Europe will “faithfully” implement new international standards that will force its banks, struggling to regain investor trust, to raise around €135 billion in additional capital to face future crises, the European Commission said on Tuesday (12 November).
As part of the international response to the financial crisis, regulators agreed in the Basel Committee in December 2017 that banks should add more capital cushions to better cope with future financial turbulences.
Although the new requirements penalised particularly European banks, Commission Vice-President for financial services, Valdis Dombrovskis, told a banking conference on Tuesday the EU is “committed to carrying through the final Basel III reforms faithfully”.
Europe argued in favour of remaining loyal to the international agreement in order to avoid a “regulatory race to the bottom”, which “will certainly backfire in the event of another financial crisis”, the European Banking Authority chief, Jose Manuel Campa, told the same event.
Still, Dombrovskis argued for a cautious approach, assessing whether the capital increases are justified in light of the risks, and if they would affect the EU economy “disproportionally.”
“We need to consider proportionality to cater for the diversity of the EU banking sector, as well as differences in bank size, complexity, business model and risk profile when applying the single rulebook,” he said.
Dombrovskis confirmed that the Commission will put forward its legislative proposal to implement the Basel III reform in Europe in the second quarter of 2020.
In order to meet the Basel III standards, the European Banking Authority (EBA) estimated last August that European banks would need a capital requirements hike of around 25% compared with the current situation (around €135 billion).
Seeking additional funds in the markets would come at a difficult time for the European banks, given that “full trust in the EU banking sector has not been restored yet,” said Campa.
He noted that investors have “doubts” on the long-term sustainability of the earnings of EU banks, especially compared with their US peers.
Efficiency explains why investors prefer US entities. But EU banks also suffer partly from the lack of trust derived from how the markets perceived the EU implementation of global prudential standards, Campa explained.
That is why he stressed that “we need to loyally implement the reforms.”
“Modest” economic impact
Financial sector representatives were concerned about the impact on the real economy of requesting additional buffers for banks, given their struggling situation and the crucial role they play in financing companies and consumers.
Campa, however, said that their ongoing assessment is showing that there are “modest transitional costs” of the implementation, which will fade away while the longer-run benefits are “substantial”, for example, thanks to higher long-term growth.
But in order to mitigate the short-term costs, Campa said there needs to be a “gradual” phase-in period of the new rules.
Against this backdrop, Dombrovskis said Europe will use the full phase-in period allowed by the Basel Committee, until the end of 2026.
The EU executive is currently consulting the financial sector and other players to gather their views and further evidence before putting forward its proposal.
One of the most controversial issues included in Basel III rules is the output floor, which limits banks using their internal models to calculate risks as European entities do.
During the negotiations, Europe pushed down the output floor threshold from higher levels, but the outcome would still force European banks to find billions in additional funds to back their risk-weighted assets.
Campa said the final agreement “is a compromise making all parties relatively unhappy, but it was the price to pay to reach a final global agreement that preserves the use of internal models.”
But if Europe fully adopts Basel III package, including the output floor thresholds, the bloc expects other regions and jurisdictions to follow through to ensure a global level playing field.
Still, Europe is considering some adjustments. Dombrovskis invited proposals on how the new framework could reflect the climate and other environmental factors.
The EBA is already assessing the possibility of introducing a “green supporting factor” to benefit green investments by lowering capital requirements.
“Prudential rules could favour ‘green’ investments and loans, naturally while keeping prudential considerations in mind,” said Dombrovskis.
EU sources also said the Commission would adjust in its proposal the Basel III recommendation for the SME supporting factor.
The new international standards acknowledged the lower risk weight for SMEs credits to support lending to the real economy.
However, this SME supporting factor had a smaller scope compared to the current one included in EU legislation. Therefore, full alignment with the international proposal would result in a “significant increase” of capital, warned the French banking federation.
[Edited by Zoran Radosavljevic]