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EU at risk of missing 2022 deadline for final Basel III capital rules

EU authorities are at risk of missing their deadline to implement the final part of the Basel III bank capital reforms, as debate about the best way to transpose the rules into law is still going on, and agreement is not yet in sight.

The Basel III framework was introduced in the wake of the global financial crisis as a way to strengthen risk management and regulation in the banking industry. The last part, due to come into force on Jan. 1, 2022, will hit EU banks hardest because of their greater use of internal modeling to assess credit risk compared to banks elsewhere in the world.

In its latest assessment of the reforms' impact, the European Banking Authority estimated that EU lenders would experience a total shortfall of €83 billion in common equity Tier 1 capital and a 23.6% average rise in risk-weighted assets — the two components used to calculate a bank's solvency ratio. European banks' average CET1 ratio is expected to drop to 11.5% at full implementation of the reforms, from 14.4% as of June 30, 2018.

Tough sell

The key challenge for EU banks is the so-called output floor, which limits the capital requirements for institutions using internal models to a minimum of 72.5% of those required under the standardized approach. Unlike the rest of the Basel III requirements, the floor will not be fully implemented from the start of 2022 but will be gradually phased in by 2027.

Even so, there is strong resistance against it from banks across Europe, which are calling on EU regulators to take into account domestic "specificities" to ensure a level playing field in terms of global competition.

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"Basel has to integrate all that when we come to implementation of the final framework," Gilles Briatta, executive board member of French bank Société Générale said at an EU Basel III conference on Nov. 12.

He said that, as it stands, there is a risk that Basel would hurt EU banks in a disproportionate way, noting the risk-weighted assets inflation for U.S. banks is "something like zero."

Another big EU-specific issue, which banks believe deserves further regulatory attention, is the proportionate approach to the implementation of the final Basel rules, taking into account smaller banks.

The European Commission has already provided some relief to "small non-complex banks" in its latest banking package from June 2019, by reducing some of their reporting and disclosure requirements. But the EC does not believe it should loosen prudential requirements for smaller banks as their size does not necessarily mean they are less risky.

"The quality of prudential oversight for smaller banks should not be lower," Sean Berrigan, deputy director-general at the EC's Financial Stability, Financial Services, and Capital Markets Union directorate, FISMA, said at the EU Basel III conference.

"If you get 40, 50 of these banks stressed at the same time, you have a problem," he said.

The proportionality debate is further complicated as some bank sector representatives and politicians do not believe a different treatment of smaller banks will be enough to offset the negative impact of the final Basel III rules on the overall EU banking sector given that large institutions will carry most of the burden, based on EBA estimates. They are therefore calling for a proportionate treatment of different risk types and different business models.

Time constraints

The European Commission is set to release the legislative proposal for the implementation of the final Basel rules by June 2020. The talks on this new banking package, including the Sixth Capital Requirements Directive and the Third Capital Requirements Regulation, CRD6/CRR3, are likely to be tough, according to analysts who doubt 18 months would be enough to complete them.

There is a significant risk of delay because of the EU member states' diverging views on key issues such as the implementation of the output floor, Dierk Brandenburg, head of Scope Ratings' financial institutions team, said in a written comment.

The possible pushback from different parties, and also the time EU actors have needed to agree on previous banking reforms, suggests a delay in implementation cannot be ruled out, Vaclav Vacikar, a senior credit analyst at Rabobank told S&P Global Market Intelligence.

Given the precedent set by the EU's earlier negotiations of CRR2 and the original CRR, the talks on the CRR3 package are likely to take at least two years to complete, according to David Strachan, head of EMEA regulatory strategy at global auditing firm Deloitte. Furthermore, in all cases of capital regulation, once the text has been agreed on a political level, there has almost always been an implementation period of at least 12 months, he said in an interview.

The EU authorities have clearly stated they are aiming to meet the Jan. 1, 2022, deadline and they might find a way to speed up the negotiation process, but it will be quite challenging to achieve this, Strachan said.

That said, there are no penalties for missing a deadline set by the Basel Committee on Banking Supervision, he said. For example, the EU has delayed the implementation of the net stable funding ratio for banks, even though the BCBS deadline was Jan. 1, 2018, he said.

The EU introduced amendments to the NSFR for small non-complex banks in its June 2019 banking package, including CRD5/CRR2, with implementation still pending.