Central banks of 20 member states, including Malta, sound warning to EU Commission

The Central Bank of Malta has joined a host of other central banks and financial supervisory authorities in demanding that the European Commission’s proposal for the implementation of the Basel III framework into European Union (EU) law does not include any further deviations from the agreement.

On Tuesday, 25 central banks and financial supervisory authorities from 20 European Union member states released a stern warning to the Commission to ensure the full, timely and consistent implementation of all the standards contained in the framework, which was developed in response to the global financial crisis of 2007-2010 and took about eight years to agree on.

The Commission is currently preparing a legislative proposal to implement the final parts of the Basel III framework for banks, which is a set of reforms designed to mitigate risk within the international banking sector by requiring banks to maintain proper leverage ratios and keep certain levels of reserve capital on hand.

S&P Global Market Intelligence reports that some of the largest European banks, like Deutsche Bank AG and BNP Paribas SA, which are the largest banks in Germany and France, respectively, “fear the finalisation of the rules … could affect their capitalisation and ability to lend”.

“Top bank executives and sector associations have urged policymakers to consider the impact of higher capital requirements at a time when European economies are depending on bank lending to recover from COVID-19,” reported the leading credit rating agency.

A Commission spokesperson said the EU’s implementation of the rules “will meet our international commitments to implement the Basel III standards, but adjustments to those will be made to reflect the specificities of the EU economy and banking sector.

In their letter, the central banks and financial supervisory authorities said that the global financial crisis had clearly demonstrated the need to strengthen the prudential treatment of banks, while experiences during both that crisis and the COVID-19 pandemic have “demonstrated the interdependencies between economies globally”.

They noted that “what happens in the US sub-prime market or in Wuhan affects us all,” and argued that “in such an environment, we are all better off implementing the minimum standards to ensure the resilience we all need. The EU is no exception to this.

“We, as prudential supervisors and central banks in the EU, very much support a full, timely and consistent implementation of all aspects of this framework,” they said, adding that in their view, “this implementation should adhere to both the letter and the spirit of the Basel III agreement”.

“Diluting the framework would not be in the best interests of Europe,” they continued. “The pandemic shows that more resilient banks are better able to support the real economy, even during times of crisis. Ensuring that banks are resilient is therefore good for economic growth, something Europe clearly needs.”

The signatories noted that adhering to the Basel framework would also facilitate market monitoring, as it simplifies comparisons of different banks.

“This, in turn, would assist in the much-needed restructuring of the European banking industry.”

The central banks and financial supervisory authorities therefore insisted that the output floor should be implemented as agreed in Basel, with all risk-based capital measures and buffers calculated on the basis of one single set of risk-weighted assets.

“This has several benefits,” they argued. “It is simple and transparent. It reduces the variability of risk-weighted assets. It builds confidence in banks’ capital structures. It improves the level playing field between banks using internal models and banks using standardised models, as well as between different banks using internal models worldwide. It also increases the usability of the capital buffers.

“A parallel stack approach to the output floor does not attain these benefits and therefore should not be pursued. Furthermore, it should be considered to apply the output floor to all levels of consolidation, consistent with other prudential requirements, such as the leverage ratio.”

The central banks and financial supervisory authorities further insisted that the new Basel standardised approach for credit risk should be implemented as agreed globally, saying that the new approach is more risk sensitive than the old one. “It entails a delicate balance between the risks in different exposure types and we should preserve that balance.

Finally, the signatories said that EU-specific deviations should be minimised, and the deviations that already exist should be re-assessed. “In addition, the EU should refrain from making further exemptions from Basel III or from making the banking regulatory framework more complex.”

They noted that if the EU deviates from the agreement, implementation may also be derailed in other countries. “It is therefore in the long term interests of the EU to implement globally agreed standards, including all aspects of the Basel III-agreement, in a full, timely and consistent way.”

The full letter can be found on the website of the Central Bank of Malta here.

The output floor

The output floor is the limit on the deviation between the capital requirements of a bank when it calculates its own capital requirements through internal models as opposed to when those requirements are calculated through the Basel III standardised model.

The output floor has a long phase in period lasting from 2023 to 2028, rising from 50 per cent to 72.5 per cent by the end of the period.

Long a controversial topic, the output floor ascertains that no bank can claim it requires less than 72.5 per cent of the capital requirements it would be calculated to need when using the standardised model. This is meant to ensure adequate capital buffers for all banks globally.

However, banks have expressed concerns that these capital requirements will be burdensome and limit their ability to lend – possibly derailing the post-pandemic economic recovery.

The launch of the last set of Basel III rules has already been postponed by a year from the original date of 1st January 2022, due to the pandemic, but another delay is unlikely as the threat of COVID-19 continues to fade.

Alexandre Birry, chief analytical officer of financial institutions at S&P Global Ratings, said in an interview, said that what is more likely to happen is a dilution in the way the rules are implemented.

Speaking to S&P Global Market Intelligence, the rating agency said it considers a divergence in policies to be a possibility as local authorities take different paths to adoption.

“Three factors will drive such decisions — complacency about the need for tighter requirements given the banks’ resilience to the pandemic so far; a shift in focus on business model viability as bank profitability remains a bigger concern; and continued emphasis on domestic short-term policy goals as authorities consider banks conduits for economic and monetary measures.”