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We call on the co-legislators to focus on the resilience of the banking sector. Strong rules lead to strong banks, and strong banks are better able to serve firms, citizens and the economy at large.
The post-financial crisis overhaul of the Basel standards has been a long and demanding journey. With the finish line nearing, Europe is now at a critical juncture: implementing the internationally agreed Basel III standards will be decisive in keeping our banking system safe and sound. Europe sat at the negotiating table in Basel, and the final agreement consequently incorporates many suggestions and adjustments put forward by European actors. Claims that the agreement is not a good “fit” for the EU financial sector are therefore misleading.
We are very concerned that in the ongoing legislative discussions in the EU Council and the European Parliament on the EU banking package, numerous calls have been made to deviate from the international standards. The ECB and the European Banking Authority (EBA) have consistently argued for a full, timely and faithful implementation of Basel III. The rules have been carefully articulated to ensure a worldwide minimum safety net against the plethora of risks that we painfully experienced during the global financial crisis.
The legislative proposal of the European Commission already included several deviations from the Basel III rules. The EBA and the ECB were critical[1] of these deviations, as they would leave pockets of risk unaddressed and could increase risks to financial stability.
In a report published in September 2022[2] the EBA estimated that the Commission’s proposal would reduce by 3.2 percentage points the expected increase in Tier 1 aggregate capital requirements stemming from the Basel III reform at the end of the phase-in period.[3] Even this estimate is likely to understate the actual differential, as due to limited data availability only some of the Commission’s proposed deviations could be quantitatively assessed.
The EU Council and the Parliament are assessing the introduction of further deviations from Basel III in different areas, including the risk weighting of equity intra-group exposures, of subordinated debt, exposures to land acquisition, development and construction and off-balance sheet trade finance exposures.
At stake here are the reputation, the competitiveness and, ultimately, the funding costs of the EU banking sector. Back in December 2014, the Basel Committee already deemed the EU to be “materially non-compliant”[4]. If all deviations under discussion make it into the final legislative package, we cannot rule out the Basel Committee labelling the EU to “non-compliant” (the lowest possible grade).
The Basel III rules were endorsed by both the Financial Stability Board and the G20. We therefore risk undermining global cohesion and weakening the EU’s standing in international negotiations if we do not keep our commitments. The current geopolitical disorder shows how important it is to safeguard cohesion and cooperation at global level. Most importantly, Europe and European banks would suffer not only in terms of reputation, but also in terms of resilience. The COVID-19 pandemic again demonstrated the virtue of strong banks for the economy. European banks acted not as shock amplifiers, but as shock absorbers during the pandemic. Today, the Russian invasion of Ukraine and the energy crisis are shaping a highly uncertain outlook. We are convinced that the overriding principle for this banking package – the needle in our compass – must be prudence.
Our concerns regarding the proposed deviations are not limited to the capital relief relative to the pure Basel regime. A leading principle for both the EBA and the ECB has been to introduce a regulatory regime that limits complexity as much as possible. However modest in terms of capital relief, the inclusion of additional deviations from the Basel standards will inevitably make the system more complex. This not only adds to the cost of compliance for banks, but also complicates the work of supervisors and market participants.
We also need strong supervision. This means empowering supervisors with all the tools necessary to ensure that banks keep their risks under control. Another priority for the banking package is to therefore close gaps in our current rulebook. We clearly need increased ambition on environmental, social and governance risks. However, the work of both the ECB[5] and the EBA[6] in this area shows that banks are lagging behind on this front. Not only will ambitious proposals in the EU banking package help banks to rectify these shortcomings, they will also ensure supervisors can step in should banks fall behind. This will also help cement the EU’s global leadership role in this important area, which is developing quickly. It will therefore be important that the final agreement not only shows the way in terms of ambition, but also sets out a framework that remains risk-based and which allows scope for future developments in an area that will evolve rapidly over the coming years.
Finally, we need sound and harmonised rules for third country branches. We also need tools to avoid inappropriate bank management and poor governance. In order not to fall short in addressing these risks, it is important that the co-legislators do not to lower the ambition compared to the Commission’s proposal. Notably on the fit and proper assessment of banks’ management, we need an ambitious improvement of the rules to tackle the challenges we see. Only capable decision-makers can enable sound decisions and sound risk management, and supervisors need to be able to intervene accordingly. Looking ahead, this is clearly the most effective way of avoiding problems in banks.