1.  The need for the new CRR3/CRDVI prudential package

1.1.   The reforms undertaken so far have made the banking system more RESILIENT, and better prepared to face the shock of the COVID 19 pandemic

1.1.1.    The need for the EU to participate in the international effort to harmonise supervisory practices

In response to the major financial crisis of 2008-09, the EU implemented substantial reforms to the prudential framework for banks in order to improve their resilience and thus help preventing the recurrence of a similar crisis. These reforms were largely based on the international Basel III standards.

The global standards developed by the Basel Committee have subsequently become increasingly important due to the increasingly global and interconnected nature of the banking sector. While a globalized banking sector facilitates international trade and investment, it also generates more complex financial risks. Without uniform global standards, banks may choose to locate their operations in the jurisdiction with the most lenient regulatory and supervisory regimes. This could lead to a race to the bottom in regulation to attract banking firms, increasing the risk of global financial instability. International coordination on global standards limits to a large extent this kind of risky competition and is essential to maintain financial stability in a globalized world.

Global standards are also easier to implement for internationally active banks – including many EU banks – as they ensure that broadly similar rules are applied in the world’s major financial centres.

1.1.2.    The current prudential framework has focused on increasing capital requirements, reducing excessive leverage and improving liquidity management

The reforms implemented so far have focused on increasing the quality and quantity of regulatory capital that banks are required to have to cover potential losses. In addition, they have aimed to reduce banks’ excessive leverage, increase the resilience of institutions to short-term liquidity shocks, reduce their reliance on short-term funding, reduce their concentration risk, and address too-big-to-fail systemic problems.

As a result, these rules tightened the eligibility criteria for regulatory capital, increased the minimum capital requirements and introduced new requirements for credit valuation adjustment (CVA) risk and for exposures to central counterparties. In addition, several new prudential measures were introduced: a minimum leverage ratio requirement, a short-term liquidity ratio (LCR), a longer-term stable funding ratio (NSFR), limits for large exposures and macro prudential capital buffers.

As a result of this first set of reforms implemented in the Union, the EU banking sector has become significantly more resilient to economic shocks and entered the COVID-19 crisis on a significantly more stable footing than it was at the onset of the 2008 financial crisis.

1.2.   However, they remain insufficient to cover all the risk areas identified during the 2008 financial crisis

While the overall level of capital in the EU banking system is now considered satisfactory on average, some of the problems identified in the wake of the 2008 financial crisis have not yet been resolved.

1.2.1.    The problem of unjustified variability, from one bank to another, of RWAs calculated using the internal method

Analyses carried out by EBA and the ECB have shown that the capital requirements calculated by EU-based banks using internal models show a significant level of variability that is not justified by differences in the underlying risks. This, ultimately, undermines the reliability and comparability of their capital ratios.

1.2.2.    A standard approach that is insufficiently sensitive to risk

The lack of risk sensitivity of capital requirements calculated using standardised approaches results in either insufficient or excessively high capital requirements for certain financial products or activities.

1.3.   A new CRR3/CRDVI package in line with the Basel III finalization reforms of December 2017

In December 2017, the Basel Committee agreed on a final package of reforms to international standards to address these issues. In 2019, the Commission announced its intention to present a legislative proposal to implement these reforms in the EU prudential framework.

In light of the COVID-19 pandemic, preparatory work on this proposal has been delayed. This delay reflects the Basel Committee’s decision on March 26, 2020 to extend the previously agreed implementation deadlines for the final elements of the Basel III reform by one year.

2.  A CRR3/CRDVI package to strengthen banking resilience and support post-pandemic recovery

This CRR3/CRDVI package has two general objectives: to contribute to financial stability and to contribute to the stable financing of the economy in the context of the recovery from the COVID-19 crisis.

2.1.   Strengthen the risk-based capital framework, without significantly increasing overall capital requirements

The temporarily tense economic conditions due to the health crisis have not altered the need to complete this structural reform. The completion of the reform is necessary to resolve the outstanding issues and to further strengthen the financial soundness of the institutions established in the EU, putting them in a better position to support economic growth and to face possible future crises.

The implementation of the outstanding elements of the Basel III reform is also necessary to provide banks with the necessary regulatory certainty, completing a decade of reform of the prudential framework. Finally, the completion of the reform is in line with the EU’s commitment to international regulatory cooperation through concrete actions to be implemented in a faithful and timely manner.

2.2.   Increased focus on ESG risks in the prudential framework

2.2.1.    A strong Commission commitment to the transition to a sustainable economy

An equally important need for reform stems from the Commission’s ongoing work on the transition to a sustainable economy. The Commission’s Communication on the European Green deal and the Commission’s Communication on achieving the EU’s 2030 climate target “Fit for 55” clearly set out the Commission’s commitment to transforming the EU economy into a sustainable one, while addressing the unavoidable consequences of climate change.

It also announced a strategy for financing the transition to a sustainable economy which builds on previous initiatives and reports, such as the Action Plan on Financing Sustainable Growth and the reports of the Technical Expert Group on Sustainable Finance. This reinforces the Commission’s efforts in the sustainable approach.

2.2.2.    The key role of banks in supporting this energy transition

Banking intermediation will play a crucial role in financing the transition to a more sustainable economy. At the same time, the transition to a more sustainable economy is likely to create risks for institutions that they will need to manage properly to ensure that risks to financial stability are minimized. Therefore, a prudential regulation is needed and will play a crucial role.

2.2.3.    Integration of ESG risks into the prudential framework

The strategy for financing the transition to a sustainable economy highlights the need to include better integration of environmental, social and governance risks in the EU supervisory framework, as current legal requirements alone are considered insufficient to encourage systematic and consistent management of ESG risks by banks.

Together with the recognition of ESG risks and the integration of ESG elements into the supervisory framework, this initiative complements the EU’s broader strategy for a more sustainable and resilient financial system. It will contribute to the European Green Deal objective of managing and integrating climate risks into the financial system and the strategic areas of action identified in the Strategic Outlook 2021.

2.3.   Further harmonization of oversight powers and tools for greater effectiveness of the msu

2.3.1.    A toolbox available to supervisory authorities that is insufficient to deal effectively and in a harmonised manner with the various situations encountered

Another area of interest is the proper enforcement of prudential rules. Supervisory authorities must have the tools and powers to do so (e.g. supervisors must have powers to authorise certain banking activities, to assess the appropriateness of their management or to sanction breaches of the rules).

While EU legislation ensures a minimum level of harmonisation, the supervisory toolbox and procedures vary considerably across Member States. This fragmented regulatory landscape in the definition of certain powers and tools available to supervisors and their application in Member States undermines the level playing field in the single market and raises doubts about the sound and prudent management of banks and their supervision.

This problem is particularly acute in the context of the Banking Union. The differences between 21 different legal systems prevent the Single Supervisory Mechanism (SSM) from exercising its supervisory functions effectively and efficiently. Moreover, cross-border banking groups have to deal with a number of different procedures for the same supervisory issue, which unduly increases their administrative costs.

2.3.2.    A supervisory framework for third country groups whose incompleteness has been highlighted following Brexit

Another important issue, namely the lack of a robust EU framework for third country groups providing banking services in the EU, has taken on a new dimension after Brexit. The establishment of third country branches is mainly subject to national legislation and is only harmonised to a very limited extent by the CRDV.

A recent EBA report shows that this dispersed supervisory landscape offers significant opportunities for third country branches to engage in regulatory and supervisory arbitrage in conducting their banking activities on the one hand, while leading to a lack of supervisory oversight and increased financial stability risks for the EU on the other.

Supervisors often lack the necessary information and powers to deal with these risks. The lack of detailed supervisory reporting and the insufficient exchange of information between the authorities responsible for supervising the different entities/activities of a third country group leave blind spots.

The EU is the only major jurisdiction where the supervisor on a consolidated basis does not have a complete picture of the activities of third country groups operating through both subsidiaries and branches. These shortcomings have a negative impact on the level playing field between third country groups operating through both subsidiaries and branches in different Member States, as well as vis-à-vis EU-based institutions.

2.4.   reducing banks’ administrative costs related to pillar iii and improving access to banks’ prudential data through centralization by the eba

This proposal is also necessary to further strengthen market discipline. It is another important tool to enable investors to exercise their role in monitoring the behaviour of institutions. To do so, they need access to the necessary information. The current difficulties in accessing prudential information deprive market participants of the information they need on the prudential situation of banks. This ultimately reduces the effectiveness of the prudential framework for banks and potentially casts doubt on the resilience of the banking sector, particularly in times of stress.

For this reason, the reform aims to centralize the publication of supervisory information with a view to increasing access to supervisory data and comparability across sectors. The centralization of publications in a single access point established by the EBA also aims to reduce the administrative burden for banks, in particular the small and less complex ones.

3.  Reaffirmation of the importance of the principle of proportionality at the heart of the system

Proportionality has been an integral part of the impact assessment accompanying the RRC3/ARDIC. The proposed amendments in different regulatory areas have been assessed individually against the proportionality objective.

In addition, the lack of proportionality of existing rules was presented in several areas and specific options were analysed to reduce the administrative burden and compliance costs for small institutions.

This is particularly the case for measures in the area of disclosure, where the compliance burden for small and non-complex banks will be significantly reduced or eliminated.

In addition, the disclosure requirements related to ESG risk disclosure that are proposed to be applied to all banks (i.e. beyond the large listed banks to which the existing requirement will apply from 2022), will be tailored in terms of periodicity and detail to the size and complexity of institutions, thus respecting the proportionality principle.

4.  A priori moderate impact of the new reform in terms of increase of RWAs, capital and costs

For each of the problems identified, the impact assessment examined a range of policy options in four key policy dimensions, in addition to the baseline situation where no EU action is taken.

As regards the implementation of Basel III, the macroeconomic analysis and modelling developed in the impact assessment shows that the implementation of the preferred options and the inclusion of all reform measures should lead to a weighted average increase in banks’ minimum capital requirements of between 6.4% and 8.4% in the long run (by 2030), after the envisaged transition period. In the medium term (by 2025), the increase should be between 0.7% and 2.7%.

According to estimates provided by EBA, this impact could lead to a limited number of large banks (10 out of 99 banks in the test sample) having to collectively raise additional capital of less than EUR 27 billion to meet the new minimum capital requirements under the preferred option.

To put this amount in perspective, the 99 banks in the sample (representing 75% of EU banking assets) held a total amount of regulatory capital worth €1414 billion at the end of 2019 and had combined profits of €99.8 billion in 2019.

More generally, while banks would incur one-off administrative and operational costs to implement the proposed rule changes, no significant cost increases are expected. In addition, the simplifications implied by several of the preferred options (e.g. removal of internally modelled approaches, centralised disclosures) should reduce costs compared to today.

5.  Terms of entry into force

Most of the proposed amendments are expected to come into force in 2025. Nevertheless, there are some exceptions to be noticed in the text.

6.  References


Abbreviations and glossary

EBA: European Banking Authority