The new legislative package that the European Commission tabled on Wednesday 27 October aims to faithfully include in the EU’s banking prudential rules the still outstanding rules stemming from the ‘Basel III’ agreement ratified at the end of 2017 (see EUROPE 11921/20), while taking into account the specificities of the European banking industry, which finances three quarters of the EU economy.
In 2019, the EU legislator adopted a large part of the ‘Basel III’ agreement on risk reduction, a reform that led to a substantial increase in bank capital (see EUROPE 12152/4). “What is important now is to complete those reforms - this time focusing on how banks measure risks”, said executive vice-president Valdis Dombrovskis.
According to him, the additional capital requirements that this legislative package will entail will be “not substantial”, as they will be between 3 and 5% during the first years of the transitional phase and between 8 and 9% in 2030. According to the Commission, if the specificities of the European sector were not taken into account, the capital increase would amount to 18.5%.
Output floor. As EUROPE reported on Monday (see EUROPE 12819/12), at the heart of the two pieces of legislation unveiled on Wednesday is the gradual introduction of an ‘output floor’ for banks using an internal model to calculate capital requirements based on the nature of the risks they face.
From 2030 onwards, the result obtained by the internal model may not be less than 72.5% of the capital requirement calculation obtained via the standard model, a model under which banks use a regulatory formula often based on financial ratings.
The following linear path to the 72.5% threshold is suggested: 50% in 2025, 55% in 2026, 60% in 2027, 65% in 2028, 70% in 2029, 72.5% in 2030.
The Basel III Agreement has called for the introduction of an ‘output floor’ from 2023. Asked about the Commission’s trajectory, Mr Dombrovskis referred to a “realistic” timetable. He said he was prepared to discuss this with other major jurisdictions such as the US and the UK, which have not yet tabled their proposals to finalise the introduction of the ‘Basel III’ agreement into their national legislation.
Furthermore, as advocated by the Chair of the Single Supervisory Board at the ECB (see EUROPE 12812/11), the Commission has retained the ‘single stack’ approach because, in its view, this approach better reflects the logic and purpose of the minimum capital threshold agreed in the Basel Committee. Nevertheless, in order to avoid unjustified increases in capital requirements, supervisors will review the calibration of capital requirements when supervising a group at the level of each banking entity (Pillar II).
European banks were opposed to theoutput floor during discussions in the Basel Committee (see EUROPE 11806/12), even though, according to the EU institution, studies have shown that the application of internal models often leads to an underestimation of risks.
“Here we are staying faithful to the agreement, while using the flexibility within it and certain targeted adjustments to reflect the specific features of the EU economy and banking sector”, said European Commissioner for Financial Services Mairead McGuinness.
Indeed, the Commission suggests targeted transitional arrangements that will spread the impact of the output floor over a period of up to eight years. This includes exposures to unrated companies, low-risk mortgages and derivatives. At the end of the transitional measures for each type of exposure, the Commission will carry out an “assessment” of the situation and may make a proposal for an extension, but “by default, the option retained is that there should be a cut-off date”, a Commission expert said on Tuesday.
ESG risks. Other parts of the legislative package presented on Wednesday concern the consideration of environmental, social and governance (ESG) risks.
From now on, all banks will have to publish data on the management of these risks, a requirement that currently only applies to large listed banks. Supervisors will be competent to introduce ESG risks in their supervisory activities, including stress tests. And the European Banking Authority will have to present proposals on the prudential treatment of environmental, social and governance risks in 2023 instead of 2025.
WireCard. In addition, the Commission is making proposals to learn the lessons of the accounting scandal that hit German payment service provider ‘WireCard’ in 2020 (see EUROPE 12684/23).
“We are making two specific improvements: - first, clearer rules to deal with fintechs that engage in banking activities; - and secondly, minimum requirements on supervisory independence, for example to avoid potential conflicts of interest”, argued McGuinness.
In order to ensure the independence of the supervisor from the banking industry, Member States will be required, as a minimum, to prohibit staff employed by the supervisor from investing in supervised entities or from being immediately employed by entities that they themselves have directly supervised (or companies providing services to such entities).
Rules are also introduced to ensure that members of a bank’s board of directors and persons occupying key positions on the board have the appropriate qualifications, experience and reputation to carry out their activities.
Furthermore, in terms of sanctions, the possibility of imposing temporary financial penalties (‘periodic penalty payments’) has been introduced at EU level, intended to force offending banks to comply with the rules quickly.
Third country branches. The legislative package introduces minimum requirements to improve the currently fragmented national supervision of third country branches - branches of banking groups operating in the EU.
These rules concern the authorisation of these branches, their capital and liquidity levels, and reporting requirements. Those on the calculation of capital requirements will apply to different degrees of intensity to branches depending on their size (threshold of €5 billion of assets under management) or their nature (activities in the retail sector).
For branches of third country banks managing more than €30 billion of assets in one or more EU countries, competent authorities will have to assess whether these entities pose a systemic risk to the markets where they are established. If this is the case, the competent authorities may require third country banking groups to convert their branches into subsidiaries or impose additional prudential requirements (restructuring of certain activities, additional capital) on the branches to ensure financial stability.
See the legislative package: https://bit.ly/3EcV2aK (Original version in French by Mathieu Bion)