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The EU-27 member states will apply the Basel III standards from January 2025; in mid-2024, the EU institutions completed implementation phase of these standards into the member states’ legislation. The new rules represent a vital step in strengthening stability and resilience of the EU-wide banking sector. Besides, the Basel standards are aimed at facilitating European economic growth, competitiveness as well as preserving the banking sector’s global level playing field.
Background: Basel standards and implementation in the EU
The Basel standards (in existence for half a century) include the set of international banking regulations developed by the Basel Committee on Banking Supervision, BCBS for minimum bank capital adequacy, stress testing and liquidity risk. The goal of these standards has been to enhance banks’ ability to withstand financial shocks and reduce the likelihood of a new global financial crisis.
The BCBS is the main global “standard setter” for the prudential regulation of banks and provides a forum for regular cooperation on banking supervisory matters; 45 members from 28 jurisdictions comprise the BSBS.
On Basel Supervision Committee in: https://www.bis.org/bcbs/index.htm; and in: https://www.bis.org/bcbs
Remaining faithful to the international financial commitment, the EU is going to implement the new Basel III framework starting from January 2025. The Basel standards on banking prudential requirements will apply to all banks in the member states (approximately 4 500) in order to provide an important additional layer of resilience to the European banking system.
The present Basel III-strategy’s background dates back to the 2023 banking turmoil in the US, in which several medium‑sized banks not subject to the full Basel III framework failed; however, this time the “US crisis” did not give rise to contagion in the EU banking sector, contrary to what happened in 2008-09.
As anticipated in the publicly available impact assessment studies carried out by the European Banking Authority, the impact of the latest EU-banking package reform on the minimum capital requirements proved manageable and positive: i.e. also because the package would be phased in over time. However, the impact will be more significant for some EU banks, depending on their business model and on whether they use internal models to calculate their minimum capital requirements.
The EU-wide Basel-implementation is to be introduced in phases, tome periods and adjustments, reflecting different banking system structures, bank practices, as well as the banks’ business models in various EU member states. This Basel standards implementation will also “smoothen the impact of the capital requirement” to be increased during coming years. Importantly, Commission has acknowledged, “almost all of these new adjustments are temporary with clear end dates and/or framed, i.e. requiring supervisory approval”.
Reference to: https://finance.ec.europa.eu/news/basel-iii-2024-07-25_en
Basel III: main principles
At least four main principles shall be mentioned:
= Minimum capital requirements: Basel III accord increases the minimum capital requirements for banks from 2% in Basel II to 4.5% of common equity, as a percentage of the bank’s risk-weighted assets. There is also an extra 2.5% buffer capital requirement that brings the total minimum requirement to 7% in order to be fit into the Basel’s rules. Thus, banks can use the buffer when they face financial stress, but using the buffer can lead to even more financial constraints when paying dividends.
= Countercyclical measures: in 2015, the Tier I capital requirement increased from 4% in Basel II to 6% in Basel III; the latter includes 4.5% of Common Equity Tier 1 plus 1.5% of additional Tier 1 capital. These requirements were originally meant to be implemented starting in 2013, but banks have had until January 2022 to implement the changes.
= Leverage ratio: Basel III introduced a non-risk-based leverage ratio as a backstop to the risk-based capital requirements. Banks are required to hold a leverage ratio in excess of 3%, and the non-risk-based leverage ratio is calculated by dividing Tier 1 capital by the average total consolidated assets of a bank. For example, the US Federal Reserve Bank fixed the leverage ratio at 5% for insured bank holding companies, and at 6% for Systematically Important Financial Institutions (SIFI), in order to conform to this requirement.
= Liquidity requirements: Basel III introduced the use of two liquidity ratios, including the Liquidity Coverage Ratio, LCR and the Net Stable Funding Ratio, NSFR; the former requires that banks are supposed to hold sufficient highly liquid assets that can withstand a 30-day stressed funding scenario, specified by the supervisors. This standard was introduced in 2015 at only 60% of its stated requirements and it was expected to increase by 10% each year until 2019, when it takes full effect. The NSFR mandates that banks maintain stable funding above the required amount of stable funding for a period of one year of extended stress.
Source and reference: https://www.delphix.com/glossary/basel-iii
New banking package
At the end of October 2021, the European Commission adopted a review of EU banking rules (composed of the Capital Requirements Regulation, CRR and the Capital Requirements Directive, CRD IV). The new rules were to ensure that EU banks would be more resilient to potential future economic shocks, while contributing to Europe’s recovery in the post pandemic period and to be fit into the EU-wide climate neutrality’s transition process.
In post-financial crisis, the EU embarked on wide-ranging reforms of its banking rules to increase the resilience of the EU banking sector; due to these reforms, the EU banking sector revived after crisis.
However, as the Commission acknowledged, while the overall level of capital in EU banks was on average satisfactory, some problems had not been addressed.
Source: the web site of the D-G for Financial Stability, Financial Services and Capital Markets Union in https://finance.ec.europa.eu/publications/banking-package_en
The EU implementation package comprised the following elements:
= Implementing Basel III rules for strengthening resilience to economic shocks; for this to achieve, the package aimed at implementing the international Basel III agreement, while taking into account the specific features of the EU’s banking sector, for example when it comes to low-risk mortgages.
= Sustainability issues contributing to the EU’s green transition; the new rules were supposed to require the banks systematically identify, disclose and manage sustainability risks (environmental, social and governance risks) as part of their risk management.
= Stronger enforcement tools ensuring sound management of EU banks and better protecting financial stability; in this regard, the package provided stronger enforcement tools for supervisors overseeing EU banks.
On new banking package in: https://finance.ec.europa.eu/publications/banking-package_en
Up to the beginning of the next year, i.e. during coming months, the Commission will continue to monitor international financial developments and reassess the situation, including regarding whether further measures are necessary. The empowerment allows the Commission to further delay the entry into application of the market risk standard by one more year, or to introduce it with modifications.
Notwithstanding the targeted use of the empowerment for a delegated act in the specific area of market risk, the broader application of the Basel standards from the beginning of next year sends a strong signal about the Commission’s commitment to the internationally agreed Basel standards.
Bottom line: it is expected that Basel III should lead to safer markets for bond investors and more stability for stock market investors. Thus, a better understanding of Basel III regulations will enable investors to comprehend the ways the national/regional financial sector would move forward while helping them formulating macroeconomic opinions on the stability of the national/international financial system, as well as on the socio-economic development.
More information on the issue in: https://finance.ec.europa.eu/news/banking-package-questions-and-answers-2024-07-24_en