The European Commission plans to be faithful in its implementation of Basel III, but with some caveats, exceptions and, of course, delays. By Justin Pugsley. 

What is happening?

The European Commission (EC) recently released its banking package, which translates Basel III into the Capital Requirements Regulation and Directive (CRR3/CRD6). The EU’s interpretation is very much a case of delaying and diverging from aspects of the Basel text. For instance, the EU aims to have much of it implemented by 2029 rather than 2027. This will certainly not please the Basel Committee on Banking Supervision as this is two years after its desired deadline. They believe these reforms should be implemented as quickly as possible to better safeguard the banking system for the next crisis. 

Reg rage anxiety

Other deviations include halving risk weights under the standardised approach for low-risk residential mortgages and reducing them by a third for unrated corporates that banks view as investment grade. While those reliefs are in place, they are a deviation from the Basel framework, and the EC proposes ending them before 2033. 

There is also an environmental focus in the package, although most of the details are yet to be thrashed out. The European Banking Authority (EBA) has been asked to advance the publication of its recommendations on the prudential treatment of environmental, social and governance exposures by two years to 2023. What the EC is saying is that it will be Basel-compliant, but in its own way and in its own time.

Why is it happening? 

The EC’s Q&A stressed that the extra capital banks need to meet Basel III will be relatively modest. It said it would likely increase EU banks’ capital requirements by less than 9% on average at the end of the envisaged transitional period in 2030, compared with 18.5% if European specificities were not taken into account. The capital increase would be below 3% at the beginning of the transitional period in 2025. That is roughly half of the EBA’s numbers published on December 15, 2020. 

The reason for the improved capital estimate is the two-year delay — more time to build up capital from profits — and the output floor will only be applied at a consolidated level. This imposes a 72.5% floor on how far internal model outputs can diverge from the standardised approach. It is a measure disliked by many EU banks as it means they will have to carry more capital against some exposures.  

What do the bankers say? 

Overall the package is not too bad from a banker’s perspective, as they have extra time to implement most of the rules. It will also be years before many of the deviations from the Basel framework are rectified, meaning plenty of time for banks to lobby for them to become permanent. 

However, there are a lot of technical niggles that worry banks. One of them is the rules that banks would have to follow when investing in equity investments in funds through derivatives structures. Banks are supposed to get a deep insight into what those funds are invested in, with the EC suggesting a convoluted approach to doing this. Another is that third-country banks accessing the EU will be under greater pressure to move capital and staff into the bloc, making it more expensive to operate across borders.  

Will it provide the incentives?  

The EU is implementing Basel III, albeit with variations — as indeed do most jurisdictions. The problem is that these reforms originated from the global financial crisis over a decade ago; memories of that event are fading and are further overshadowed by the demands of addressing the Covid-19 pandemic. 

Banks are much better capitalised now and the attention of politicians is turning to economic growth and sustainability. They are not going to be too bothered over deviations from the Basel framework. The problem arises when each jurisdiction feels free to introduce its own particular tweaks, which can lead to a very bumpy playing field for global banks, creating friction for capital flows. 

The EC’s package is also far from the final version. The council and parliament are yet to wade in, and some industry sources believe the latter will be heavily focused on getting the capital framework to promote environmental, social and corporate governance, and support smaller corporates. It is likely that within two years a clearer picture should emerge as to the final shape of the EU’s Basel III interpretation.

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