The European Banking Union is taking a new step with the adoption of a series of measures called the “banking package” last June.
In addition to aligning a little more with the revised international standards of the Basel Committee on banking supervision, this strengthening of the regulatory and normative framework also aims to improve the capacity of the banking and financial sector to withstand potential shocks.
The European Parliament adopted, last spring, a series of legislative measures called the “banking package”, published in the Official Journal of the European Union (OJEU) on June 7, 2019, these measures aim to reform four major texts of the banking industry:
- The Capital Requirements Regulations, called CRR II
- The Capital Requirements Directive, called CRD V
- The Directive on the recovery and resolution of banks, called BRRD II
- And the Single Resolution Mechanism Regulations, called SRMR
However, banking establishments benefit from a transitional period in order to prepare for the changes brought about by the reforms since, unless otherwise provided, CRR2 and SRMR2 will apply on June 28, 2021. As for the directives, they must be transposed no later than June 28 December 2020 in the Monetary and Financial Code.
The CRR II and CRD V “package” aims to transpose into Community law reforms adopted between the Basel III standards of 2010 and 2017 for a more solid regulatory framework and banking system capable of overcoming post-crisis difficulties, strengthening the framework of the 3 Basel pillars.
The major changes made by CRR II and CRD V
1- New requirements in terms of capital and liquidity
Minimum leverage ratio requirement of 3% The leverage ratio remains set at 3% of Tier 1 capital. By capping the ratio between total assets and equity, the Basel Committee thus mitigates the probability of capital erosion and the contradiction in the supply of credit as in the 2008 financial crisis.
The aim here is to limit the leverage effect in the banking sector in order to mitigate the risk that its reversal poses to the stability of the financial system.
Implementation of a leverage ratio cushion for G-SIBs, systemic risk banks
According to the BCBS prerogatives, systemic banks will have to meet an additional leverage cushion requirement equal to 50% of their G-SIBs capital cushion.
For example, if the G-SIBs cushion to be respected is 2.5%, the total leverage ratio requirement will not be equal to 3, but to 4.25% (3 + (50% * 2.5%) = 3% +1.25%).
The NSFR – Minimum requirement for a long-term liquidity ratio of 100% The NSFR (Net Stable Funding Ratio) is a long-term liquidity ratio that banks must calculate and produce to date.
The NSFR is expressed as a percentage, with a minimum level to be respected of 100%. Until then, its compliance was not mandatory.
It corresponds to the amount of stable funding available (liabilities) compared to the amount of stable funding required (assets).
By bringing the ratio to 100%, the amount of stable funding available will be at least equivalent to the amount of stable funding required.
2 – Consolidation and reinforcement on risk monitoring
TLAC and MREL (total loss absorption capacity / minimum requirement for funds and liabilities)
As part of the CRD V / CRR II package, the EBA recommends harmonization between the two systems, by adopting the same calculation basis for MREL, as a percentage of RWA (risk-weighted assets) and not as a percentage of funds own.
For European G-SIBs, affected by the two regulations, this harmonization avoids them having to undergo two separate regulations for loss absorption capacity.
MREL and TLAC aim to:
- To constitute a cushion of own funds usable in the logic of the “ bail-in ” (“bail in”: Financial practice which imposes on certain creditors of a bank in difficulty a reduction in the amount of the claims they have on the establishment of credit or converting them into equity shares. The bail-in allows banks to recapitalize in the event of a crisis.)
- Limit any recourse to public funds (“ bail-out ”: Bailout of a financial institution in difficulty, generally by a state, by injection of equity in order to allow its survival and protect depositors and lenders.), in the event of failure of a banking establishment.
Since 2019, Systemic Banks (G-SIBs) must display a total solvency ratio equivalent to at least 16% of their RWA and 6% leverage ratio under pillar 1. As of January 1, 2022, they will have to present 18% of their RWA and 6.75% leverage ratio under pillar 1.
The financial instruments eligible for TLAC are mainly capital consisting of hard capital (CET1), hybrid capital instruments (AT1, Tier 2) as well as some senior debts.
SA-CCR
The standardized approach for counterparty credit risk (SA-CCR) as a new standardized method for calculating the exposure value of derivative instruments replaces the two existing standard methods.
Counterparty risk exposures are calculated as the sum of the replacement cost (RC) and the potential future exposure (PFE) multiplied by a coefficient of 1.4, the methods for determining the CR and the PFE have been revised to get closer to the value in internal model.
The replacement cost in this approach is the estimate of the exposure to a counterparty in the event of default on the calculation date and has the following characteristics:
- it is primarily defined by the valuation of derivatives (including clearing);
- it takes into account the amounts of collateral received or posted as variations in margins as well as other elements of collateral (initial margin) taking into account their volatility during a liquidation period;
- the elements of thresholds and minimum transfer amounts constitute a floor to the RC which must not be negative for the SA – CCR (whereas there currently exists in internal model negative valuations)
Basel 3: deployment of the new provisions in 2020
The EBA published the first part of its response on credit risk and operational risk in July 2018. A second report on market risk and the CVA (Credit Valuation Adjustment, market value of the risk of counterparty default) is expected in 2020.
The European Commission also launched a public consultation on October 11, which ended in early January, on the implementation of the Basel III agreements in the EU.
The CRR3 / CRD6 legislative proposal will ratify the establishment of a global “Output floor”. The RWAs (risk-weighted assets of the Bank) will be applied a floor corresponding to a percentage of the standard method (credit, market and operational). The output floor level will gradually increase, from 50% in 2022 to 72.5% in 2027.
The points of attention to follow are therefore:
- Application of the output floor at consolidated / group level
- The link between the output floor and Pillar 2 (prudential supervision of the assessment of equity risk)
- The focus on financing the economy
New SRB: MREL policy
For fiscal year 2020, the CRU (single resolution board) is in the process of setting the MREL requirements, the consolidated ratio of “minimum capital requirement and liabilities payable” during an internal bailout, “bail in”).
The CRU should consult at the end of the year on its MREL policy which will transpose the BRRD2 directive which will be applicable at the end of 2020.
The main priorities of the SRB for 2020 banking institutions will be:
- The implementation of the “bail-in” and the “bail-in playbook” to trace the bailout process
- Access to market infrastructures
- Operational continuity