Unlike the Treaty provisions relating to free trade in goods and services, the principle of freedom of capital movements does not apply directly. All progress towards such freedom involves an extension, by way of Directives, of the Community obligations last laid down in 1960 and 1962. The following two aims must be pursued in view of this extension:

-as an accompaniment to measures to coordinate the conditions under which financial intermediaries operate and thus to promote the development of a common market in financial services. To this end, a proposal for a Directive concerning the liberalisation of transactions in the units issued by collective investment undertakings for transferable securities is currently being discussed by the Council. A similar liberalising proposal will be necessary in due course in the mortgage lending field;

-in order to adapt Community obligations to changes in financial techniques and so improve the arrangements for operations which have grown substantially in importance. Action will have to be taken at Community level to liberalise operations such as the issue, placing and acquisition of securities representing risk capital, transactions in securities issued by Community institutions and long-term commercial credit.

In addition to the responsibility which Community bodies have for creating and administering a legislative framework for the liberalisation of capital movements they will have to take action with a view to gradually liberalising all operations of Community interest.

The Commission intends to step up its monitoring of any exchange control measures which, while not infringing Community obligations to liberalise capital movements, nevertheless constitute a potential obstacle to payments relating to normally liberalised trade in goods, services or capital. Following the “Luisi-Carbone” judgement of 31.1.1984, the Commission has already informed Member States about the limits to the controls which Member States may apply. From 1992 onwards, any residual currency control measures should be applied by means other than border controls.”.

6.The Commission’s White Paper suggested, in relation to financial services, that liberalisation of such services, linked to that of capital movements, would represent a major step towards Community financial integration and the widening of the Internal Market.

The liberalisation of financial services, linked to that of capital movements, will represent a major step towards Community financial integration and the widening of the Internal Market.

The accent is now put increasingly on the free circulation of ‘financial products’, made ever easier by developments of technology… The Commission considers that it should be possible to facilitate the exchange of such ‘financial products’ at a Community level, using a minimal coordination of rules (especially on such matters as authorisation, financial supervision and reorganisation, winding up, etc) as the basis for mutual recognition by Member States of what each does to safeguard the interests of the public.

Such harmonisation, particularly as regards the supervision of ongoing activities, should be guided by the principle of ‘home country control’. This means attributing the primary task of supervising the financial institution to the competent authorities of its Member State of origin, to which would have to be communicated all information necessary for supervision. The authorities of the Member State which is the destination of the service, whilst, not deprived of all power, would have a complementary role. There would have to be a minimum harmonisation of surveillance standards, though the need to reach agreement on this must not be allowed further to delay the necessary and overdue decisions.

The implementation of these principles in the field of credit institutions (especially banks) is being pursued actively, in particular on the following lines:

-the standards of financial stability which credit institutions must live up to and the management principles which they must apply (concerning for instance, their own funds, the solvency and liquidity ratios, the monitoring of large exposures) and being thoroughly coordinated;

-the rules contained in the fourth and seventh company law Directives on annual accounts and consolidated accounting are being adopted to the sector of credit institutions;

-furthermore, the conditions which must be fulfilled by institutions seeking access to the markets as well as the measures to be taken at Community level when it comes to reorganising or winding up an institution in case of crisis are being coordinated;

-to name a more specific area, the Commission is working towards the mutual recognition of the financial techniques used by mortgage credit institutions and of the rules applying to the supervision of such institutions.”.

7.The Directive under consideration is a follow-on from the first banking directive enacted in 1977 (77/780/EEC) which sets down the main conditions for freedom of establishment in EC countries.

-that banking activities must be duly authorised by the competent licensing authorities appointed by the State;

-that the competent licensing authorities co-operate in furnishing to each other appropriate information about the institutions monitored by them;

-that the Member States would work towards the establishment of common solvency and liquidity ratios.

C.MAIN PROVISIONS OF DRAFT DIRECTIVE

8.As of now, a bank established in a Member State wishing to set up a branch or subsidiary elsewhere in the Community must receive separate clearance from the “host” supervisory authorities. The second directive proposes a system of mutual recognition of regulatory and supervisory standards which, if accepted, will amount to a single banking licence system whereby a bank licensed by its home authority will be permitted to operate in other Member States without initial endowment capital as long as it continues to satisfy the agreed supervisory criteria.

9.The directive will apply to “business which is integral to banking and shall be included within the scope of mutual recognition” viz.

-lending, including in particular consumer credit, mortgage lending, factoring and invoice discounting, trade finance

-issuing and administering means of payment (credit cards, travellers cheques and bankers drafts)

-trading for own account or for the account of customers in money market instruments (cheques, bills, CD’s etc.), foreign exchange, financial futures and options, exchange and interest rate instruments, securities

-participation in share issues and the provision of services related to such issues

10.The draft directive will apply, accordingly, to all Irish credit institutions except credit unions and friendly societies.

11.The intention of the Commission is that the draft Directive should be adopted by end June, 1989. The Committee is advised that this deadline may prove optimistic.

12.The date indicated for adoption by the Council is in accordance with the time schedule proposed in the Commission’s White Paper on the Internal Market.

13.The draft directive is regarded by the Commission as the centre-piece of its proposals for the banking sector in the context of the completion of the Internal Market by 1992. Along with the liberalisation of capital movements and other accompanying community instruments in the banking sector (on own funds, large exposures, harmonised solvency ratio, deposit guarantee system) the directive sets out to achieve the removal of the remaining barriers to freedom of establishment in the banking sector and to provide for full freedom of banking and financial services.

14.The approach in the directive is based on the White Paper concepts of harmonisation of essentials, mutual recognition and home country control.

15.The single banking licence (Para. 8 above) will allow a bank which is licensed to establish branches and provide services in other Member States without initial endowment capital and without seeking prior authorisation from each Member State banking supervisory authority.

16. The single banking licence depends upon the harmonisation of certain essential supervisory standards and the draft directive includes proposals for harmonisation of such standards as:

-minimum capital for authorisation and continuing business, [Articles 3 and 8, text of which are given in Appendix I],

-supervisory control of major shareholders and of banks’ participations in the non-bank sector, [Articles 9 and 10, text given in Appendix II).

-sound accounting and control mechanisms, [Article 11, text given in Appendix III).

17.The provisions referred to in the preceding paragraph being insufficient to ensure either solvency or the protection of investors, implementation of the directive will not be possible until legislation is in place on:

Draft legislation on these two matters is being processed through the instance of the Community.

18.Home country supervisors will be responsible for the application and monitoring of the above harmonised standards for all banks and their branches regardless of in which Member State the branches are established. Host country supervisors will retain primary responsibility for the supervision of liquidity and exclusive responsibility for measures resulting from monetary policy. Provision is made for extensive co-operation between home and host country supervisors. These provisions will apply also to finance institutions which are wholly or almost wholly owned by banks and who meet a series of strict conditions.

19.The draft directive also deals with the conditions under which banks from third countries may be granted the single licence. Third country banks wishing to open subsidiaries in the Community will be required to file the relevant licence application with the supervisory authority of the Member State in which they are seeking to establish but the actual granting of the licence by that supervisory authority will depend on a Community procedure which will evaluate whether banking institutions from all Member States enjoy reciprocity in the State of the applicant, and what measures might be taken to redress the balance if this is not the case. (See paragraph 27 below).

D. VIEWS OF THE JOINT COMMITTEE

20.In general, the Joint Committee accepts that the draft Directive conforms to the principles enunciated in the Commission’s White Paper on the Internal Market as regards harmonisation of essentials, mutual recognition and home country controls and that the draft is well designed to achieve objectives which would be desirable in themselves, even without reference to the completion of the Internal Market. The drive to achieve the Internal Market enhances the desirability of these objectives.

21.The essential objectives the Committee has in mind are two fold - benefit to industry and benefit to the consumer. In both cases, substantial benefits should flow from the increased competition the directive will engender. The Commission summarises the positive aspects of the directive in the following terms:-

-cross-border financial services will be easier and less expensive, whether they are foreign payments or investments or concerned with business finance, and particularly with the financing of international activities;

-the intensification of competition between credit institutions will produce a greater range of choice for citizens and businesses and will certainly lead to a reduction in the cost of banking services;

-the innovation resulting from the introduction of new financial techniques will allow citizens and business to choose financial products better suited to their requirements and needs, on the most favourable terms.

22.In a general way, and in the light of its discussions with the interest groups, the Committee would be disposed to accept the Commission’s claims.

23.Given the structure of Irish industry, the Sub-Committee and the Joint Committee have paid particular attention to the implications of the directive for small and medium-sized enterprises. As regards this sector, the Commission makes a number of claims, the more important of which are:

(i)No new administrative requirements will arise from the application of the legislation;

-the complete freedom with respect to establishment and supply of services which will be available to Community credit institutions will intensify competition in the sector and play an important role in promoting innovation. The SMEs will accordingly benefit from wider choice, more favourable terms and financial products better suited to their needs. The harmonisation measures contained in this directive will further strengthen the financial basis of credit institutions, which is an important element in overall economic stability;

(iv)As regards employment levels, positive developments in the cost and quality of financial services will equally have favourable effects on the profitability of enterprises in other sectors and thus on employment.

24. Following its consultations with the interest groups, the Committee is satisfied that, on the whole, the interests of the SMEs are likely to be promoted by the provisions of the draft directive.

25.It has been represented to the Sub-Committee and the Joint Committee in written submissions and in oral consultations that, particularly in view of the track record of many of them in international services, Irish banks in general should be able to cope well with the increased competition to be generated by the directive. While it does not, overall, disagree with this view, the Committee feels that the provisions of the Directive will constitute a substantial threat to the competitiveness of the smaller banks. The Committee feels also that, while the track record of the larger banks in developing services internationally has not been unimpressive, activity, for the most part, has been confined to English-language countries. It is clear that the challenge of the central European market must be vigourously tackled. The Committee is advised, in this connection, that the Institute of Bankers has developed new computer-based language training modules to provide the basis for improvement in banks language skills.

26.The Committee accepts that, to the extent that the draft directive will ensure further harmonisation of supervisory standards and criteria throughout the Community, potential Irish banking business will not be lost to countries whose regulatory mechanisms and standards are not as highly developed as those obtaining in Ireland and certain of the other Member States, notably the UK and Germany.

27.The position as regards licensing provisions for third country banks is touched upon in paragraph 19 above. The Committee is concerned that, at a time when the financial market is, in reality, a 24 hour global market, the draft Directive provides that the Commission be empowered to decide whether the third country in question offers Community credit institutions reciprocal treatment as regards the establishment of subsidiaries or the acquisition of participations in credit institutions in the third country in question. This provision appears undesirable in the context of a global market which the Community, in principle, should wish to see deregulated and liberalised to the greatest extent possible. (Article 7 of the draft Directive is relevant; the text is reproduced in Appendix IV). The Joint Committee understands that, in view of widespread dissatisfaction of the Member States with the Article as drafted, the Commission is to present new proposals.

28.Article 20 of the Directive provides for a procedure for the making of technical amendments to the Directive in a number of areas. The Committee considers that the EC Banking Advisory Committee should play the leading role in advising and formulation of appropriate amendments (The text of Article 20 is attached as Appendix V).

29.Article 22 (Appendix VI to this Report) sets out the date for the adoption by the Member States as the later of the two dates laid down for compliance with the Council Directives on the harmonisation of own funds and solvency ratios and at the latest by 1 January, 1993. The Committee appreciates the Commission’s resolve to achieve the target laid down in the Commission White Paper of 1985 and recognises also that it is not unreasonable to expect that the proposed Directives on solvency ratios and own funds will be finalised and operative before that date. Nonetheless it cannot be accepted that freedom of establishment or freedom to provide services would be implemented in the absence of harmonisation of these minimum norms.

E. RECOMMENDATIONS OF THE JOINT COMMITTEE

I.The smaller banks should give urgent attention to the necessity of implementing strategies to defend their competitive position.

II.Initiatives to penetrate the European market with its language and cultural barriers should be developed by the Irish banking industry. The Committee is pleased to note the language training facility developed by the Institute of Bankers and trusts that this facility will be utilised comprehensively and with a sense of urgency.

III.The words “and at the latest by 1 January, 1993” (Paragraph 29 above) should be deleted from draft article 22 (Appendix VI).

IV.In considering the new proposals regarding draft Article 7 (Paragraph 27 above and Appendix IV) the Irish negotiators should aim to secure that decisions to admit financial institutions should be taken by the Member States.

V.As regards draft Article 20 (Paragraph 28 above and Appendix V) concerning the procedure for making technical amendments, the EC Banks Advisory Committee should be designated the appropriate body.

VI.The Irish Banking Industry should not be subjected to prudential and supervisory controls more onerous than those obtaining in other Community countries.

A. INTRODUCTION

B. BACKGROUND

C.MAIN PROVISIONS OF DRAFT DIRECTIVE

D. VIEWS OF THE JOINT COMMITTEE

E. RECOMMENDATIONS OF THE JOINT COMMITTEE