Relevant to: Board members, executives, risk and finance leads, heads of capital planning, heads of Basel implementation programmes at banks operating in the EU.
The “Banking Package” is the most important piece of bank prudential legislation proposed in the EU in the last decade. It includes revisions to the Capital Requirements Directive and Regulation (known as CRD6/CRR3) that implement the finalised Basel 3 reforms (known in the UK as Basel 3.1) in the EU.
The legislative process began in October 2021 with a legislative proposal from the European Commission. Since then, the Council of the European Union (hereafter “the Council”) and the European Parliament (hereafter “the Parliament”) worked to develop their own internal position on the texts. The Council agreed on its General Approach (GA) on 8 November 2022 (you can read our analysis here, comparing the GA with the Commission’s original proposal). More recently, the European Parliament’s ECON Committee voted to adopt the Parliament’s proposed amendments to the Commission’s proposal, setting out its position in two reports (on CRD6 and CRR3).
Interinstitutional negotiations (known as “trilogues”) began in early March 2023. Trilogues are the final stage of the EU legislative process, in which the Council and Parliament (with input from the Commission) negotiate a common position. We expect trilogues to last until the second half of 2023, with legislators potentially adopting the final text by the end of the year. This timeframe would give the banking sector about a one-year period to adapt to the new package, the core elements of which are due to apply on 1 January 2025.
Although negotiations will primarily focus on the existing content of the Council and Parliament’s proposals, the Commission is expected to introduce additional elements during the trilogues process relating to the review of the macroprudential framework and the securitisation framework.
Trilogue negotiations on the Banking Package are likely to focus mostly on a limited set of issues on which the Parliament and Council’s positions differ materially. In this section, we list the key areas of difference:
There are also points of difference between the Council and Parliament’s positions on ESG risks and third-country branches (TCB) rules. These will be covered in subsequent blogs.
A key conclusion from analysing the positions on the Banking Package taken by the Council and Parliament is that both institutions have largely maintained an approach to implementing the Basel standards that makes extensive use of transitional periods, such as those for unrated corporate exposures. Both also maintain existing deviations from the standards, including the SME and Infrastructure supporting factors and the CVA exemption for transactions with corporates. Taken together, the two positions still reflect many aspects of the “EU specific adjustments” approach that the European Commission signalled was a core part of its original proposal in 2021.
The EBA has previously assessed that these adjustments are likely to have a significant mitigating effect on the capital impact of the revised rules. In its September 2022 Basel III Monitoring Report, the EBA estimated that the full implementation of the “EU specific adjustments” approach (at the end of all transitional periods in 2033) would lead to an increase in Minimum Required Capital (MRC) for all EU banks of 10.7% (and 20% for G-SIBs), compared to a 15% (and 24.7% for G-SIBs) forecast increase in MRC for all banks if the EU implemented the Basel framework faithfully. The fact that both institutions have maintained much of the EU specific adjustments approach means that the EU is now very likely to adopt a version of the revised Basel 3 rules that mitigates the impact of the Basel standards substantially.
Among the components of the Basel 3 framework, the OF is forecast to be the largest driver of MRC increases (6.8% for all EU banks and 7.7% for G-SIBs). One of the key issues for the OF in trilogues will be whether it should apply at the consolidated or sub-consolidated levels. We have written before about how applying the OF at the sub-consolidated level could have a constraining effect on cross-border banking groups that use internal models. The European Commission’s 2021 impact assessment for the Banking Package estimated that applying the OF at the consolidated level only would be more capital efficient for cross-border banks, although an EBA analysis noted that this would vary heavily from bank to bank depending on the cross-border distribution of their activities.
The Parliament’s proposal for a higher risk weight for unrated corporate exposures from 2031 would dampen the positive capital effect of the transition slightly. A potential additional four-year transition proposed by the Parliament would reduce the risk of a “cliff effect” in 2032, but continued uncertainty over the timing of the end of the transition period will complicate capital and strategic planning.
Outside of the OF, transitional provisions in the credit risk area introduced for equity exposures are likely to reduce the MRC by 0.6%. The Council’s exemption from the large exposure regime of unconditionally cancellable commitments (UCCs) could further mitigate the impact of applying the Basel 3 10% credit conversion factor for those exposures, with EU legislators having previously signalled their concern over the impact on corporates that rely on UCCs to manage seasonal or unexpected short-term changes in working capital needs.
We expect that trilogue negotiations on the Banking Package will run until the second half of 2023, and likely conclude before the end of the year.
If this is the case, then a final text of CRD6/CRR3 should be available roughly one year before the EU’s expected implementation deadline of 1 January 2025. Given that the Council and Parliament’s position on the implementation timing are aligned (both on the 1 January 2025 initial implementation and the five-year OF phase-in running to 1 January 2030), this is unlikely to be pushed back by negotiators during trilogues unless the negotiations themselves end up taking much longer than expected.
This will create a relatively short implementation timeframe for the banking sector to prepare for and comply with the new rules. While the issues at stake in trilogues could have an important capital impact on certain business lines in banks, the operational capabilities needed to support implementation of the Basel framework will be little affected.
A decision to apply the OF at the sub-consolidated level would mean a larger operational burden for some cross-border groups, as well as potential capital inefficiencies. Beyond this, however, all IRB banks will still need to put new infrastructure in place to operationalise the OF and calculate standardised and internal models RWAs in a robust and controlled way. IRB and standardised banks alike will face significant pressure to improve the accuracy of their RWA calculations, and putting in place the required systems, governance, controls and reconciliation capabilities to support this will take time and investment.
It is critical, therefore, that banks take early action to implement the framework where it is possible to do so. Taking stock of the likely capital and operational implications of the Banking Package as its negotiators near the finishing line provides them with that opportunity.