November 2021
On 27 October 2021, the European Commission published its 2021 Banking Packageopens in a new tab designed to strengthen banks' resilience and better prepare for the future.
There are three parts to the package:
- Implementing the final Basel reforms (Basel 4)
- Sustainability - contributing to the green transition
- Stronger supervision - ensuring sound management of EU banks and protecting financial stability
The first part is covered in the Commission's proposal for key amendments to the Capital Requirements Regulation, referred to as CRR3. These relate to credit risk, credit valuation adjustment risk, operational risk, market risk and the output floor and will be the basis for implementing the remaining Basel 4 requirements in the EU.
Why are further amendments required?
While the overall level of capital in the EU banking system is now generally considered satisfactory, there were still issues to address around the use of internal models and underestimation of risk. These issues are addressed by the Basel 4 requirements.
CRR3 is intended to implement faithfully the Basel 4 requirements, while taking into account the specific features of the EU's banking sector. It aims to ensure that internal models used by banks to calculate their capital requirements do not underestimate risks, thereby ensuring that the capital required to cover those risks is sufficient. This will make it easier to compare risk-based capital ratios across banks and should, in turn restore confidence in the ratios and the soundness of the sector overall.
The proposal aims to strengthen resilience, without resulting in significant increases in capital requirements. The Commission notes that it limits the overall impact on capital requirements to what is necessary, in order to maintain the competitiveness of the EU banking sector. The package also aims to reduce compliance costs, particularly for smaller banks, without loosening prudential standards.
In line with expectations?
Perhaps most importantly, the EU has made concessions to banks' calls for more time to implement the final Basel reforms. The Commission proposes to start implementing the new rules from 1 January 2025, two years later than the (already deferred) 1 January 2023 Basel Committee timeline. This, it says, is to allow banks to focus on managing the financial risks stemming from the COVID-19 crisis and on financing the recovery, and to give them enough time to adjust before the reforms reach their full effect.
It was widely expected that the Commission would reject the “parallel stacks approach” for which some banks lobbied in relation to the output floor, and it has done so. CRR3 introduces the output floor through a “single stack” approach but with safeguards to avoid duplication in capital requirements.
In a predicted deviation from Basel 4, CRR3 introduces an amendment that the `floored' total risk exposure amount be applied at the highest level of consolidation in the EU.
The proposals also make use of flexibility elsewhere in the framework to keep capital increases to a minimum - for example to reduce the impact of historical losses feeding through to capital, through deployment of transitional regimes for loans to unrated corporates and low-risk mortgages and by maintaining regional carve-outs for small businesses, infrastructure and derivatives. For more detail, see below.
And CRR3 also introduces harmonised definitions of the different types of ESG risks (aligned to definitions proposed by the EBA). Banks are now required to identify, disclose and manage these risks at an individual level and report their exposure to the competent authorities. However, no immediate increase in capital is required.
Detailed amendments
All proposed amendments described in this section are in line with Basel 4 unless otherwise specified.