29 April 2022

ECB's Elderson: Mind the gap, close the gap – the ECB’s views on the banking package reforms

The ECB published its opinion on the European Commission’s proposed revisions to the Capital Requirements Directive (CRD VI)[1]. Together with the proposed amendments to the Capital Requirements Regulation (CRR III), published in March 2022, the reforms comprise the EU’s latest “banking package”.

One of the main goals of the banking package is to implement in EU law the Basel III international standards which were developed in response to the great financial crisis. The Basel III standards bring key improvements to global financial regulation. They aim to ensure that banks throughout the world are better capitalised and more resilient to economic downturns, so that in times of crisis they can ultimately act as a shield for the economy, rather than a shock amplifier.

The Basel III standards have not yet been fully implemented in European banking regulation. The Commission’s CRR III proposals aim to achieve this full implementation, which the ECB very much supports. However, there are some differences – or gaps – between the Basel III standards and the CRR III proposals. This is why our advice to legislators is to “mind the gap” that will open up if Basel III standards are not implemented as originally designed. We believe that deviations from Basel standards will leave European banks exposed to pockets of unaddressed risks.

The CRD VI proposals, in turn, are aimed at further strengthening the EU prudential framework, tackling emerging risks to banks (especially those stemming from the climate crisis), and closing loopholes in regulation. The ECB greatly welcomes these proposals. In the current set up, certain supervisory rules and powers are decided unilaterally by each country, and not covered by European regulation. The CRD VI proposal now includes provisions on these rules and powers, so that they are finally harmonised across the EU, and implemented equally to all banks, regardless of the EU country in which they are headquartered.

In sum, reducing the riskiness of banks’ exposures and achieving greater harmonisation in rules will make the ECB’s banking supervision more effective, and in turn deliver a banking sector that is more integrated and more resilient.

This blog post summarises the ECB’s opinion on some of the key areas of the CRD VI. The ECB’s opinion on the CRR III^[2], published earlier this year, is also briefly discussed.

Capital Requirements Directive (CRD VI) – closing the gap

Managing the risks from the green transition

Environmental, social and governance (ESG) risks have far-reaching implications for the stability of both individual banks and the financial system as a whole. We welcome the Commission’s decision to include these risks more explicitly in banking regulation, as this will grant supervisors more adequate tools to require banks to address ESG risks more rapidly and effectively.

This is particularly important in light of recent findings from an ECB benchmark showing that 90% of banks deem their own practices to be only partially or not at all compliant with the ECB’s supervisory expectations for the management and disclosure of climate-related and environmental risks^[3]. Significant progress towards meeting our expectations is therefore urgently needed.

The Commission’s proposal includes a new legal requirement for banks to prepare prudential plans to address climate-related and environmental risks arising from misalignment with EU policy targets. The proposal mandates supervisors to check these plans and to require banks to implement mitigating measures if misalignment between these EU goals and a bank’s strategy leads to inadequate management of these risks.

It is important to note that these EU targets serve as a benchmark to measure banks’ deviations and to assess the associated risks. Misalignment with the EU transition pathway leads to financial, legal and reputational risks for banks. This explicit new competence to supervise transition plans should not be interpreted as stretching beyond the current risk-based focus of supervision. In fact, the opposite is true: it helps supervisors to ensure banks adequately manage climate-related risks.

For instance, a bank that finances companies which breach EU standards on carbon emissions will in the future face significant transition risks. The CRD VI obliges this bank to devise a plan for how to measure and address this increase in risk, as well as how to mitigate it by supporting the transition and adaptation of clients, especially those from the most exposed sectors.

It follows that a bank choosing to finance a non-green sector client to support this client’s transition to alignment with the EU transition pathway may be perfectly acceptable – so long as this bank adequately deals with the risks that financing these companies poses to its balance sheet....

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