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In March 1993 the Member States of the European Union formally adopted the `Capital Adequacy Directive', which deals with the measurement and assessment of the market-related risks faced by intermediaries engaged in 'investment business'. The Directive must be implemented by Member States by the end of 1995 at the latest. This article explains what implementation of the Directive will mean for UK-incorporated banks.
In March 1993 the Member States of the European Union (EU) formally adopted the `Capital Adequacy Directive' (CAD) [EC, 1993] to assist in the completion of the European `single market' in financial services [Hall, 1995a]. The CAD, which has to be implemented by Member States by the end of 1995 at the latest, is primarily designed to ensure the adoption of a harmonised approach throughout the EU (and the European Free Trade Area [EFTA])' to the measurement and assessment of the market-related risks faced by institutions - both banks and securities firms - engaged in `investment business'. In this manner it will extend the scope of the capital adequacy assessment framework currently employed in respect of `credit institutions' (henceforth, 'banks') operating in the Group of Ten (GIO)2 and EU3 areas by forcing national supervisors to accommodate market risk as well as credit risk within the assessment process.
This article explains what implementation of the CAD will mean for UK-incorporated banks based on an analysis of the recent Bank of England proposals' [Bank of England, 1994a] for implementation.5
MAIN PROVISIONS OF THE CAD AFFECTING BANKS'6 RISK-BASED CAPITAL REQUIREMENTS
Both EU banks and investment firms are subject to the risk-based requirements imposed by the CAD. For both types of intermediary, this involves summing the CAD's capital requirements for dealing with: (i) position risk, settlement risk, counterparty risk and large exposures risk arising from their `trading-book" activities, in accordance with Annexes I, II and VI of the CAD;8 (ii) the foreign exchange risk arising from all their business activities, in accordance with Annex III of the CAD; (iii) the risks arising in connection with business that is outside the scope of both the CAD and the SRD and which are similar to the risks covered by these directives ('adequate' own funds have to be held to cover these risks); and (iv) the risks...