Still much to negotiate after Europe agrees Basel III position

What is happening?

The European Parliament’s Economic and Monetary Affairs (ECON) Committee voted on January 24 to adopt several changes to the Capital Requirements Regulation and the Capital Requirements Directive.

The votes finalised the parliament’s position on EU implementation of the remaining Basel III global prudential requirements — often referred to as Basel 3.1. Negotiations will now follow with member-state representatives from the European Council in order to reach agreement on a final text.

The ECON committee agreed several key changes, covering issues such as implementation of the “output floor”, on environmental, social and governance (ESG) risk disclosure, and on crypto assets disclosure and capital weights.

On the “output floor” (the lower limit on capital requirements calculated by banks via their internal models) MEPs agreed this should be consolidated at EU level. Arrangements were also agreed to enable banks to apply preferential risk weights to low-risk exposures secured by mortgages on residential property when calculating the output floor, for a transitional period.

MEPs agreed on strengthened reporting and disclosure requirements for ESG risks, including that banks should adopt transitional plans to address ESG risks in the short, medium and long term, in line with the EU objective to be climate-neutral by 2050. They also mandated the European Banking Authority (EBA) to assess whether a dedicated prudential treatment of ESG risk exposures is needed.

On crypto assets exposures, MEPs want banks to disclose their exposure to crypto assets and have specific crypto risk-management policies. MEPs have also proposed interim risk weightings of 1250% until December 2024, where banks would have to hold €1 in reserves for every euro of crypto assets exposure. They invited the European Commission to publish legislative proposals by June 2023 for dedicated prudential treatment for crypto assets.

MEPs also adopted a third-country branches supervision regime, under which new third-country branches must not commence activities in a member state until the EBA and the third country have signed a memorandum of understanding.

Why is it happening? 

Like other jurisdictions, such as the UK, the US and major Asian economies, the EU has yet to implement certain aspects of the Basel III prudential regulatory standards developed by the Basel Committee on Banking Supervision (BCBS) in response to the financial crisis.

The reforms were originally due to take effect from January 1, 2022, but due to the Covid-19 pandemic the oversight body of the BCBS pushed that date back by one year until January 1, 2023. However, global implementation of the framework has splintered as regulators in different jurisdictions have further delayed local implementation dates, as well as introducing deviations from the internationally set framework.

The EU is now targeting an implementation date of January 1, 2025, while it finalises its interpretation of the rules.

What do the bankers say? 

Bankers welcome progress being made towards a final version of the rules, as well as agreement on core issues, such as a consolidated approach to implementation of the output floor and transitional arrangements in important areas.

But there are also several areas where key details are still be figured out. For instance, there are concerns that proposals to apply a 1250% risk weight to crypto assets are not well-defined enough and may end up being applied too broadly. There are also concerns that proposals for restricting third country financial institutions’ access to EU financial markets could disrupt important cross-border activities, such as trading on financial markets. Some have also expressed frustration that the proposed rules do not take sufficient enough account of the individual circumstances of member states.

Climate campaigners have expressed disappointment at the decision not to adopt a so-called “one-for-one” rule for fossil fuel finance, where banks would have needed to match every euro of financing for new fossil fuel activities with €1 of capital reserves. They have framed the move as a failure to address the long-term risks that continued financing of fossil fuel activities is creating within the economy, and suggest the rejection is surprising given that similar measures have been proposed in relation to crypto asset exposures. Bankers are likely to be relieved such a rule is off the table.