Basel III: Member states see national financial stability at risk

Ecofin Roundtable

Member state finance ministers meet to discuss the macroeconomic outlook, fiscal policy and Basel III capital requirements on 9 November 2021 in Brussels. [EU Council Press service]

Member states with a significant presence of foreign banks fear that the EU Commission’s proposal to implement the Basel III agreement sacrifices their national financial stability to integrate the EU’s banking sector.

On Tuesday (9 November), EU finance ministers met in Brussels to discuss the Commission’s proposal to implement the Basel III agreement. Presented by the Commission at the end of October, the proposal aims to adapt the capital requirements for EU banks to internationally agreed standards.

The capital requirements are meant to make banks more resilient to economic shocks and should thus increase financial stability. Depending on the risk a bank holds in its portfolio, the bank has to cover it with more or less of its own capital.

Currently, banks can rely on internal models to determine the risk of their assets. To a certain extent, they can therefore control how much capital they need to hold. This may incentivise banks to systematically underestimate the risk to minimise this volume.

Commission wants more capital buffers for EU banks – in about a decade

Through a newly proposed banking package the EU commission is trying to find a balance between increasing financial stability, protecting bank profits and sustainability concerns.

The Commission’s proposal tries to limit this risk by introducing a so-called “output floor”, which sets a minimum capital requirement that no internal model can undershoot. In multinational banks within the EU, this output floor would only be applied at the consolidated level and not in each of their national subsidiaries separately.

For example, the Dutch headquartered bank ING would have to apply the output floor to its consolidated balance sheet, encompassing its EU subsidiaries. But it would not have to apply the output floor to its Belgian subsidiary separately as well.

“Risks to financial stability”

The finance ministers of Belgium, Lithuania, Slovakia, Portugal, and other countries have criticised the proposal. They expressed concerns over national financial stability if bank subsidiaries that are active in the respective national market do not have to hold the same amount of capital as local banks.

“I regret that this package only applies the output floor at a consolidated level”, Belgian minister of finance Vincent Van Peteghem said. “This creates a dangerous precedent for member states that host banks from other European member states, especially because the banking union is unfinished”, he added.

Moreover, the Latvian representative saw “serious risks to financial stability at the national level”.

Willem Pieter de Groen, head of the financial markets and institutions unit at the Centre for European Policy Studies (CEPS), explained the Commission’s approach by referring to the goal of an integrated European banking market. “If you have one single market, it is difficult to understand why the output floor should be calculated at any other level than the consolidated level within the EU”, he said, arguing that output floors at the subsidiary level would create inefficiencies for cross-border operations.

Nevertheless, De Groen also finds the resistance by some member states understandable. “If you look at where the criticism comes from, it is mostly from member states whose banking markets are dominated by foreign banks”, he pointed out.

“These countries think that there are still not enough safeguards for their financial stability, and in some specific cases, they might also be concerned about the competitive position of their domestic banks”, De Groen added.

A consequence of the incomplete Banking Union

Asked about this controversy among EU member states, executive vice-president of the Commission Valdis Dombrovskis defended the proposal.

“It is a model we have chosen because we want to promote the integration of the banking sector in the EU”, he said.

“At the same time, it is clear that we also need to reassure host countries that the capital is actually available in the subsidiaries in case there are any problems”, Dombrovskis added. He explained that while the overall capital requirements were determined at the consolidated level, the capital would then be distributed proportionally between mother companies and subsidiaries.

The Belgian minister of finance, however, remains unconvinced by this approach.

“The Commission’s proposal to redistribute potential increases in capital requirements […] to subsidiaries does not address the problem in a meaningful way”, Van Peteghem said.

According to De Groen, the discussion is, to at least some extent the consequence of the incomplete Banking Union. “If the whole Banking Union was fully functional, the application of the output floor at just consolidated level within the EU should be no major issue for individual Banking Union countries”, he argued.

[Edited by Alice Taylor]

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