28 March 2022

Finance Watch: Basel III finalisation comes undone: A proposal that lets down citizens and backtracks on global agreements

Finance Watch regrets that the so-called “draft Banking Package 2021” (finalising the implementation of the Basel III prudential framework for banks in Europe) leaves European banks insufficiently capitalised, and taxpayers exposed.

Overview

The global regulatory framework agreed by the Basel Committee on Banking Supervision in December 2017 (Basel III), was created to address the insufficient capitalisation and inadequate risk controls of the banking sector that led to the financial crisis of 2008/09. The Commission’s legislative proposal, also known as the ‚Banking Package 2021‘, aims to complete the post-crisis reforms and to ‘faithfully implement the outstanding elements of the Basel III reform in the EU, while taking into account EU specificities and avoiding significant increases in capital requirements’.[1]

Contents of the legislative proposal

The Commission’s legislative proposal comprises:

• a regulation amending the Capital Requirements Regulation (CRR II)^[2] as regards requirements for credit risk, credit valuation adjustment risk, operational risk, market risk and the output floor;^[3]
• a regulation amending the Capital Requirements Regulation (CRR II) and the Capital Requirements Directive (CRD V)^[4] as regards the prudential treatment of global systemically important institutions (G-SIIs) with a multiple point of entry (MPE) resolution strategy and a methodology for the indirect subscription of instruments eligible for meeting the minimum requirement for own funds and eligible liabilities (MREL);^[5]
• a directive amending the Capital Requirements Directive (CRD V) as regards supervisory powers, sanctions, third-country branches, and environmental, social and governance risks, and amending Directive 2014/59/EU.^[6]

Regulatory objectives

The final instalment of the Basel III standards, agreed and published for the most part in December 2017[7], aims at (i) completing the post crisis reform of the prudential framework for banks at the global level; and (ii) correcting flaws that have become apparent since the first Basel III standards came into force in 2014.[8] In particular, the finalisation of Basel III comprises measures to

• reduce the excessive variability of risk-weighted assets (RWA) calculated by banks under the internal ratings-based approach (IRB) by limiting its use for certain categories of credit risk and removing it altogether for operational risk and off-balance sheet exposures;
• improve the granularity and risk-sensitivity of calculating capital requirements under the Standardised Approach (SA) for credit risk, and introduce a new, standardised framework to cover operational risk and risk related to off-balance sheet exposures;
• introduce an ‘output floor’ for banks using the internal-ratings based approach (IRB) to limit the divergence between risk-weighted assets calculated under the different approaches (SA and IRB); and
• introduce a ‘leverage ratio buffer’ to further limit the leverage of global systemically important institutions (G‑SIIs).

The Banking Package is intended to complete the implementation of the Basel III framework into EU law. The Commission’s explanatory notes set out four main objectives:

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