Transitioning to Basel III: Regulatory Framework
The plenary adopts trilogue agreements on Basel III standards implementation. New rules include an output floor, ensuring uniform capital buffers. Third country banks must establish EU branches for market access. Legal texts expected in EU Official Journal soon.
In order to bring the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD) into compliance with the final Basel III criteria, the plenary adopted trilogue agreements on the proposals. These modifications include the implementation of an output floor as well as new rules for banks and large investment businesses.
The purpose of this approach is to keep organisations using internal risk models from having substantially smaller capital reserves than firms using standardised procedures. Lawmakers also created a framework for banks in foreign countries to access EU markets, requiring them to open an EU branch and apply for licensing unless they are exempt. It was decided that current agreements with organizations in third countries would not be altered in order to maintain legal stability. In the near future, the revised CRR and CRD texts should appear in the EU Official Journal. The new CRD is expected to be effective in the fourth quarter of 2025, while the revised CRR will go into effect on January 1, 2025.
Source
[1]
Jonás FERNÁNDEZ
[2]
Alessandro Micagni
Basel III Reform in the EU
The European Union implemented substantial reforms to strengthen the resilience of its banking system in the wake of the global financial crisis, notably by bringing itself into compliance with the Basel III rules. Although these improvements strengthened the resilience of the EU financial industry during the COVID-19 pandemic, other concerns remain unaddressed. Implementing outstanding Basel III components accurately is essential to addressing these, as it ensures regulatory clarity and communicates commitment to international partners. With consideration for EU-specific economic issues, the emphasis is on striking a balance between avoiding excessive capital requirements and enhancing resilience. Adding an aggregate output floor is a critical step in reducing capital variability caused by internal risk models. It emphasizes resolving regulatory arbitrage, improving risk sensitivity in credit risk assessment, and harmonizing the banking internal market. In particular, transitional procedures pertaining to corporate loans and stock ownership are suggested in order to expedite the adoption of new rules. These initiatives seek to promote long-term investments and economic expansion while fortifying the EU banking industry.
Capital Requirements: Focus on Real Estate and Specialized Lending
Recalibrating capital requirements is an important task in the field of banking regulation, particularly in reaction to changing market conditions. With a focus on real estate and specialty lending, this section explores the subtleties of capital needs for business exposures. To address deficiencies and improve risk sensitivity, it specifies transitional arrangements, modifications to risk-sensitive procedures, and the deployment of specialized treatments:
- Increasing Ratings Availability: For a major part of their business exposures after the transition phase, institutions can use credit evaluations from External Credit Assessment Institutions (ECAIs). Efforts are being made to develop rating solutions outside of the current framework with the goal of improving the rating ecosystem and encouraging larger corporates to seek ratings in order to support the union of the capital markets.
- Real Estate Exposures: A new subcategory under corporate exposures, income-producing real estate (IPRE) exposures, was added by Basel III regulations. This attempts to enhance consistency with Internal Rating Based Approaches (IRBA) and appropriately depict the hazards related to such exposures.
- Risk-Sensitive Treatment: To achieve risk sensitivity, adjustments are suggested for exposures involving residential and commercial real estate. The technique of loan splitting will persist, albeit adjusted to comply with Basel III regulations, particularly for mortgages that have extremely low loan-to-value (LTV) ratios.
- Transitional Arrangements: A particular type of arrangement is suggested in order to minimize disturbances to the lending of low-risk residential mortgages. During the transitory period, institutions that employ Internal Ratings Based (IRB) procedures may choose to apply lower risk weights.
- Specialized Lending: Under the Standardized Approach for Credit Risk (SA-CR), specialized lending exposures are given a unique treatment. The objectives are to appropriately represent the related hazards, enhance coherence with IRB procedures, and establish differentiations among various subcategories of specialized exposures.
These actions highlight the EU's dedication to streamlining capital requirements, maintaining stability, and developing a strong banking industry that can handle changing market conditions.
Basel III: Risk Sensitivity in Capital Requirements
In particular, the new CRD explores the subtleties of capital requirements in specialist lending and treatment alignment. Although Basel III requirements offer a more detailed approach to unrated specialized lending exposures, they don't pay enough attention to risk. A lower risk weight is suggested as a solution for "high-quality" object finance exposures that satisfy particular requirements. In addition, efforts to achieve alignment encompass the categorization of retail risks, interim plans for unconditionally cancellable contracts (UCC), and limitations on the Internal Ratings Based (IRB) methodologies.
Furthermore, strategies to mitigate uncertainty in risk parameters estimation and guarantee uniformity in sovereign exposures are put forth. It is advised that a new exposure class be established for RGLA-PSA exposures and that guarantee recognition techniques be clarified. These changes are intended to improve risk assessment techniques, encourage uniformity, and ensure robustness in capital requirements across various exposure types.
Capital Requirements Sensitivity and Regulatory Clarity
The emphasis is on the need of capital requirements being sensitive and clear, especially when it comes to false cash flows and securitization positions. It requires the European Banking Authority (EBA) to evaluate the effect of the output floor on securitization operations and recommends for revisions to the discounting regulations. In order to address shortcomings in the current market risk framework, it also emphasises the implementation of binding capital requirements for market risk based on the final Fundamental Review of the Trading Book (FRTB) criteria.
Proposed are steps to ensure proportionality in capital requirements calculations for institutions with medium-sized trading book businesses and to lessen the impact on Union banks. Furthermore, in order to preserve fair playing fields internationally, emphasis is placed on the convergence of FRTB standards across jurisdictions. And last, changes to the operational risk framework, including the adoption of a single non-model-based method, are proposed to enhance simplicity and comparability while ensuring effectiveness at the Union level.
Risk Mitigation and Disclosure in Banking Operations
The purpose of this new directive is to enhance the banking industry's transparency policies and risk mitigation strategies. It covers how to use insurance policies to reduce operational risk, how to handle distressed restructuring in the face of economic shocks, and how to improve credit institutions' disclosure obligations. It also focuses on the creation of centralised platforms for disclosure in order to lessen the burden of compliance and advance transparency:
- Use of Insurance Policies: Encourages the use of insurance policies as a practical means of reducing operational risk in banking operations. Within 24 months of the Regulation's enactment, EBA is required to report to the Commission on a uniform method for determining capital requirements based on specified criteria. By doing this, the Commission will be given the authority to present a legislative proposal that addresses insurance policies for operational risk capital requirements within the next 36 months.
- Guidelines for Distressed Restructuring: Recognizes the COVID-19 epidemic and geopolitical tensions as major sources of economic shocks; highlights the responsibility of institutions in promoting recovery by making concessions to deserving debtors who are having financial difficulties. In order to ensure that there is a clear definition of what a material lowered financial obligation in troubled restructuring is, the EBA is required to create guidelines.
- Enhanced Disclosure Requirements: Increased Transparency Requires small, non-complex, non-listed credit institutions to disclose performing, non-performing, and forborne exposures as well as to age their past due exposures. This intends to improve comparability and transparency in disclosures and is in line with earlier EBA measures as well as the Council Action Plan on Non-Performing Loans (NPLs).
- Centralized Web-Based Platform: To expedite information disclosure from institutions, it is recommended that the EBA construct a centralized web-based platform. As a single point of access for institutions' disclosures, this platform would uphold institutions' ownership and accountability for the veracity of released information while fostering transparency and lowering compliance requirements.
- Integration of Supervisory Reporting and Disclosures: Supporters of centrally published institution disclosures by EBA, especially for small and non-complex institutions, on the basis of reported data. The goal of this centralization is to improve openness and lessen administrative overhead, allowing data comparability between institutions and encouraging market discipline.
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