BASEL III finalisation stage

The final elements for the implementation of Basel III in the EU called “CRR III/CRD IV or “banking package” has beed now agreed and endorsed by the Council and Parliament and will be implemented in EU law.

In December 2023, the preparatory bodies of the Council and Parliament have endorsed the banking package. It consists of the following legislative elements

- a legislative act to amend the Capital Requirements Directive (Directive 2013/36/EU)

- a legislative act to amend the Capital Requirements Regulation (Regulation No (EU) 2013/575)

Co-legislators confirmed that the new CRR rules will start applying on 1 January 2025. The provision included in the CRD will need to be transposed by Member States before they start applying.

With the decisions taken by the Council and European Parliament preparatory bodies, the legal texts have now been published on the Council website (CRR text and CRD text) and on the Parliament website (CRR text and CRD text). Although still subject to legal revision and to the final vote in the Plenary, the texts provide full transparency about the agreed new rules. This will also allow banks to prepare for the final phase of their implementation of the Basel III agreement in the Union.

As the legal text are now available, EBA is starting its consultation on key technical standards as detailed in EBA's roadmap on Basel III implementation. This will allow the practical implementation of the agreement by the banks in the next 12 months and beyond.

Key elements of CRR III/CRD IV

1. Introduction of the output floor to reduce excessive variability of banks’ capital requirements calculated with internal models

- The output floor works as a lower limit (‘floor’) on the capital requirements (‘output’) that banks calculate when using their internal models. The output floor is introduced to reduce the excessive variability of banks’ capital requirements calculated with internal models. It is a measure whose aim is to enhance the confidence in risk-based capital requirements and to improve the solidity of banks that make use of internal models, making capital requirements more comparable across banks

- Appropriate transitional arrangements have been agreed upon to ensure banks have sufficient time to gradually adapt to the new rules. The OF will be phased in and will become fully applicable by 2032

- In the context of the discussion on the level of application of capital requirements, the co-legislators also mandated the Commission to prepare a holistic report, by 2028, taking stock of the last 15 years of reforms to the banking sector

2. Implementation of the Basel III agreement to strengthen Union banks’ resilience face at the main risk areas (credit risk, market risk, operational risk)

- In the area of credit risk, the key elements of the banking package include the revision of the standardized approach in line with the Basel standard, e.g. with the introduction for the preferential treatment of real estate exposures, including a new category of ‘buy-to-let’ exposures (Income Producing Real Estate) and exposures to real estate acquisition, development and construction (ADC).

- In the area of market risk, the banking package completes the implementation of the Fundamental Review of the Trading Book (FRTB). Notably, co-legislators agreed to include a number of mandates for the Commission to specify certain elements of the market risk framework, based on EBA input on a certain number of technical standards.

- In the context of operational risk, the package implements the new Basel standards. The calculation of capital requirements for operational risk is made simpler, it mainly relies on the corresponding financial statements of banks. An Internal Loss Multiplier (ILM) reflecting historical losses was not included (therefore, ILM=1). This simplification is explicitly recognized in the Basel standard and aims to limit increases in capital requirements.

Beyond implementing the final Basel III elements, the banking package also covers improvements in other important areas of bank prudential regulation.

3. Environmental, Social, and Governance risks (“ESG risks’)

Co-legislators further strengthened the provisions related to Environmental, Social, and Governance risks (“ESG risks’), as proposed by the Commission, on a number of aspects such as

- Co-legislators agreed that banks will have to draw up transition plans under the prudential framework that will need to be consistent with the sustainability commitments banks undertake under other pieces of Union law, such as the Corporate Sustainability Reporting Directive (CSRD).

- Bank supervisors will oversee how banks handle ESG risks and include ESG considerations in the context of the annual supervisory examination review (SREP).

- ESG reporting and disclosure requirements will apply to all EU banks, with proportionality for smaller banks.

- Lastly, the co-legislators agreed to allow banks to enjoy a favorable risk weight treatment only where they finance an infrastructure project that have a positive or neutral environmental impact assessment.

4. Clear rules for third country banks operating in the Union

- The package introduces minimum harmonizing conditions for on the establishment of branches of third-country banks in the EU. While third country banks’ branches will continue to be subject to national supervision, supervisory powers have been strengthened to make sure supervisors remain able to manage risks related to these entities, which have significantly increased their activity in the EU over recent years. New rules will ensure a higher degree of cooperation among national supervisors and a stronger role for the EBA.

5. Strengthened supervision

- Co-legislators have increased the harmonisation of certain supervisory powers and tools. Notably, supervisors will be given more powers to check if certain transactions (e.g. large acquisitions) undertaken by banks are sound and do not entail excessive risks for banks.
- The package also enhances and further harmonises supervisory sanctioning powers to enforce rules, and provides authorities with better oversight of complex banking groups, including fintechs.

6. Governance: fit and proper assessment for bank managers

- Co-legislators harmonised the checks carried out on bank managers (‘fit-and-proper'), requiring that, except in specific cases, banks conduct the suitability assessment before the managers take up their positions. They also extended the scope of the rules to include other influential managers ('key function holders') and ensured that the bank supervisors are equipped with the appropriate powers and tools to perform their task.

- The co-legislators also agreed to introduce a minimum common set of procedural rules and standardised information requirements for verifying the suitability of bank managers and key function holders of large banks by their supervisors. Moreover, in those Member States where the fit-and-proper assessment is carried out after the manager has taken up the position in the management body, a specific regime will apply to the key positions on the board of large banks: bank supervisors will receive the relevant information sufficiently in advance of the appointment taking effect, so as to ensure a meaningful cooperation between the bank and the supervisor in the suitability assessment.

- Finally, the co-legislators further strengthened anti-money laundering suitability requirements for bank managers and key function holders, as well as the promotion of diversity in the composition of the management body as the basis for banks' sound governance

Source: European Commission News

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