Reforming EU banking capital and liquidity requirements, with a flavour of post-Brexit regulation
29 November 2016
So one of the proposed pieces of legislation that banks were waiting for with trepidation is finally here.
Last week, the European Commission published its first proposals for revised rules to calibrate capital and liquidity requirements – in the form of a Regulation and a Directive (CRR II and CRD V), as well as additional amendments to the bank recovery and resolution Directive (BRRD), to implement global standards for total loss absorbing capital (TLAC).
The aim is to finalise Basel III implementation in Europe and take the first step on the path to implementing what the banking community refers to as ‘Basel IV’.
They have major – and differing - implications for large and small banks, and also give some early hints to the post-Brexit regulatory landscape.
As expected, the rules could likely lead to a substantial increase of capital requirements, particularly for large banks with sizeable trading book, although it is difficult so far to give an overall assessment as it will vary greatly depending on the size and risk profile of the bank.
But the real news is on the following:
- Proportionality: the proposal is welcome news for smaller firms, as the CRR/CRD package explicitly incorporates the concept of proportionality for the first time. The EC proposes smaller institutions and those with smaller trading operations will be subject to reduced and/or simpler compliance requirements – e.g. exemptions to the Fundamental Review of the Trading Book and simplified approaches for standardised approach for measuring counterparty credit risk (SA-CCR). This should make it easier for smaller banks to compete with larger firms.
- Adjustments to the EU market: The Commission made clear that it wants to minimise the impact on lending to the real economy. This is reflected in the NSFR treatment of residential mortgages and trade finance for instance, while the leverage ratio excludes certain exposures such as public lending by public development banks, pass-through loans and officially guaranteed export credits. Those adjustments will also make it easier, over time, to achieve a more level playing field with the US for implementation of global (Basel Committee) rules, which in the US have always focused on global list of systemically important banks (G-SIBs) only.
- New requirement for non-EU groups: The relationship between US and EU regulatory frameworks is particularly significant in the context of Brexit. The CRD includes a new Article 21b which had not been in the widely-leaked draft directive just a week earlier. The new Article will require any non-EU based banks that operate more than one subsidiary in the EU to form a new Intermediate Holding Company which would then be required to seek a banking licence within the EU. The additional burden for international banks which operate their international networks from London, and for the UK's large cross-border banks post-Brexit, could be substantial. So banks need to assess this proposed requirement in the context of their Brexit planning.
One certainty that we have is that the changes will require huge efforts at implementation. The changes are complex with a very granular level of detail. Implementing the changes effectively will require banks to enhance infrastructure, data granularity, processes and controls. Banks also need to understand the interaction between the different regulatory requirements such as leverage ratio, net stable funding (NSFR) ratio or TLAC. They will need to review their product mix to balance regulatory requirements, cost and profitability.
Overall, these proposals give banks a great deal more clarity over the future shape of capital regulation. And while the implementation date for most of the measures is 2019 at the earliest, they should engage with the legislative process and start the hard work on preparations now.