The Capital Requirements Directive (CRD) is an EU directive that regulates the capital adequacy of banks and other financial institutions. It is based on Basel II, which is a set of international guidelines for banks' capital adequacy. The CRD replaced the previous rules in 2007 (Basel I).
In July 2011, there came a proposal for a revision of the CRD (CRD IV) based on the new Basel III standards, among other things. The new rules, which have not yet been adopted, are expected to take effect in 2013.
The following is a description of the current version of the Directive.
The CRD allows banks to choose among various methods of fulfilling the capital requirements. Key aspects of the directive are broader risk management, flexibility and greater sensitivity to risk.
The CRD gives the opportunity to establish a closer correlation between banks’ internal risk management models and the capital adequacy models for which the directive and the regulatory authorities set forth requirements. This helps to make the supervision of financial institutions more flexible and responsive.
The principle of the directive is that the more creditworthy a customer is, the less capital is required to cover the risk on the exposure. The rules thus entail a more precise relation between actual risk and the capital requirement.
The CRD is organised upon three pillars, as illustrated below:
Transitional rules for potential capital reductions
- Pillar I: Calculation of the minimum capital requirement
Pillar I contains generic rules for calculating credit, market and operational risks to determine a bank’s risk-weighted assets (RWA). It also stipulates the minimum capital requirement for banks: 8% of RWA.
- Pillar II: Supervisory review process
Pillar II sets forth the framework for the supervisory review process (SREP) and the framework for banks’ internal capital adequacy assessment process (ICAAP). Pillar II concerns bank's risks in a wider sense, including risks not defined under Pillar I (e.g., business, pension and concentration risks as well as the banks’ situation and expectations in general). It also treats stress tests.
- Pillar III: Market discipline and disclosure requirements
Pillar III presents a number of disclosure requirements. The objective is to raise the level of market discipline by giving external stakeholders a better understanding of banks’ capital adequacy calculations and the procedures involved.
For banks that have chosen to use the advanced methods of calculating credit risk, there are limits on how much their capital requirements may be reduced. Transitional rules apply until the end of 2012.
The limits, which are based on the capital requirements relative to those in Basel I, are shown in the table below.
History of international capital adequacy standards and EU implementation
The table below shows the historical development of capital adequacy rules from the Basel Committee.
||Basel I introduces risk weighting and off-balance-sheet assets.|
Market risk measurement introduced in various areas, including the following:
Exchange rate risk
Interest rate risk (special and general)
Release of the first version of Basel II, based on three pillars:
Pillar I: Minimum capital requirement
Pillar II: Supervisory review
Pillar III: Market discipline
||Final approval of the CRD in the EU|
||Implementation of the CRD: |
Transitional period begins
||Release of Basel III|
||European Commission's proposed revision of the CRD (CRD IV)|
||Expected implementation of CRD IV|
Last updated on 28 November 2011