As the CRR3/CRDVI package is a very rich set of texts, several NLs will be written to decipher it. This fifth NL of the CRDVI series deals with capital requirements, the transitional provisions of the Output Floor and the scope of the EBA Benchmarking
1. Reaffirmation of the relevance of aligning the composition of own funds in the P1R and P2R
To improve the internal consistency of the regulatory framework, the CRDV has aligned the nature of P2R regulatory capital with the minimum capital composition of P1R.
However, supervisors have the discretion to decide, on a case-by-case basis, to impose P2R requirements with a higher share of Tier 1 or CET 1. This new treatment has only recently been implemented during the COVID-19 crisis. While it is still too early to draw full conclusions on the recent alignments, an initial review in the context of the drafting of the CRDVI has confirmed the usefulness of aligning P1R and P2R requirements.
2. Adjustments accompanying the introduction of the output floor
The introduction of the output floor will have an impact on capital requirements such as:
- The conservation buffer.The countercyclical buffer.
- The buffer for systemically important institutions (G-/O-SII).
- The systemic risk buffer.
Two of these requirements, namely P2R and the systemic risk buffer, can be used to address risks that are similar in nature to those addressed by the Output Floor. Therefore, it is possible that some risks (e.g., model risk) may be counted twice once the Output Floor comes into effect.
This double counting should be avoided. Thus, EBA has recommended reconsidering the appropriate level of P2R and systemic risk buffer accordingly.
The CRDVI thus introduces safeguards to prevent unjustified increases in the P2R and systemic risk buffer requirements:
- The P2R and systemic risk buffer requirements will be “frozen” to avoid automatic increases in the amount of regulatory capital required under these two requirements. This guarantee is justified by the fact that the increase in RWAs linked to the output floor is, all other things being equal, purely arithmetical and does not reflect a real increase in risks that would justify requiring additional capital from the institution.
- The bank’s competent authority will be required to review the calibration of the P2R and, as appropriate, will be required to review the calibration of the systemic risk buffer requirement, to determine whether there is double counting of risk and, if so, recalibrate these requirements accordingly.
- Both requirements will remain frozen until the respective revisions are completed and the relevant decisions on the appropriate calibration of the requirements are announced.
The CRDVI also specifies that P2R and the systemic risk buffer cannot be used to cover risks that are already fully covered by the Output Floor.
Finally, the CRDVI requires the competent authorities to review the calibration of the GSIB/OSII bank buffer requirement once the output floor comes into force, to ensure that the calibration remains appropriate.
3. Extension of the eba Benchmarking scope with the inclusion of IFRS9 and FRTB-ASA models
3.1. Extension of the eba benchmarking scope
Two new approaches are introduced into the scope of prudential benchmarking, namely
- ECL’s calculation models under IFRS9 and under national accounting standards.
- The FRTB-ASA.
This inclusion concerns all banks using the ECL IFRS9 calculation models, whether they are using the standard method for calculating RWA for credit risk or the internal IRB model method.
However, the EBA is required to decide which of these institutions should be included, considering the principle of proportionality.
3.2. Possible reduction in the frequency of benchmarking exercises under certain conditions
To reduce the administrative burden for institutions subject to the exercise, it will now be possible to move from an annual to a biennial frequency in recognition of the fact that after several exercises have been carried out, a lower frequency may be sufficient to monitor the performance of the institutions’ approaches.
Abbreviations and glossary
EBA: European Banking Authority