Using a recently proposed banking package, the European Commission is trying to find a balance between increased financial stability, protection of bank profits and sustainability. The proposed implementation of the higher capital requirements will be spread over several years.
The new banking package was necessary to bring the EU’s financial system into line with the Basel III framework, an international agreement to increase the stability of the financial sector through capital requirements and other measures.
“Today’s proposal ensures that we implement the most important parts of the international Basel III standards. This is important for the stability and resilience of our banks, “said Valdis Dombrovskis, Vice – President of the Commission, as he presented the Commission’s proposal on Wednesday (October 27).
Long transition period for new capital requirements
The package contains amendments to the Capital Requirements Directive and the Capital Requirements Regulation. With these changes, EU management wants to increase capital buffers for EU lenders, encourage them to take sustainability more seriously and strengthen supervision to prevent fraudulent behavior like the recent WireCard scandal.
With regard to capital buffers – the reserves to be set aside by banks – the Commission emphasized that capital requirements will not increase significantly, reducing fears in the banking sector. Bank profitability is usually calculated in relation to the bank’s equity, which is why higher capital requirements tend to reduce the bank’s profitability.
Banks typically use internal models to calculate the risk of their assets, which then results in the necessary capital buffers. To address the temptation for banks to underestimate risk in their internal models, the Commission has proposed an “output floor” setting a minimum requirement for bank capital.
However, the Commission intends to give European banks sufficient time to fully implement the capital requirements and proposes a transition period of five to eight years, starting in 2025.
Nevertheless, European banks fear losing their competitiveness. The European Savings and Retail Banking Group (ESBG) criticized the output floor and called for a “proportionate implementation” of the Basel III framework.
“The implementation […] should reflect the principle of proportionality and take into account the risky nature, scope and complexity of the activities of European credit institutions, ”said Peter Simon, CEO of ESBG.
Climate risk management …
The Commission also wants banks to integrate environmental, social and managerial (ESG) risks into their risk management. The proposal requires banks to disclose their ESG risks and introduces regular climate stress tests. In order to reduce the administrative burden, these requirements should be less stringent for small banks.
“By incorporating ESG risk assessments, banks will be better prepared and protected from future challenges such as climate risks,” said Mairead McGuinness, Commissioner for Financial Services, Financial Stability and the Capital Markets Union.
EU lawmaker Markus Ferber of the center-right EPP criticized the Commission’s proposal, arguing that prudential regulation is not the place to address sustainability issues.
“We need to make banks safer, not greener,” Ferber said.
… but no capital buffer for climate risks
Activists and financiers have previously struggled to increase capital requirements for fossil fuel exposures, as many of these exposures will lose value as the ecological transition progresses. If these exposures are not backed by sufficient capital, climate change and ecological change could prove to be a systemic risk to financial stability, they argued.
Thierry Philipponnat of Finance Watch, an NGO involved in regulating the financial sector, lamented that the Commission does not plan to increase capital requirements for fossil fuel exposures.
“By decision no […] The Commission is failing in its duty to propose capital measures needed to address the systemic risks associated with climate change [EU-]apply the precautionary principle enshrined in the Treaties, ”said Philipponnat.
An EU official pointed out that more data is needed before forcing banks to increase their capital buffers for fossil fuel exposure. He indicated that the European Banking Authority would address the issue again in 2023.
More power for regulators
The banking package also gives regulators a stronger role. In this way, the Commission wants to ensure that supervisors can better assess whether senior bank employees have the necessary skills and knowledge to run a bank.
In response to the WireCard scandal, the Commission wants to equip regulators with additional tools to monitor fintech companies.
Finally, the Commission proposes to harmonize the rules for branches of third country banks in the EU, which will enable supervisors to “better manage the risks associated with these entities”. Third-country bank branches have recently become a problem, as UK-based lenders will be considered third-country banks after Brexit.
The banking package will then be discussed in the European Parliament and by the governments of the member states in the EU Council.
[Bearbeitet von Zoran Radosavljevic]