FACTBOX - EU, Basel to tighten bank capital charges

(Reuters) - The European Union's executive proposed higher capital charges on banks operating in the bloc in a bid to apply lessons from the credit crunch.

Separately, the Basel Committee on Banking Supervision, a global body, published the final version of its tougher trading book rules that the EU proposal will put into law in the 27-nation bloc.

The European Commission will require banks to hold more capital against risky assets on their trading books and gives supervisors powers to impose higher capital charges or fines on banks that have pay policies that encourage too much risk-taking.

The draft law is in line with pledges made by the G20 group of industrialised and emerging market countries in April and with work under way at the Basel Committee on Banking Supervision which is toughening up its globally-applied Basel II bank capital rules.

The following are the main elements of the draft law that will need approval from the European Parliament and EU governments to come into force and could be subject to changes.

The draft law is expected to take effect sometime from the end of 2010 but will be delayed if there is no sustained economic recovery:

TRADING BOOK

Capital requirements on assets held on a trading book are currently calculated using a bank's own model for potential future losses. This resulted in too little capital being held as the credit crunch unfolded.

Under the new rules, banks would have to estimate potential losses over much longer periods of possible stress and from events such as a credit rating downgrade.

There will also be a separate standard capital charge to cover risks on a trading book.

Disclosure requirements on assets held on a trading book will be beefed up to increase market confidence.

RE-SECURITISATION

This applies to products such as collateralised debt obligations (CDOs) squared which have securitised products as their underlying assets, making them complex and less transparent.

The draft law proposes a capital charge roughly three times higher than on securitised products such as mortgage-backed securities, which have a simpler underlying asset.

Also proposes a case-by-case check by supervisors on the due diligence done by banks when they buy re-securitised products.

If supervisors are not satisfied with the due diligence, a higher, onerous capital charge can be imposed as a disincentive for banks to invest in them, or as an incentive to improve due diligence procedures.

The capital requirement on re-securitised assets can go as high as 1 euro per 1 euro invested if the bank is unable to show supervisors it fully understands the risks posed by the assets.

The Basel Committee's finalised reforms also introduce higher risk weightings -- and therefore higher capital charges -- for re-securitisation exposures.

The Committee requires banks to conduct more rigorous credit analyses of externally rated securitisation exposures.

REMUNERATION

The Commission and the European Committee of Banking Supervisors (CEBS) have already adopted best practice and guidelines so that pay policies don't encourage overly risky short term behaviour that threatens companies in the long term.

The draft law gives supervisors the teeth to implement these principles and guidelines by giving them powers for first time over pay policies though not caps on actual amounts.

Supervisors will be able to punish breaches, ranging from fines to higher capital charges.

The management of a bank will have to establish sound remuneration policies and take responsibility for them.

Banks must review their remuneration policies each year to ensure they are consistent with standards in the draft law.

Remuneration must not be purely focussed on an individual but must take into account the performance of the business unit and company overall.

There must be an appropriate balance between fixed and variable pay so that bonuses are not a disproportionately large part of overall pay, and an appropriate part of the bonus must also be deferred.

Supervisors will not be given powers to claw back bonuses which, with hindsight, should not have been paid.

PROVISIONING

The Basel Committee said it will make proposals in the first quarter of 2010 on provisioning or how banks will have to build up buffers in good times to run down when markets fall. (Reporting by Huw Jones; Editing by David Cowell)