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Basel II

The New Basel Capital Accord, or Basel II, has been implemented into Czech law by amendments to several acts regulating the Czech financial market, effective as of July 1 2007. The Czech National Bank, as the regulator, has published the detailed implementing regulations. The Czech Republic has missed the implementation deadline by six months.

Basel II is comprised of Directive 2006/48/EC, relating to the taking up and pursuit of the business of credit institutions, and Directive 2006/49/EC, on the capital adequacy of investment firms and credit institutions.

The requirements on management and control systems, capital adequacy and exposure (Pillar 1 of Basel II) will apply to banks and savings unions on an individual basis. Controlling banks, and banks and savings unions in financial holding groups, must meet these requirements on a consolidated basis. The new concept of capital adequacy will enable banks to use their own ratings of debtors if the banks apply advanced methods of calculating credit risk. Specialized agencies' ratings (for example, Standard & Poor's, Fitch, Moody's) may be used while applying the simple methods of calculation. The application of advanced (special) methods of calculation is subject to the approval of the Czech National Bank. A new capital adequacy requirement to cover operational risk is being introduced.

The requirements on qualified participations and maintenance of internally stipulated capital (Pillar 2 of Basel II) apply to banks and savings unions only if they are not part of banking or financial holding groups, or are not included in the consolidation. On a consolidated basis, these requirements apply to controlling banks at the level of EU member states, and to banks and savings unions in the financial holding groups.

The requirements on disclosure of information on risk management and compliance with the prudential rules (Pillar 3 of Basel II) apply to banks and savings unions on an individual basis only if they are not part of banking or financial holding groups, or are not included in the consolidation. On a consolidated basis, the information requirements apply fully to controlling banks at the EU level, while the controlled banks holding a significant position in the financial market can provide reduced information. The effective disclosure of information should enable other market participants to gain a better overview, for example, of the risk profile and capital adequacy of a particular entity.

These requirements will also apply to investment firms, regulated by the Act on Undertakings on the Capital Market, including the principles of their application on an individual or consolidated basis. The investment firms will have a new option to use their own ratings of debtors when calculating the capital adequacy requirement related to credit risk (ensuing predominantly from margin trades), if they apply the advanced methods of measurement. Ratings of specialized agencies will be used when applying simple methods of measurement.

The new legislation provides the framework for closer cooperation between the Czech National Bank and other competent supervisory authorities in the member states to supervise the activities of financial groups. This cooperation should cover the initial phase, that is, the approval of the financial groups' own rating methods, which will reduce costs for regulated entities and improve the efficiency of the supervision. Also, the competent supervisory authorities will be obliged to inform the credit institutions on the legal and methodical approaches they apply.

The overall effect of the new legislation on credit institutions will probably be a slight increase in the total capital requirement. The biggest increase will result from the introduction of new capital requirements for operational risk. The application of special (advanced) methods of calculation will probably result in lower capital requirements than when using the simple (standard) methods of calculation.

Pavel Marc and Michal Pravda

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