On 27 October 2021, the European Commission adopted a review of EU banking rules. The new rules will ensure that EU banks remain resilient in the face of any potential future economic shocks, while contributing to Europe’s recovery from the COVID-19 pandemic and the transition to climate neutrality.

Keeping the prudential framework fit for purpose

The review marks the final step of the prudential reform the EU and its G20 partners agreed in the Basel Committee on Banking Supervision, known as “Basel III”. It completes the overhaul of the prudential rules that was initiated in response to the financial crisis of 2007-8. The first elements of that reform – implemented in the EU in two steps in 2013, and then later in 2019 – already contributed significantly to making the EU banking sector more resilient. This has been demonstrated during the Covid-19 crisis, which has seen the banking sector weather the crisis relatively well.

Beyond the implementation of the Basel III agreement, the legislative package also contains a number of measures to ensure the rules on prudential requirements remain fit for purpose when it comes to sustainability risks and supervision, including for branches of non-EU banks. Finally, a number of targeted changes to legislation surrounding bank resolution have been proposed to help make sure the rules are being properly applied.

The package will improve the EU prudential framework for banks in three main areas.

Implementing Basel III – strengthening resilience to economic shocks

The package faithfully implements the international agreement, while taking into account the specific features of the EU’s banking sector, for example when it comes to SMEs. It includes transitional provisions in a number of areas, such as unrated corporates or low-risk mortgages, to allow more time for the system to adapt. The main objective of the proposals is to make sure that “internal models” used by banks to calculate their capital requirements do not underestimate risks. In this way, the proposals will help ensure the capital required to cover those risks is sufficient. In turn, this will make it easier to compare risk-based capital ratios across banks, restoring confidence in those ratios and in the soundness of the sector overall.

The proposals aim to strengthen the banking sector’s resilience, without resulting in significant increases in capital requirements. Overall, the impact on capital requirements is limited to what is necessary. The package also further reduces compliance costs, in particular for smaller banks.

Sustainability – contributing to the green transition

Strengthening the EU banking sector’s resilience when it comes to environmental, social and governance (ESG) risks is a key area of the Commission’s Sustainable Finance Strategy. Improving the way banks measure and manage these risks is essential, as is ensuring that supervisors and markets can monitor what banks are doing. Prudential regulation has a crucial role to play in this respect.

The proposed measures will require banks to systematically identify, disclose and manage ESG risks as part of their risk management. This includes regular climate stress testing by both supervisors and banks. Supervisors will need to assess ESG risks as part of regular supervisory reviews. All banks will also have to disclose the degree to which they are exposed to ESG risks. To avoid unnecessary administrative burden on smaller banks, disclosure rules will be proportionate.

With the proposed measures, European banks will be able to play their part in the EU’s efforts to transition towards a sustainable economy.

Stronger supervision – ensuring sound management of EU banks and preserving financial stability

The banking package further harmonises certain supervisory powers and tools. Specifically, it gives supervisors more powers to check that transactions are sound and that bank managers have the skills and knowledge required to manage a bank. Furthermore, it boosts supervisors’ sanctioning powers to enforce the rules, and it allows them to have better oversight of complex banking groups, including fintechs.

The review also addresses the provision of banking services by non-EU banks operating in the EU. These have significantly increased their activity through branches in recent years. At present, non-EU branches are mainly subject to national legislation, harmonised only to a very limited extent. The package introduces common minimum standards for the regulation and supervision of these branches, allowing supervisors to more effectively keep related risks in check.

Read more about the banking package