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Western EuropeAugust 1 2022

Intra-EBU exposure reforms is a step in the right direction

The biggest lenders in Europe are set to have their cross-border exposures in the European Banking Union redefined, which could lower capital requirements and lead to the revival of cross-border mergers in the single market. Burhan Khadbai reports.
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Intra-EBU exposure reforms is a step in the right direction

Following a review, at the end of May the Basel Committee on Banking Supervision announced that it would treat EU-based global systemically important banks’ (G-SIBs’) cross-border exposures within the European Banking Union (EBU) as largely domestic, rather than foreign, exposures.

Under the reforms, 66% of EU-based G-SIBs’ cross-border exposures within the EBU will be treated as domestic exposures. This will result these lenders having a lower systematicity sub-score for cross-border exposures than under the current methodology, which could lead to the banks requiring lower capital buffers.

The committee decided not to treat all intra-EU exposures as domestic because the EBU remains incomplete.

Single jurisdiction

The treatment of these exposures as domestic has been seen as another important step in the journey of the EBU, which began in 2012 with the aim of creating a fully integrated European banking market with a single supervisor, resolution mechanism and rulebook for banks in the eurozone. The first two pillars, the Single Supervisory Mechanism and the Single Resolution Mechanism, have long been established; but the third pillar, the European Deposit Insurance Scheme, has still not been created.

“It’s a step in the direction towards recognising the EBU as a single jurisdiction,” says François-Xavier Deucher, director of financial institutions and bank regulation research at Fitch Ratings. “Eurozone banks considered this was a disadvantage they had compared to US banks, having to count their exposures in the eurozone as cross-border rather than domestic.”

However, Mr Deucher adds: “There is still a lot of work … to make the EU a single jurisdiction in terms of capital treatment and liquidity, but the European Central Bank (ECB) is pushing in this direction.”

The ECB has welcomed the updated G-SIB methodology. 

“The agreement to allow for a more favourable treatment of cross-border exposures within the banking union in the G-SIB framework is another step toward a more integrated banking sector in Europe and the creation of a truly domestic market,” says an ECB spokesperson.

Big beneficiary

France’s BNP Paribas is expected to benefit the most among the G-SIBs in the EU, according to research by Fitch.

In a report published in June, Fitch estimated that BNP Paribas could move down by one bucket, from bucket three to bucket two, reducing its G-SIB buffer from 2% to 1.5%. Every G-SIB is allocated to one of five buckets that determines the capital buffer requirements, from 3.5% in bucket five to 1% in bucket one.

However, Fitch said that “the capital benefit for BNP Paribas is likely to be partly offset by the inclusion of insurance subsidiaries in the G-SIB buffer calculation when 2022 G-SIB scores are calculated.” 

BNP Paribas did not respond to a request for comment when contacted by The Banker

No bank will drop out of the G-SIB list, meaning that some EU lenders in the bottom bucket will remain there even if they have a reduced score. Groupe BPCE, UniCredit and ING could be some of the banks in the bottom bucket that will fall below the minimum threshold for a G-SIB, according to Fitch.

A G-SIB is defined as a bank whose systemic risk is of such importance that its failure could pose a threat to the international financial system.

The Bank for International Settlements has said that EU authorities will publish a more detailed methodology and requirements for banks in the EBU for the revised calculations of capital requirements. The reforms could take effect when the next G-SIB list is updated in November 2022, which would translate into revised capital buffer requirements from January 1, 2024, according to Fitch.

Cross-border mergers

The reformed capital treatment and a more integrated EU banking market could set the way for the return of big cross-border bank mergers in Europe, although whether these reforms alone will be enough to get the ball moving remains to be seen.

“It’s clearly a move that is directly aimed at assisting cross-border mergers within the EBU,” says Cyrus Pocha, a partner in the financial services regulatory practice and co-head of the global fintech group at law firm Freshfields Bruckhaus Deringer. “But when I saw this come out, I didn’t think ‘wow this is going to be a game changer’. If two banks were not going to merge before, will they decide to as a result of this proposal alone? Maybe. But there are so many other factors at play.”

He continues: “I think there is clearly a direction of travel in terms of trying to facilitate bank mergers within the EBU, thereby re-enforcing the overarching goals of the banking union. This is another step along the way, but it’s not in isolation going to materially move the dial.”

However, Mr Pocha adds that if these reforms are put “into context of the ECB’s new supervisory approach to consolidation and viewed as another measure intended to remove regulatory barriers, then I think it’s potentially quite helpful.”

The ECB finalised its supervisory approach to consolidation in January 2021, which states that credible integration plans will not be penalised with higher capital requirements.

Mr Deucher is also sceptical as to whether this will revive big cross-border bank mergers in Europe. “But it could slightly ease the burden,” he adds. “However, clearly at this stage the biggest hurdles to cross-border bank mergers in the eurozone are the absence of capital and liquidity fungibility across the banking union. To drive significant cross-border mergers, it would require some legislative changes within the eurozone, which is not something we currently see.”

While there have been several recent domestic bank mergers in Europe, such as the acquisition of UBI Banca by Intesa Sanpaolo in Italy and the merger of CaixaBank and Bankia in Spain, there have been no significant cross-border bank mergers in Europe for a while, despite numerous reports in the past couple of years linking various big European banks with each other. A tie-up between UniCredit and Commerzbank was the most recent example, with the Financial Times reporting in May that the banks were about to start merger talks before the war in Ukraine scuppered any potential deal.

“Big cross-border bank mergers have been absent for quite some time,” says Jochen Vester, financial services regulation counsel at law firm Norton Rose Fulbright. “Whether these changes will translate into more mergers, only time will tell. The redefined capital treatment is a step in the right direction, but it also depends on the business models of banks.”

The reforms should at least make cross-border bank mergers in Europe easier, even if they do not in themselves revive cross-border bank mergers in Europe. In any case, the decision by the Basel Committee to treat cross-border exposures as domestic exposures is still an important step towards a fully integrated EBU.

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Read more about:  Regulations , Western Europe