EU to make sure banks understand their own investments

Jul 13, 2009, 12:52 GMT

Brussels - European Union banks will have to be able to prove in the future that they understand the risks they are taking when they make investments, EU officials said Monday as they bid to make the financial sector proof against future collapses.

'Under the new rules, banks will be restricted in their investments in highly-complex re-securitizations if they cannot demonstrate that they have fully understood the risks involved,' the EU's executive, the European Commission, said.

The proposal is part of the EU's ongoing attempts to overhaul banking and investment rules to make sure that the bloc never again goes through the kind of meltdown it experienced last October.

Analysts say the collapse, which broke some of Europe's biggest banks and sparked the worst recession in 60 years, was partly caused by banks' inability to work out how risky some of their investments were.

That was especially true of 're-securitized' investments, such as portfolios of risky but high-interest mortgages bought from other lenders as an investment.

Banks' internal systems 'led to a significant and systematic under-estimation' of the risks involved in such products, commission experts said as the Brussels-based body unveiled proposals to make banks more risk-aware.

Under the proposals, banks that invest in such complex products will have to keep more money and assets on their books, to make sure that they can cover any losses if the investments' value collapses.

They will also have to give investors more information on what kind of products they are holding, and prove to regulators that they have analysed the risks that the investments present.

And they will have to follow a set of EU principles on how to pay executives, so that their bonus systems do not encourage managers to sacrifice long-term stability for short-term profit.

The proposals will have to be approved, and could be amended, by the European Parliament and EU member states.

It is the second time since the autumn that the EU has proposed improvements to its rule on banking stability.

A third set of improvements is expected in October, commission officials said.