In December 2017, the Basel Committee on Banking Supervision, which gathers bank supervisors from the world’s largest economies, agreed on the last major piece of the regulatory reforms that were launched almost 10 years ago, known as the Basel III framework. This last set of changes completes the overhaul of bank regulation that was initiated in the wake of the global financial crisis. The European Commission is now carrying out a thorough impact assessment, including a consultation, before proposing how to implement these rules in the EU. Tommy De Temmerman, policy expert at the Commission, explains in more detail.

Agreed measures

A number of key measures had already been agreed at international level over the last few years and have been, or are currently being, implemented in the EU. These include, for instance, increases in the level and quality of bank capital. They also include requirements to address liquidity risks, notably by demanding that banks hold buffers of liquid assets that can be easily and quickly sold to raise cash in case of liquidity crisis. And a leverage ratio limits the amount of money a bank can lend compared to its capital, regardless of how risky its assets are. This prevents banks from building up excessive leverage while maintaining seemingly strong risk-based capital ratios.

While these previous measures bolstered banks’ balance sheets, the goal of the latest batch of reforms is slightly different. It aims to make the calculation of risk-weighted assets – an estimate of risk on which bank capital requirements are based – more reliable. In doing so, it will improve the comparability between banks’ capital ratios. For that purpose, the standardised approaches used to measure credit risk, market risk, operational risk and credit value adjustment risk have been made more risk-sensitive. In addition, the rules limit the use of internal models, which banks can employ to estimate their capital requirements. Specifically, restrictions have been set on the inputs that banks can use to calculate their capital requirements with their own models. In some cases, the use of models has been banned altogether (e.g. for operational risk and credit value adjustment risk). But the most controversial innovation has been the introduction of an ‘output floor’ for internal models. The idea here is to limit the benefit in terms of lower capital requirements that banks can derive from using internal models rather than the standardised approach.

Impact on banks

What is the impact on EU banks likely to be? The European Banking Authority’s assessment in its advice to the Commission is that capital requirements may increase by 24.4%. However, this estimation is based on conservative assumptions, and the actual figure is likely to be lower. The impact will primarily be felt by large banks, which are most likely to use internal models.

The EU is committed to carrying through the final Basel III reforms. Putting these rules properly into effect demonstrates a commitment to multilateralism and international regulatory cooperation. The Commission will conduct a thorough impact assessment before making a proposal on how to implement these rules in the EU. The proposal could be ready in the second quarter of 2020.

The assessment will cover the potential impact of the various elements of the reform package on the EU banking sector and the wider economy. There will clearly be a focus on EU specificities, where increases in capital requirements might have a disproportionately negative impact on certain sectors, business models or activities. To inform the impact assessment and future policy decisions, the Commission recently held a conference in Brussels and also launched a public consultation, which runs until 3 January 2020 and in which everybody is encouraged to express their views.

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