COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT REPORT Accompanying the documents Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Regulation (EU) No 575/2013 on prudential requirements for credit institutions as regards requirements for credit risk, credit valuation adjustment risk, operational risk, market risk and the output floor Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Directive 2013/36/EU as regards supervisory powers, sanctions, third-country branches, and environmental, social and governance risks, and amending Directive 2014/59/EU

EN EN
EUROPEAN
COMMISSION
Brussels, 27.10.2021
SWD(2021) 320 final
PART 1/4
COMMISSION STAFF WORKING DOCUMENT
IMPACT ASSESSMENT REPORT
Accompanying the documents
Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE
COUNCIL amending Regulation (EU) No 575/2013 on prudential requirements for
credit institutions as regards requirements for credit risk, credit valuation adjustment
risk, operational risk, market risk and the output floor
Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE
COUNCIL amending Directive 2013/36/EU as regards supervisory powers, sanctions,
third-country branches, and environmental, social and governance risks, and amending
Directive 2014/59/EU
{COM(2021) 663 final} - {SEC(2021) 380 final} - {SWD(2021) 321 final}
Offentligt
KOM (2021) 0663 - SWD-dokument
Europaudvalget 2021
1
Table of contents
1. INTRODUCTION: POLITICAL AND LEGAL CONTEXT.....................................5
2. PROBLEM DEFINITION ........................................................................................12
2.1. What are the problems and problem drivers?..................................................12
2.1.1. Deficiencies in the current framework for calculating risk-based
capital requirements.............................................................................12
2.1.2. No dedicated capture of ESG risks in the prudential framework........17
2.1.3. Inconsistency of powers and tools made available to supervisors
across the Union ..................................................................................19
2.1.4. Fragmentation and inefficiency in the disclosure of banks’ prudential
information ..........................................................................................21
2.2. How will the problems evolve?.......................................................................22
3. WHY SHOULD THE EU ACT? ..............................................................................26
3.1. Legal basis.......................................................................................................26
3.2. Subsidiarity: Necessity of EU action...............................................................26
3.3. Subsidiarity: Added value of EU action..........................................................27
4. OBJECTIVES: WHAT IS TO BE ACHIEVED? .....................................................27
4.1. General objectives ...........................................................................................27
4.2. Specific objectives...........................................................................................28
5. WHAT ARE THE AVAILABLE POLICY OPTIONS? ..........................................29
5.1. What is the baseline from which options are assessed? ..................................29
5.2. Description of policy options ..........................................................................30
5.2.1. Improve the current framework for calculating risk-based capital
requirements ........................................................................................30
5.2.2. Dedicated capture of ESG risks in the prudential framework.............40
5.2.3. Improve the consistency in the application of supervisory powers.....41
5.2.4. Reduce disclosure costs and improve market access to bank prudential
information ..........................................................................................43
6. WHAT ARE THE IMPACTS OF THE POLICY OPTIONS AND HOW
WOULD THEY COMPARE? ..................................................................................44
6.1. Improve the current framework for calculating risk-based capital
requirements ....................................................................................................44
6.2. Dedicated capture of ESG risks in the prudential framework.........................52
6.3. Improve the consistency in the application of supervisory powers.................54
6.4. Reduce disclosure costs and improve market access to bank prudential
information ......................................................................................................57
7. PREFERRED POLICY OPTIONS...........................................................................58
2
7.1. Effectiveness....................................................................................................58
7.2. Efficiency ........................................................................................................59
7.3. Coherence........................................................................................................60
7.4. REFIT (simplification and improved efficiency)............................................61
8. HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED.........62
ANNEX 1: PROCEDURAL INFORMATIONERROR! BOOKMARK NOT DEFINED.
1. LEAD DG, DECIDE PLANNING/CWP REFERENCESERROR! BOOKMARK NOT DEFINED.
2. ORGANISATION AND TIMING.........ERROR! BOOKMARK NOT DEFINED.
3. CONSULTATION OF THE RSB..........ERROR! BOOKMARK NOT DEFINED.
4. EVIDENCE, SOURCES AND QUALITYERROR! BOOKMARK NOT DEFINED.
ANNEX 2: STAKEHOLDER CONSULTATIONERROR! BOOKMARK NOT DEFINED.
ANNEX 3: WHO IS AFFECTED AND HOW?ERROR! BOOKMARK NOT DEFINED.
ANNEX 4: EVALUATION...........................ERROR! BOOKMARK NOT DEFINED.
ANNEX 5: ADDITIONAL INFORMATION ABOUT POLICY OPTIONSERROR! BOOKMARK NOT
1. IMPROVE THE CURRENT FRAMEWORK FOR CALCULATING RISK-
BASED CAPITAL REQUIREMENTS .ERROR! BOOKMARK NOT DEFINED.
1.1. Credit risk framework – Standardised approach Error! Bookmark not defined.
1.2. Credit risk framework – Internal model approachError! Bookmark not defined.
1.3. Market risk framework....................................... Error! Bookmark not defined.
1.4. Operational risk framework................................ Error! Bookmark not defined.
1.5. Credit valuation adjustment risk framework...... Error! Bookmark not defined.
1.6. Minimum haircut floor framework for SFTs ..... Error! Bookmark not defined.
1.7. Standardised approach for counterparty credit riskError! Bookmark not defined.
1.8. Output Floor ....................................................... Error! Bookmark not defined.
ANNEX 6: SPECIFIC IMPACTS OF PREFERRED POLICY OPTIONSERROR! BOOKMARK NOT D
1. Impact on administrative and operational costs ............ Error! Bookmark not defined.
2. Impact on competitiveness ............................................ Error! Bookmark not defined.
3. Impact on SMEs ............................................................ Error! Bookmark not defined.
4. Macro-economic costs and benefits analysis ................ Error! Bookmark not defined.
ANNEX 7: ANALYTICAL METHODS.......ERROR! BOOKMARK NOT DEFINED.
1. EBA impact analysis ..................................................... Error! Bookmark not defined.
2. ECB macroeconomic costs and benefits analysis ......... Error! Bookmark not defined.
3
List of abbreviations
Term or acronym Meaning or definition
AIRB Advanced IRB
BA-CVA Basic Approached for Credit Valuation Adjustment
BCBS Basel Committee on Banking Supervision
CCB Capital Conservation Buffer
CCyB Countercyclical Capital Buffer
CfA Call for Advice
CIU Collective Investment Undertaking
CMU Capital Markets Union
CRR Capital Requirements Regulation
CRD Capital Requirements Directive
CVA Credit Valuation Adjustment
EAD Exposure At Default
EBA European Banking Authority
ECB European Central Bank
EGD European Green Deal
ESMA European Securities Markets Authority
EU European Union
EUCLID European Centralised Infrastructure for Supervisory Data
FRTB Fundamental Review of the Trading Book
GaR Growth-at-Risk
GFC Great Financial Crisis
GDP Gross Domestic Product
GI Gross Income
ILM Internal Loss Multiplier
IRB Internal Ratings Based
LDP Low Default Portfolio
MRC Minimum Required Capital
MS Member State
OF Output Floor
PD Probability of Default
4
P2R Pillar 2 Requirement
QIS Quantitative Impact Study
RW Risk Weight
RWA Risk-Weighted Asset
SA-CCR Standardised Approach for Counterparty Credit Risk
SA-CR Standardised Approach for Credit Risk
SA-CVA Standardised Approach for Credit Valuation Adjustment
SFT Security Financing Transaction
SFTR Securities Financing Transactions Regulation
SME Small and medium-sized enterprise
SyRB Systemic Risk Buffer
SSM Single Supervisory Mechanism
SREP Supervisory Review and Evaluation Process
TLAC Total Loss-Absorbing Capacity
TRIM Targeted Review of Internal Models
5
1. INTRODUCTION: POLITICAL AND LEGAL CONTEXT
The Great Financial Crisis of 2008-09 (GFC) had its origins in various deficiencies of the
financial sector, in particular in the banking sector. According to the ‘Report of the de
Larosière Group’1
, the origins of the GFC emanated from the combination of several
factors, mainly the low cost of borrowing prevailing before the GFC, the financial market
search for ever–higher returns and the emergence, and widespread use, of complex
financial products created by bundling up new tradable securities from existing
underlying risky loans. The deterioration of the credit quality of a large number of these
loans triggered a rapid contagion of financial difficulties across the banking sector,
highlighting its various deficiencies, including the failure of credit agencies and financial
institutions to appropriately assess the risks of these new securities, the excessive
interconnectedness of financial institutions worldwide, the inadequacy of banks’
prudential framework to impose sufficient loss-absorbing own funds and liquid assets
requirements and the insufficiency of supervisory oversight.
The consequences of the GFC on the financial sector resulted in major costs2
for
governments as they had to support the financial sector, and also in a massive
contraction3
of economic activity in the Union and across the world. In response to the
GFC, the Union implemented substantial reforms of the prudential framework applicable
to banks in order to enhance their resilience and thus help prevent the recurrence of a
similar crisis. Those reforms were largely based on international standards adopted since
2010 by the Basel Committee on Banking Supervision (BCBS)4
. The standards are
collectively known as the Basel III standards, the Basel III reforms or the Basel III
framework5
. A summary of the content and timelines of those reforms, as well as their
implementation in the Union, is provided at the end of this Section (see Figure 3).
The global standards developed by the BCBS have become increasingly important due to
the ever more global and interconnected nature of the banking sector. While a globalised
banking sector facilitates international trade and investment, it also generates more
complex financial risks. Without uniform global standards, banks could choose to
establish their activities in the jurisdiction with the most lenient regulatory and
supervisory regimes. This might lead to a regulatory race to the bottom to attract bank
businesses, increasing at the same time the risk of global financial instability.
International coordination on global standards limits this type of risky competition to a
large extent and is key for maintaining financial stability in a globalised world. Global
1
See “Opinion of the European Economic and Social Committee on the Report of the de Larosière Group
(Own-initiative opinion)”.
2
The total amounts of state aid used by Member States to shore up the banking sector during and after the
GFC (i.e. over the 2008-2017 period) is estimated to €2 trillion.
3
While the annual EU GDP growth remained slightly positive in 2008 (+0.8%), it dropped in 2009 (-4.2%)
(see https://ec.europa.eu/economy_finance/publications/european_economy/2010/interim_forecast_2010-
09_en.htm).
4
Members of the BCBS comprise central banks and bank supervisors from 28 jurisdictions worldwide.
Among the EU Member States, Belgium, France, Germany, Italy, Luxembourg, the Netherlands, and
Spain, as well as the European Central Bank are members of the BCBS. The European Commission and
the EBA participate in BCBS meetings as observers.
5
The consolidated Basel III framework is available at https://www.bis.org/bcbs/publ/d462.htm.
6
standards also simplify the life of internationally active banks – among which are a good
number of EU banks – as they guarantee that broadly similar rules are applied in the most
important financial hubs worldwide. The EU has therefore been a key proponent of
international cooperation in the area of banking regulation
In the Union, the first set of post-crisis reforms that are part of the Basel III framework
have been implemented in two steps:
 in June 2013 with the adoption of Regulation (EU) No 575/2013, also known as
the Capital Requirements Regulation (CRR)6
, and Directive 2013/36/EU, also
known as the fourth Capital Requirements Directive (CRD IV)7
;
 in May 2019 with the adoption of Regulation (EU) 2019/8768
, also known as the
second Capital Requirements Regulation (CRR II), and Directive (EU) 2019/878,
also known as the fifth Capital Requirements Directive (CRD V)9
.
The reforms implemented so far focused on increasing the quality and quantity of
regulatory capital that banks have to hold to cover potential losses. Furthermore, they
aimed at reducing banks’ excessive leverage, increasing banks’ resilience to short-term
liquidity shocks, reducing their reliance on short-term funding, reducing banks’
concentration risk, and addressing too-big-to-fail problems10
.
As a result, the new rules strengthened the criteria for eligible regulatory capital,
increased minimum capital requirements, and introduced new requirements for credit
valuation adjustment11
(CVA) risk and for exposures to central counterparties12
.
Furthermore, several new prudential measures were introduced: a minimum leverage
ratio requirement, a short-term liquidity ratio (known as the liquidity coverage ratio), a
longer-term stable funding ratio (known as the net stable funding ratio), large exposure
limits13
and macro-prudential capital buffers14
.
6
Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on
prudential requirements for credit institutions and investment firms and amending Regulation (EU) No
648/2012 (OJ L 321, 26.6.2013, p. 6).
7
Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the
activity of credit institutions and the prudential supervision of credit institutions and investment firms,
amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC (OJ L 176,
27.6.2013, p. 338).
8
Regulation (EU) 2019/876 of the European Parliament and of the Council of 20 May 2019 amending
Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for
own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties,
exposures to collective investment undertakings (CIU), large exposures, reporting and disclosure
requirements, and Regulation (EU) No 648/2012.
9
Directive (EU) 2019/878 of the European Parliament and of the Council of 20 May 2019 amending
Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding
companies, remuneration, supervisory measures and powers and capital conservation measures.
10
See https://www.bis.org/publ/bcbs189.htm.
11
CVA is an accounting adjustment to the price of a derivative to account for counterparty credit risk. For
more details, see Section 1.5 in Annex 5.
12
These were the only significant changes to the part of the standards that deal with risk-based capital
requirements that were introduced as part of the first stage of the Basel III reform.
13
A minimum requirement on large exposure limits was already a feature of Union legislation, but was a
novelty for the Basel standards.
7
Thanks to this first set of reforms implemented in the Union15
, the EU banking sector has
become significantly more resilient to financial shocks. One key indication of this
increased resilience is the overall increase in regulatory capital EU banks have: between
the end of 2014 and mid-202016
, the average Common Equity Tier 1 (CET1)17
capital
ratio18
of EU banks improved by 2.5 percentage points (pp) to 15%19
, as shown in Figure
1: Weighted average capital and leverage ratios for EU banks over time.20
.
Figure 1: Weighted average capital and leverage ratios for EU banks over time.
Source: Risk Assessment of the European banking system, EBA, December 2020.
Note: the above ratios are based on the prevailing rules of the prudential framework of the Union at the time, including
under the prevailing transitional arrangements.
As a result, the EU banking sector entered the COVID-19 crisis on a significantly more
resilient footing when compared to its condition at the onset of the GFC. In addition,
temporary relief measures were taken by supervisors and legislators at the outset of the
COVID-19 crisis. In its Interpretative Communication on the application of the
accounting and prudential frameworks to facilitate EU bank lending - Supporting
14
More specifically the capital conservation buffer (CCB), the countercyclical capital buffer (CCyB), the
systemic risk buffer (SyRB), and capital buffers for global and other systemically important banks
(respectively, G-SII and O-SII).
15
Those first set of reforms have also been implemented in most jurisdictions worldwide as can be
observed in the eighteenth progress report on adoption of the Basel regulatory framework published in July
2020 (see https://www.bis.org/bcbs/publ/d506.htm).
16
Before the publication of this impact assessment, these data will be updated with the latest figures as of
Q4 2020 which will be published by the EBA in Q2 2021 it their next Risk Assessment Report.
17
CET 1 capital is the form of banks’ capital recognised by the prudential framework for having the
highest capacity to absorb unexpected losses that arise during the normal course of banks’ businesses. It is
mainly composed of banks’ common shares and retained earnings.
18
The CET 1 ratio is calculated by dividing a bank’s CET 1 capital by its total assets weighted by their
relative riskiness (“risk-weighted assets” or RWA). The CET 1 ratio is a key indicator of banks’ resilience
to idiosyncratic risks.
19
EBA Risk Assessment of the European banking system, December 2020 (see
https://www.eba.europa.eu/risk-analysis-and-data/risk-assessment-reports).
20
Since 2016 the weighted average leverage ratio of EU banks, which will become a binding requirement
in June 2021, remained relatively stable and well above the minimum requirement that would be applicable
in the EU (3% for all EU banks from June 2021, at least 3.5% for G-SIIs from January 2023). The fact that
the leverage ratio did not increase similar to the capital ratios could be explained by the fact that EU banks
reduced their exposures to risky assets over the last few years which has no effect on the leverage ratio.
8
businesses and households amid COVID-19 of 28 April 202021
, the Commission
confirmed the flexibility embedded in the prudential and accounting rules as highlighted
by the European Supervisory Authorities and international bodies. In June 2020, co-
legislators adopted targeted temporary amendments to specific aspects of the prudential
framework – the so-called CRR “quick fix” package22
. Together with resolute monetary
and fiscal policy measures23
, this helped banks to keep on lending to households and
companies during the pandemic (as can be observed from Figure 2 below, which also
shows some of the impacts of the relief measures for the Euro area). This, in turn, helped
mitigate the economic shock24
resulting from the pandemic.
Figure 2: Annual growth rate of loans to Euro area households (left hand-side) and some
aggregate impacts of the temporary relief measures provided by supervisors and
legislators in Q2 2020 on banks’ CET1 ratio (right hand-side).
Source: European Central Bank (ECB) Financial stability review, November 2020.
Note: In the two right-hand side charts, the y-axis represents the aggregate impacts of temporary relief measures
expressed in percentage points changes between the banks’ CET1 ratio between end-Q1 2020 (i.e. before the measures
applied) and end-Q2 2020 (i.e. after the measures applied). In the left-hand side chart, the x-axis represents the
distribution of the aggregate impacts of temporary relief measures across individual banks supervised by the ECB. In
the second chart, the x-axis represents the inter-quantile distribution of the individual banks’ impacts of two specific
temporary relief measures, specifically the amendments to the CRR related to transitional arrangement for the
application of IFRS 9 provisions and the date of application of the SME factor.
However, while the overall level of capital in the EU banking system is now considered
satisfactory on average, some of the problems that were identified in the wake of the
GFC have not yet been addressed. Analyses performed by the EBA and the ECB (see
Section 2.1.1) have shown that the capital requirements calculated by EU banks using
21
See https://ec.europa.eu/info/publications/200428-banking-package-communication_en.
22
See https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32020R0873&from=EN.
23
A comprehensive list of such measures has been collected by the ESBR, see “Policy measures in
response to the COVID-19 pandemic”.
24
In its COVID-19 vulnerability analysis published in July 2020, the ECB showed that the largest euro
area banks would be sufficiently capitalised to withstand a short-lived deep recession and that the number
of those banks with insufficient capital resources in case of a more severe recession would be limited (see
https://www.bankingsupervision.europa.eu/press/pr/date/2020/html/ssm.pr200728_annex~d36d893ca2.en.
pdf).
9
internal models demonstrated a significant level of variability that was not justified by
differences in the underlying risks, ultimately undermining the reliability and
comparability of their capital ratios. In addition, the lack of risk-sensitivity in the capital
requirements calculated using standardised approaches results in insufficient or unduly
high capital requirements for some financial products or activities (and hence specific
business models primarily based on them). In December 2017, the BCBS agreed on a
final set of reforms25
to the international standards to address these problems. In March
2018, the G20 Finance Minister and Central Bank Governors welcomed these reforms26
.
In 2019, the Commission announced its intention to table a legislative proposal to
implement these reforms in the EU prudential framework.27
In light of the COVID-19 pandemic, the preparatory work has been delayed, reflecting
the BCBS’s decision of 26 March 2020 to postpone the previously agreed
implementation deadlines for the final elements of the Basel III reform by one year28
.
Beyond the temporary measures adopted to facilitate bank lending in the context of
COVID-19 referred above, this delay has allowed the Commission services to reassess
the impact of the planned reform in light of the potential consequences of the COVID-19
pandemic. The temporarily stressed economic conditions have not altered the
Commission services’ views on the need to deliver on this structural reform. Completing
the reform will address the outstanding issues highlighted above and will thus further
strengthen EU banks’ financial soundness, putting them in a better position to support
economic growth and withstand potential future crises. It will also give banks the
necessary regulatory certainty, completing a decade-long reform of the prudential
framework for banks. The Commission services consider that the reform can be carried
out in a manner that will not disrupt the recovery from the COVID-19 crisis.
This would also be in line with the actions of other members of the BCBS that are
committed to implementing the reform timely and faithfully. Indeed, major jurisdictions,
(US, UK, JP, HK, CA, AU and SG), have publically committed to adopting rules
implementing the reform by 1 January 2023. Some of them, namely JP, CA, HK and SG,
have already published draft rules. Those jurisdictions expect the EU to stick to its
commitment to implement the reform on time.
Figure 3 below provides an overview of the first and final set of Basel III reforms, as
well as the timelines of their adoption in the prudential framework applicable to EU
banks.
25
See https://www.bis.org/bcbs/publ/d424.htm
26
See http://www.g20.utoronto.ca/2018/2018-03-30-g20_finance_communique-en.pdf. The relevant
passage of the statement - the latter was agreed by the European Union as a member of the G20 - reads:
“We welcome the finalisation of Basel III, which completes main elements of the post crisis reforms. We
remain committed to the full, timely and consistent implementation and finalisation of the reforms and their
evaluation to help identify and address any material unintended consequences and ensure that the reforms
accomplish their objectives.” The message has regularly been repeated in subsequent G20 press statements.
27
See https://ec.europa.eu/commission/presscorner/detail/en/SPEECH_19_6269.
28
More specifically to 1 January 2023 for the starting date of application and to 1 January 2028 for the full
application of the final elements of the reform.
10
Figure 3: Summary of the main revisions to the Basel framework adopted by the BCBS
post-GFC and their implementation timelines in the Union.
Source: European Commission.
Note: The dates coloured in yellow at the top are the dates of adoption of the various Basel III standards by the BCBS.
The dates coloured in blue at the bottom are the dates of adoption of standards in Union law.
The completion of the reform of the prudential framework for banks following the GFC
is not the only important initiative related to the banking sector.
Another initiative is linked to the Commission’s ongoing work on the transition to a
sustainable economy. The Commission Communication on the European Green Deal
(EGD)29
clearly set out the Commission’s commitment to transform the EU economy
into a sustainable economy while also dealing with the inevitable consequences of
climate change. It also announced a Sustainable Finance Strategy30
that will build on
previous initiatives and reports, such as the action plan on financing sustainable growth31
and the reports of the Technical Expert Group on Sustainable Finance32
, but will
reinforce the Commission’s efforts in this area to bring them in line with the ambitious
goals of the EGD. The Taxonomy Regulation33
will play an important enabling role in
this context, by establishing a list of environmentally sustainable economic activities.
Bank-based intermediation will play a crucial role in financing the transition to a more
sustainable economy. At the same time, the transition to a more sustainable economy is
likely to entail risks for banks that they will need to properly manage to ensure that risks
to financial stability are minimised. This is where prudential regulation can play an
important role. The abovementioned Strategy acknowledged this and highlighted the
need to include a better integration of climate and environmental risks into the EU
prudential framework.
29
See https://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1588580774040&uri=CELEX:52019DC0640.
30
See https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12635-Renewed-
sustainable-finance-strategy
31
See https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52018DC0097.
32
https://ec.europa.eu/info/publications/sustainable-finance-high-level-expert-group_en
33
https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32020R0852
11
Work in that direction has already started. In the CRR II, the co-legislators introduced a
requirement for large, listed banks to disclose environmental, social and governance
(ESG) risks and mandated the EBA to prepare two reports on how the treatment of ESG
risks could be incorporated in the prudential framework. In October 2019, the EBA
published its Action Plan on sustainable finance34
, outlining how it intends to achieve the
three actions above. In this report, among other things, the EBA encouraged banks to
integrate ESG risks, identify simple climate-risk metrics, adopt climate change related
scenarios and use scenario analysis.
Work is also ongoing within the international supervisory community. In 2017, central
banks and supervisors launched the Network for Greening the Financial System
(NGFS)35
. The aim of the network is to enhance the role of the financial system to
manage risks and to mobilise funding for green and low-carbon investments in the
broader context of environmentally sustainable development. In May 2020, it has
published a handbook for supervisors on how to incorporate climate-related risks into
supervision.36
The final area of focus is the proper enforcement of prudential rules. Both supervisors
and markets play a crucial role in this respect. In order for rules to achieve their intended
effect, they need to be properly enforced. For this to happen, supervisors need to have at
their disposal the necessary tools and powers (e.g. powers to authorise banks and their
activities, require information from them, or sanction them in case they break the rules).
The Commission keeps monitoring the functioning of the supervisory framework laid
down in the CRD, including through close dialogue with national supervisors, the ECB
and the EBA, in order to ascertain whether the powers and tools made available to
supervisors are adequate, complete and used appropriately.
Market discipline is another important tool. In order to for investors to properly exercise
they role of monitoring the behaviour of banks, they need to access the necessary
information. This is why the CRR requires banks to disclose certain information to the
markets. As in the case of the supervisory framework, the Commission keeps monitoring
disclosure rules, including through dialogue with market participants, to gauge whether
the information disclosed by banks is sufficient and easy to obtain.
The above monitoring activity allows the Commission to identify areas where rules need
to be adjusted in order to address identified issues.
34
https://www.eba.europa.eu/sites/default/documents/files/document_library/EBA%20Action%20plan%20
on%20sustainable%20finance.pdf.
35
See https://www.ngfs.net/en.
36
https://www.ngfs.net/sites/default/files/medias/documents/ngfs_guide_for_supervisors.pdf
12
2. PROBLEM DEFINITION
2.1. What are the problems and problem drivers?
2.1.1. Deficiencies in the current framework for calculating risk-based
capital requirements
Banks are exposed to different types of risk as part of their day-to-day business. While
the specific types of risks (as well as the intensity of those risks) a bank will be exposed
to will depend on the business model of that bank, the four main types of risk that might
result in financial losses for banks are credit risk, operational risk, market risk and
counterparty risk37
. In order to ensure that banks have sufficient amounts of regulatory
capital to cover unexpected financial losses caused by those risks, banks are subject to
binding risk-based capital requirements under the prudential framework (Figure 4 below
shows the aggregate level of risk weighted assets38
(RWA) for those risks for EU banks
over the last few years).
Despite the wide-ranging first set of reforms implemented in the Union after the GFC,
increased levels of capital (as shown in Figure 1: Weighted average capital and leverage
ratios for EU banks over time.) have not yet allowed to fully restore the confidence in the
EU banking sector and some problems identified during the GFC remain. One important
reason for this is the lack of trust in the risk-based capital requirements calculated by
using internal models39
.
37
Counterparty risk relates to bilateral transactions (e.g. derivatives or securities financing transactions)
and include two types of risks: the risk of losses upon the default of the counterparty (default risk) and the
risk of market value losses on bilateral transactions due to the decrease in the creditworthiness of the
counterparty (CVA risk).
38
In the prudential framework, banks have first to calculate the corresponding RWAs for those risks (the
RWAs are calculated by multiplying the size of a bank’s exposure (e.g. a loan) with the appropriate risk
weight, which captures the degree of riskiness of the exposure) and then determine the capital requirements
as a small portion of those RWAs.
39
See for instance https://www.wsj.com/articles/basel-committee-to-stop-banks-gaming-risk-models-
1446472711; https://blogs.cfainstitute.org/marketintegrity/2015/03/17/bank-risk-weighted-assets-how-to-
restore-investor-trust/; or p. 53 of
https://voxeu.org/sites/default/files/file/Post_Crisis_Banking_Regulation_VoxEU.pdf.
13
Figure 4: Amount in EUR trillions of risk weighted assets by type of risk for EU banks
over time40
.
Source: Risk Assessment of the European banking system, EBA, December 2020.
Indeed, banks can use two types of approaches to calculate their risk-based capital
requirements: the standardised approaches, which banks have to use by default, or the
internal model approaches (based on banks’ own modelling assumptions), which banks
may use upon the permission from their supervisors.
Standardised approaches are benchmark risk measurement techniques which banks have
to us by default unless they have been granted permission to use the internal model
approaches. Under these approaches, banks have to calculate their risk-based capital
requirements according to standard formulas and pre-defined parameters (e.g. regulatory
risk weights, loss-given default parameters, market volatilities, etc.) specified in the
legislation. This ensures that banks apply those approaches in a uniform manner which
makes the calculation of capital requirements under those approaches largely comparable
across banks for similar risks. The standardised approaches’ parameters are intended to
capture a conservative estimate of the average risk of an exposure in a way that is
sufficiently simple for a widespread use. The majority of EU banks relies on standardised
approaches to calculate their capital requirements.
Standardised approaches have shown a number of weaknesses during the GFC which
prevent them from acting as solid benchmark. First, some observations of actual losses
incurred by banks during the GFC showed that the existing standardised approaches do
sometimes underestimate the risks of certain types of exposures leading to insufficient
amounts of capital required. The opposite was also found to be true: sometimes
standardised approaches overestimated risks, leading to excessive amount of capital
required. This can be explained, to an important extent, by the fact that they are designed
to be simple. They hence do not always properly reflect the various characteristics of
financial products, especially the most complex ones. This may, in turn, have an impact
on banks’ activities. For example, if the capital requirement for a certain type of loan is
40
Before the publication of this impact assessment, these data will be updated with the latest figures as of Q4 2020
which will be published by the EBA in Q2 2021 it their next Risk Assessment Report
14
too low compared to the riskiness of that loan, then the bank may grant too many of those
loans while having insufficient capital if those loans start defaulting (and vice versa).
The lack of risk-sensitivity of standardised approaches has been observed for all types of
risks, although to different extents. For example, in its 2019 benchmarking exercise of
internal models for credit risk41
, the EBA highlighted the high variability of the ratio
between the risk weights generated by banks’ internal models for credit risk and the
corresponding risk weights under the standardised approaches, for different types of
credit exposures. As shown in Figure 5 below, the high discrepancies of those ratios
across institutions cannot be explained solely by the high variability in banks’ internal
model approaches but also by the lack of risk-sensitivity in the standardised approaches.
Figure 5: Comparison between risk weights implied by individual banks’ internal
models for credit risk or ‘Internal Rating Based’ (RW IRB) and risk weight of the credit
risk standardised approach (RW SA) for mortgage exposures.
Source: EBA.
Notes: Each point represent one EU bank participating to the exercise.
Unlike the standardised approaches, internal model approaches allow banks to estimate
most or all the parameters required to compute capital requirements on their own. Since
putting in place and maintaining such internal models requires significant resources, the
cost of operating internal model approaches are significantly higher than the costs of
using standardised approaches. This is why the number of banks that use internal models
is much smaller than the number of banks using standardised approaches: according to
the EBA’s 2019 study of the impact of the final elements of the Basel III reform, , only
79 banks out of 189 participating to the EBA data collection were using internal
models42
. However, those banks tend to be the largest ones in the EU, accounting for a
large proportion of the total EU assets. Hence, the capital requirements calculated under
the internal model approaches by those banks represent more than half of the overall
capital requirements of EU banks as shown in
Figure 6.
41
See https://eba.europa.eu/regulation-and-policy/supervisory-benchmarking-exercises.
42
In reality, the proportion of EU banks using internal model approaches would be much smaller since the
EBA data collection does not include the vast majority of the thousands of small and medium-sized banks
established in the EU, most of which do not use internal model approaches.
15
Figure 6: Breakdown of EU banks’ RWAs calculated under the standardised and internal
model approaches of the current prudential framework for credit, market and CVA risks.
Source: Basel III reforms: Impact study and key recommendations, August 2019, EBA.
When using internal models, banks can capture risks more accurately by taking into
account their own assessment of the characteristics of exposures, such as loans (e.g. the
likelihood that the borrower would default and the size of the loss the bank would incur
in case there is a default). Since the use of internal models is predicated on close
monitoring and assessment of the risks banks are exposed to, banks have a better
understanding of how to manage and mitigate those risks.
However, the freedom that internal model approaches give to banks has potential
downsides. Depending on how these models are built and on the modelling assumptions
underpinning them, internal models of different banks can produce different estimates of
risks and hence different levels of capital requirements. Given that each bank originates
loans to different clients, invests in different assets and trades with different
counterparties, a certain degree of variation is to be expected. However, a range of
studies conducted at both international43
and EU44
levels found a level of variation in
capital requirements across banks using internal models that cannot be explained solely
by differences in the riskiness of banks’ exposures. In fact, those studies have shown that
internal models can produce very different capital requirements for very similar or even
identical exposures. In some cases, capital requirements for the exact same portfolios of
exposures have shown a variation of more than 600%, as illustrated by Figure 7 below in
the area of market risk45
. This variation makes it difficult to compare capital ratios across
banks, puts in question their calculation and undermines confidence in capital ratios and
distorts competition across banks.
43
For the BCBS Regulatory Consistency Assessment Program reports on the variability of risk-weighted
assets, see https://www.bis.org/bcbs/publ/d363.htm, https://www.bis.org/publ/bcbs267.htm, and
https://www.bis.org/bcbs/publ/d337.htm.
44
For EBA benchmarking exercises see https://eba.europa.eu/regulation-and-policy/supervisory-
benchmarking-exercises.
45
Risk of losses due to adverse price movements in trading activities.
16
Figure 7: Variability of capital requirements produced by internal models for market risk
for different types of trading activities. Ratio between the individual bank “Value-at-
Risk” risk measures for a given portfolio with the median for that portfolio.
Source: EBA report - results from the 2019 market risk benchmarking exercise.
Notes: The category ‘FX’ refers to trading portfolios with foreign-exchange rate risk, ‘Comm’ to trading portfolios
with commodity risk (e.g. energy or agricultural goods) and ‘CTP’ to trading portfolios with subject to the specific
Correlation Trading Portfolio capital requirement (e.g. collateralised debt obligations).
Moreover, a recent study46
published by the Bank for International Settlements (BIS)
illustrates that, besides a wide degree of variability in capital requirements among banks
using internal models, the market perception of the financial risks that banks face is
persistently higher than banks’ own assessment of risk when calculating capital
requirements with internal models. As shown by Figure 8 Figure 8below, this problem
of perceived underestimation of risks by internal models is significant for certain banks.
The reliability and robustness of the capital requirements produced by internal models is
predicated on the condition that banks should not use internal models to reduce their
capital requirements to levels which jeopardise the very objectives of safeguarding
financial soundness and covering potential losses. For this purpose, the current prudential
framework already provides a number of safeguards, most notably the need for
supervisory approval to use an internal model as well as its regular monitoring and
review. However, given the growing number and sophistication of models used by banks
and the updates made to those models47
, their supervision is becoming more complex and
more resource intensive.48
Furthermore, a reliable internal model requires sufficient data
of sufficient quality to be available. This condition is not always met: in some cases the
amount of available data is insufficient to allow for reliable and robust modelling of
losses. This in turn produces unreliable estimates of the size of the risks a bank is
exposed to and hence leads to inaccurate capital requirements.
46
See https://www.bis.org/publ/work844.htm.
47
Banks change the design and calibration of (parts of) models to keep pace with changing portfolios, new
data and modelling techniques.
48
In principle, supervisors have the ability to withdraw the permission to use internal models from a bank.
However, such measure can have a significant impact on the bank that loses the permission, which is why
it is usually used as a very last resort.
17
Figure 8: Comparison of the Variability Ratio*
across countries.
Source: “Variability in risk-weighted assets: what does the market think?”, BIS, 2020.
Notes: *
The variability ratio is defined as the risk perception by the market compared to the risks measured in the
regulatory framework across banks in a given country. The higher the ratio, the larger the perceived underestimation of
risk.
The identified problems have raised doubts on the adequacy of internal models.
Supervisory approval is required for banks to use internal models and supervisors can
naturally decide not to allow a bank to use inappropriate internal models. However, the
supervisors’ approval process of internal models cannot prevent in itself the variability
observed across the outcomes of banks’ internal models. The supervisory authorities
have already undertaken dedicated initiatives to reduce to some extent such variability. In
2016, the EBA produced a roadmap to comprehensively review the current rules for
credit risk internal models and in order to issue guidelines, opinions or develop technical
standards49
. Also since 2016, the ECB/SSM has carried out a large-scale targeted review
of internal models (TRIM) for the banks under its direct supervision in cooperation with
the national supervisory authorities50
. However, there is a limit to the number of
interventions supervisors can make to address issues with individual models used by
individual banks, because supervisors have limited resources at their disposal. Once that
limit is reached, more structural solutions, like changes to the rules governing models,
may need to be contemplated.
2.1.2. No dedicated capture of ESG risks in the prudential framework
Climate change and the profound economic transformations that are needed to contain it
pose significant risks to banks, primarily in the form of transition risk (whereby the
transition to a sustainable economy can result in big shifts in asset values) and physical
risks (whereby more frequent or more severe weather events impact banks and their
49
For the current status of this exercise, EBA report on progress made on its roadmap to repair IRB
models, July 2019 (see https://eba.europa.eu/eba-publishes-report-on-progress-made-on-its-roadmap-to-
repair-irb-models).
50
In April 2021, the ECB published the outcomes of the TRIM exercise which resulted in Euros 275
billion increase in RWAs over the last three years and more than 5,000 findings for banks to remediate (see
https://www.bankingsupervision.europa.eu/press/pr/date/2021/html/ssm.pr210419~94c010eb9d.en.html).
18
customers). Climate (and, more broadly, environmental) risks are often considered
together with social risks51
and governance risks52
under the heading of ESG risks, as
these risks share a number of characteristics and are often intertwined.53
ESG risks, in
turn, are closely linked with the concept of sustainability, as ESG factors represent the
main three pillars of sustainability.
ESG risks affect different types of banks’ exposures differently: over the longer term,
exposures related to the financing of sustainable activities are most likely less risky for
banks than exposures financing unsustainable activities. If these risk differentials are not
adequately reflected in banks’ decision-making, banks may underestimate the overall
level of risk that they face, which raises financial stability concerns. For example, Alessi,
L., Di Girolamo, F., Petracco-Giudici, M. and Pagano, A. (2021) argue that transition
risks might result in an increase of bank losses by 4% in a crisis. Also, banks may also
underestimate the risks of unsustainable activities compared to sustainable activities and
as a result may overinvest in unsustainable activities while underinvesting in sustainable
activities. An adequate reflection of ESG risks in banks’ decision-making in turn would
help addressing this misallocation of resources and hence make it more likely that banks
finance sustainable activities, enabling the Union to reach the EGD’s goals.
Against this background, it is essential that banks are able to measure and monitor their
exposure to ESG risks, also to enable supervisors and market participants to
appropriately assess the ESG risks faced by each bank in order for supervision and
market discipline to function effectively.
The current legal framework does not prevent banks from considering ESG risks in their
decision-making nor from disclosing information on their exposure to such risks. While
availability of relevant data for banks has been an obstacle in this context, steps have
been taken to facilitate banks’ access to such data, for example by means of requirements
under the Corporate Sustainability Reporting Directive (CSRD)54
and the Taxonomy
Regulation. These measures should put banks in a better position to manage ESG risks.
Also, EU co-legislators have deemed that a dedicated approach to capture ESG risks in
banks’ financial activities could help address the aforementioned challenges and
51
According to the EBA Discussion Paper on management and supervision of ESG risks for credit
institutions and investment firms, “[s]ocial risks are the risks posed by the exposure of institutions to
counterparties that may potentially be negatively affected by social factors”, with social factors in turn
being “related to the rights, well-being and interests of people and communities, which may have an impact
on the activities of the institutions’ counterparties”.
52
According to the EBA Discussion Paper on management and supervision of ESG risks for credit
institutions and investment firms, “[g]overnance risks are the risks posed by the exposure of institutions to
counterparties that may potentially be negatively affected by governance factors”, with governance factors
in turn covering “governance practices of the institutions’ counterparties, including the inclusion of ESG
factors in policies and procedures under the governance of the counterparties”.
53
According to the EBA Action Plan on Sustainable Finance, “[e]nvironmental and social considerations
are often intertwined, as especially climate change can exacerbate existing systems of inequality. The
governance of public and private institutions, including management structures, employee relations and
executive remuneration, plays a fundamental role in ensuring the inclusion of social and environmental
considerations in the decision-making process.
54
See https://ec.europa.eu/info/business-economy-euro/company-reporting-and-auditing/company-
reporting/non-financial-reporting_en.
19
introduced in CRR II provisions aimed at improving the capture of ESG risks. First, large
banks with publicly listed issuances will start disclosing information on ESG risks from
2022 onwards. Second, the EBA has been mandated to assess by June 2021 the potential
inclusion of ESG risks in the supervisory review and evaluation process (SREP)
performed by supervisors. Third, the EBA has been mandated to assess by 2025 whether
a dedicated prudential treatment of exposures related to assets or activities associated
substantially with environmental and/or social objectives would be justified. However,
the immediate effectiveness of these provisions is limited, as a large number of banks are
outside of the scope of the CRR disclosure rules, and any advice from the EBA on the
other two areas under investigation would require subsequent changes to the CRR.
As a result, the present legal requirements alone are insufficient to provide incentives for
a systematic and consistent management of ESG risks by banks. This has also been
recognised by the EBA in its aforementioned discussion paper, which states that it “sees
the need for enhancing the incorporation of ESG risks into institutions’ business
strategies, business processes and proportionately incorporate ESG risks in their internal
governance arrangements”. The EBA considers the current legal requirements
insufficient for this purpose and therefore “recommends to incorporate ESG risk-related
considerations in directives and regulations applicable to the banking sector (e.g. CRD
and CRR)”.
2.1.3. Inconsistency of powers and tools made available to supervisors
across the Union
In order to perform their duties, national and European55
competent authorities in charge
of banking supervision have to use their powers under national laws transposing the
CRD. In this regard, the CRD requires Member States (MS) to provide competent
authorities with a minimum set of powers to exercise their supervisory functions56
(thereafter “supervisory powers“) and to impose sanctions through administrative
measures57
and administrative penalties58
(thereafter “sanctioning powers”) for banks
breaching regulatory requirements (as set out in the CRR rules or national laws
transposing the CRD). While the CRD ensures a minimum level of harmonisation across
the Union, some MS have identified59
a number of areas for which they considered it
55
Since its entry into force in November 2014, the Single Supervisory Mechanism (SSM), established
within the ECB, is in charge of the direct supervision of 115 significant banks of the Members of the
Eurozone (82% of banking assets in those countries) and of non-Eurozone Member States which have
entered, on voluntary basis, into close cooperation with the ECB. The other banks of those Member States
(the less significant banks) continue to be supervised by their national supervisors, in close cooperation
with the SSM. The action of the SSM is framed by the SSM Regulation and the SSM Framework
Regulation, which specifies the functioning and powers of the SSM, within the remit of the broader
supervisory framework set at European level by the CRD and transposed in national laws.
56
For instance, the power to require institutions to have additional own funds in excess to those required
pursuant to Pillar 1 requirements; or the power to restrict or limit the business, operations or network of
institutions.
57
For instance, the withdrawal of a banking license.
58
For instance, fines paid to the supervisory authority.
59
The difference of approaches from MS in this area may come from, differences in their legal system
prior to the application of Union law, the structure of the national banking sector or the supervisory culture
of the MS.
20
necessary to further elaborate the rules and/or to introduce additional powers for
supervisory authorities. Consequently, these MS introduced additional provisions in their
national laws, making use of the discretion allowed under the CRD. This has led to a
situation where supervisors in different MS have different powers.
In the area of sanctioning powers, some MS included additional provisions in order to,
inter alia, sanction banks for breaches60
other than those contained in the minimum list
provided in the CRD61
, and determine administrative penalties62
incurred by banks in
case of breaches of CRD/CRR, including the maximum amount63
of administrative
penalties.
In the area of supervisory powers, some MS further specified the assessment of the
prudential soundness of banks in case of acquisitions of material holdings in entities
other than banks64
, material transfers of assets and liabilities between a bank and a third
party, and mergers or de-mergers with other banks.
As regards the supervision of members of a bank’s management body and of key
function holders65
, the CRD sets a number of principles to assess their suitability (‘fit-
and-proper assessment’). However, the CRD lacks details on how and when supervisors
should conduct fit-and-proper assessments of board members and how to identify the key
function holders and assess their suitability. While the publication of joint guidelines66
by
the EBA and the European Securities Markets Authority (ESMA) published in 2017 and
the guide to fit and proper assessments published by the SSM67
in 2018 improved the
harmonisation68
of practices across MS, material divergences in national laws remain.
For instance, the supervisors in some MS assess the suitability of board members only a
significant period of time after their appointment69
while in the majority of MS
supervisors perform this assessment prior to their appointment. In the case of key
function holders, some supervisors do not properly identify them and therefore do not
60
For instance, breaches of capital requirements, internal models approval and remuneration requirements.
61
The SSM estimates that for several significant institutions under its direct supervision breaches of
CRD/CRR requirements with material impacts cannot be sanctioned due to the lack of powers in the
relevant national laws.
62
Some MS introduced additional powers to impose periodic penalty payments, for instance daily
payments until the breach justifying this penalty has ended.
63
Some MS further specified the definition of ‘total annual net turnover’ (used in the determination of the
maximum amount of administrative penalties) since the CRD lacks details on the inclusion of important
elements reflecting the ordinary activities of institutions, for instance interest payables and similar charges,
commissions and fees, net profit on financial operations.
64
Some MS introduced an ex ante notification requirement for banks that allows supervisory authorities to
oppose the operation in case of prudential concerns.
65
According to the applicable EBA/ESMA guidelines key function holders means persons who have
significant influence over the direction of an institution, but who are neither members of the management
body and are not the CEO. They include the heads of internal control functions and the CFO, where they
are not members of the management body.
66
See https://www.eba.europa.eu/regulation-and-policy/internal-governance/joint-esma-and-eba-guidelines-
on-the-assessment-of-the-suitability-of-members-of-the-management-body.
67
See https://www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.fap_guide_201705_rev_201805.en.pdf.
68
For example, the Guidelines identified more specifically key functions holders as the heads of the
internal control functions and the CFO, where they are not members of the management body, and provide
provisions identify other key functions holders based on an assessment of their materiality by institution.
69
Assessment is carried out ex post in eight MS (DK, DE, EE, EL, FR, FI, IT, AT), and partially ex post in
four MS (CZ, PL, SI, SE).
21
carry out an assessment of their suitability to perform their duties, while other do it in a
variety of ways70
.
This fragmented regulatory landscape in the definition of certain powers and tools
available to supervisors and their application across MS undermines the level playing
field in the Single Market and raises doubts about the sound and prudent management of
EU banks and their supervision. This problem is particularly acute in the context of the
Banking Union, as already highlighted in the Commission’s report on the SSM71
.
Differences across 19 different legal systems prevents the SSM from performing its
supervisory functions effectively and efficiently72
. Moreover, as a result of the diverse
transposition of the CRD at national level, cross-border banking groups have to deal with
a number of different procedures for the same prudential issue, unduly increasing their
administrative costs. Banks as well as supervisors, in particular in the SSM, and MS have
therefore acknowledged the problem (for more details see Section 6.3. and Annex 2).
2.1.4. Fragmentation and inefficiency in the disclosure of banks’ prudential
information
Prudential regulation requires banks to publicly disclose financial and other quantitative
and qualitative information73
so that investors, clients, depositors and other interested
stakeholders can gauge their level of risk. Banks’ disclosure of financial information also
contributes to enhanced transparency and market discipline, thereby promoting sound
risk management.
In the Union, the CRR II implemented the revised BCBS framework74
on public
disclosure (also known as the ‘Pillar 3’ framework), and adjusted the content75
and scope
of bank disclosures to make them applicable to all EU banks in a proportionate manner.
Under the CRR II, the amount of information that banks need to disclose depends on the
size and complexity of their activities (the larger and more complex a bank is, the more
information it is required to disclose).
Banks are currently required to disclose all relevant prudential information in one single
document or a separate section of their financial report prepared under the applicable
accounting standards. Information on banks are therefore scattered on their individual
70
For instance, some MS will only identify key function holders as those performing anti-money
laundering or audit duties within an institution while others MS will rely on the definition provided in the
EBA/ESMA guidelines, or even extend the scope of this definition.
71
Cf. SWD(2017) 336 final.
72
On the issue of fit-and-proper assessments see the in-depth analysis requested by the ECON committee:
Is the current “fit and proper” regime appropriate for the Banking Union?, March 2020.
73
The institution’s capital and liquidity ratios are examples of the former, while a description of the
institution’s processes for managing credit risk is an example of the latter.
74
Pillar 3 requirements have been developed in stages and finalised in December 2018. For more
information, please be referred to https://www.bis.org/bcbs/publ/d455.htm.
75
With limited exceptions, the CRR currently gives institutions a certain degree of freedom in terms of the
detail of the information to be disclosed and a significant degree of freedom in terms of the format of the
disclosure. The entry into application of the amendments to the disclosure rules (introduced by the CRR II)
will bring about a significant harmonisation of disclosures. In particular, this will be done through
implementing technical standards to be developed by the EBA, which will contain detailed templates (and
related instructions to fill those templates) that institutions will need to use for their disclosures.
22
websites and other media platforms. However, stakeholders (e.g. investors making
investment decisions or analysts making recommendations to their clients) are interested
in gathering, analysing and comparing information across several banks.
At present, it is considered difficult and burdensome for these stakeholders to access and
aggregate this information. For example, available information on smaller, non-publicly
listed banks tends to be harder to find and is usually only available in the language of the
Member State in which the bank is established. The current difficulties related to the
access to prudential information deprive market participants from the information they
need about banks’ prudential situations. This ultimately reduces the effectiveness of the
prudential framework for banks and potentially raises doubt about the resilience of the
banking sector, especially in periods of stress.
In addition to having to disclose certain information, banks must also report certain
information76
to their supervisors as part of a separate process. Two separate processes to
share similar financial information imply undue administrative costs for banks77
; this also
makes these processes more vulnerable to a certain type of operational risk (i.e. the risk
of misalignment in the same type of information communicated through two different
channels).
Since 2018, the EBA, in cooperation with the ECB and national competent authorities,
has been working on the creation of the European Centralised Infrastructure for
Supervisory Data (EUCLID) to aggregate in a centralised integrated system the reporting
information shared by supervisors on the largest EU banks78
. This system will be
particularly useful to feed public reports and analysis with aggregated data and risk
indicators on the overall EU banking sector. However, the prudential framework does not
yet grant powers to the EBA to disclose individual bank data that is reported to
supervisors. Introducing those powers would allow banks to only report information to
their supervisors and the EBA which would then proceed to disclose the required parts of
that information on behalf of banks. Banks, in particular small and non-complex ones,
have repeatedly called to further reduce the administrative burden stemming from
reporting79
and disclosure requirements whereas other market participants (investors,
analysts) highlighted the need for a centralised and easy access to banks’ prudential
information.
2.2. How will the problems evolve?
As far as the deficiencies of internal models in the current framework for calculating
risk-based capital requirements are concerned, confidence in the risk based capital
requirements could be partially restored through the supervisory exercises run by the
76
There is an overlap between the information that must be disclosed and the information that must be
reported, although the amount of information that needs to be reported is normally much larger (and more
detailed).
77
The size of the undue costs cannot be estimated due to lack of data.
78
EUCLID is expected to be launched in 2021.
79
See, for example, https://op.europa.eu/en/publication-detail/-/publication/4b62e682-4e0f-11ea-aece-
01aa75ed71a1.
23
EBA and the ECB80
. Those exercises aim at ‘model repair’ by means of harmonising
certain modelling assumptions across EU banks. However, the completion of those
exercises could not fully resolve the issues, given the amount of flexibility the current
rules still provide banks to design their individual internal models. In addition, enhanced
supervisory review would not address the deficiencies identified in the standardised
approaches for calculating risk-based capital requirements. In this context it has to be
recalled that capital requirements calculated under the standardised approach represent a
significant share of total capital requirements across the Union.
In the absence of changes to address the identified deficiencies related to internal model
approaches, the risk-based capital requirements calculated by banks using those models
would remain incomparable across banks and in some cases may be too low in relation to
the risks of certain exposures. If the deficiencies related to the standardised approaches
would remain unaddressed, some financial products or activities (and hence specific
business models primarily based on them) would attract either insufficient or unduly high
capital requirements. In both cases the potential mispricing of risks by individual banks
and consequently the inadequate capitalisation of those risks by those banks would
persist.
As a consequence, some mistrust in the EU banking sector would persist with negative
consequences for banks’ market valuations and funding costs which could in turn
undermine their ability to finance the EU economy. The lack of confidence in the EU
banking sector could ultimately lead to a higher probability that future periods of stress,
whatever their origins, could turn into more severe financial crises.
As regards the capture of ESG risks in the prudential framework, the problems that
such capture could potentially address (i.e. inadequate management of ESG risks) would
become ever more pressing. Both transition risks and physical risks to banks would
inevitably increase as the economic restructuring gains speed and as environmental
events increase in magnitude and frequency. In the absence of timely legislative action to
address these problems (in addition to the limited measures included in CRR II and
elsewhere, see Section 2.1.2), banks might continue to misprice ESG risks, which would
in turn lead to inadequate financing of the transition to a more sustainable economy risks.
It could also lead to undercapitalisation of banks which could lead to financial stability
issues.
On the supervisory and sanctioning powers, in absence of a legal initiative the
discrepancies observed across national laws transposing the CRD would continue to
exist, maintaining the current fragmentation and the un-level playing field with regard to
the application of supervisory powers and the imposition of sanctions. This would have
negative consequences in two respects. On the one hand, some MS would maintain a
relative low degree of supervision, allowing some of their banks to perform certain
operations that could be risky, thus fuelling mistrust in the soundness of banks.
Furthermore, in some MS supervisors would still not be empowered to impose sanctions
80
See https://www.eba.europa.eu/regulation-and-policy/supervisory-benchmarking-exercises and
https://www.bankingsupervision.europa.eu/banking/tasks/internal_models/trim/html/index.en.html for
EBA and ECB, respectively.
24
for breaches of certain prudential requirements and would thus continue to lack an
important supervisory tool. On the other hand, other MS would continue to exercise the
legal flexibility available in the CRD in a more conservative manner. Additional
supervisory and sanctioning powers in these MS could incentivise some banks to carry
out certain activities in other MS without such powers. Finally, without a change, the
ECB/SSM would not be able to apply the same supervisory tools and exercise the same
powers to all banks under its supervision in a consistent way which would impede the
effectiveness of its supervision.
The existing inconsistencies and identified deficiencies of the application of fit-and-
proper requirements lead to a less effective and efficient supervision regime. In a
number of MS, members of the management body would continue to take up their
position without having been vetted upfront by supervisors. This involves the risk that
unqualified managers could contribute to key decisions for the banks’ businesses and its
risk management. In the absence of proper definitions of key function holders and rules
for their assessment the current un-level playing field across institutions within the Union
would continue to exist, creating reputational risk for EU banks and their supervisors,
undermining trust in the banking sector.
Finally, in the absence of actions to address the fragmentation and the inefficiency in
the disclosure of banks’ prudential information to the public, analysing and
comparing information on individual banks would remain burdensome and costly for the
relevant stakeholders and would continue to undermine the effectiveness of market
discipline. In addition, banks’ processes to report information to supervisors and to
disclose information to the public would continue to run in parallel, unduly maintaining
unnecessary administrative costs.
25
Figure 9: Mapping of problems, problem drivers and their consequences if not addressed
26
3. WHY SHOULD THE EU ACT?
3.1. Legal basis
All actions considered frame the taking up, pursuit and supervision of the business of banks
within the Union, with the objective of ensuring the stability of the internal market. One of
the fundamental components of the Union’s financial system, banking is currently providing
the largest part of financing within the internal market. The Union has a clear mandate to act
in the area of the internal market and the appropriate legal basis consists of the relevant
Treaty Articles81
underpinning Union competences in such area.
The legal basis falls within the internal market area, which is considered a shared
competence, as defined by Article 4 TFEU. Most of the actions considered represent updates
and amendments to Union law, and as such, they concern areas where the Union has already
exercised its competence and does not intend to cease exercising such competence. A few
actions (particularly those amending the CRD) aim to introduce an additional degree of
harmonisation in order to achieve consistently the objectives defined by that Directive.
3.2. Subsidiarity: Necessity of EU action
In the context of global cooperation on financial stability, supervisors and regulators meeting
within the BCBS, including from several EU Member States, the ECB, the EBA and the
Commission, have developed common international standards that members jurisdictions
should apply to their internationally active banks. Following the GFC, the BCBS launched a
fundamental review of the international standards to strengthen the resilience of the global
banking system and improve comparability across banks worldwide. A number of the revised
standards have already been incorporated into Union law by means of the CRR and the CRD
IV, as subsequently amended by the CRR II and CRD V. However, a number of additional
revisions adopted by the BCBS in December 2017 in relation to credit risk, operational risk,
CVA risk, market risks and the replacement of the Basel I floor by an aggregate output floor
have still to be transposed in Union law. These proposed revisions address remaining
shortcomings in the international prudential framework as identified during and after the
GFC.
The objectives pursued by those revisions of international standards can be better achieved at
Union level rather than by different national initiatives as they represent adjustments to the
EU prudential framework. The identified problems (see section 2.1.1) and the underlying
causes are similar across Member States and potential differences pertain to the behaviour
and business model of individual institutions, not their location within the Union. No action
by the Union would render the existing prudential framework outdated in relation to evolving
market challenges and would create major misalignments with standards applied by other
jurisdictions. This would have reputational, financial stability and market impacts.
81
The relevant Treaty Articles conferring the Union the right to adopt measures are those concerning the
freedom of establishment (in particular Article 53 TFEU), the freedom to provide services (Article 59 TFEU),
and the approximation of rules which have as their object the establishment and functioning of the internal
market (Article 114 TFEU).
27
The ability of Member States to adopt national measures to address the identified issues is
limited, given that the CRR and the CRD already regulate those aspects, and changes at
national level would not be able to derogate from Union law currently in force. If the Union
were to cease regulating those aspects, the internal market for banking services would
become subject to different sets of rules, leading to fragmentation and undermining the
recently built single rulebook in this area. National measures would affect the degree of
cross-border service provision, capital flows and market integration across Member States.
This would be detrimental to effectively ensuring financial stability in the internal market.
With regard to the current rules on supervision (e.g. fit and proper rules, supervisory powers
and sanctions), the current national laws supplementing the prudential framework have
displayed some substantial differences. The absence of sufficient common rules does not
allow for a level-playing field, potentially fuelling regulatory or supervisory competition.
Also, in the context of the Banking Union, where the ECB exercises direct supervisory
powers set out in national laws transposing the CRD, the ECB does not have the same range
of powers with regard to all banks under its supervision. The objective of efficient and
harmonised supervision throughout the Union cannot be achieved by individual MS actions.
3.3. Subsidiarity: Added value of EU action
There are clear benefits from action at Union level. The Union’s prudential framework for
banks would be aligned with the latest international standards, thus becoming more fit for
purpose and ensuring a greater resilience of the Union’s banking sector. It is more efficient to
change the current Union rules than repealing them and replacing them with national rules.
EU action also allows for a more homogenous approach, taking into account all EU
specificities in a comprehensive way.
As regards those aspects that would supplement existing rules (e.g. fit and proper rules,
supervisory powers, sanctions) additional harmonisation will contribute to a more
homogenous approach and reduce the fragmentation of the internal market. At the same time
EU action contributes to establishing a level playing field and a higher quality of supervision
across the Union.
4. OBJECTIVES: WHAT IS TO BE ACHIEVED?
4.1. General objectives
There are two general objectives pursued by this initiative:
1. Contributing to financial stability. Only a stable and financially sound banking system,
which is well capitalised and where risks are adequately managed, will lead to a reduced
probability of banking crises, and reduce the impact of such crises should they occur. This
will in turn allow to maintain investors’ and depositors’ confidence in the banking
system, especially in periods of stress.
2. Contributing to steady financing of the economy in the context of the recovery post-
COVID-19 crisis. The EU economy is heavily reliant on financing provided by the
28
banking sector. While initiatives are underway to develop a Capital Markets Union
(CMU) that might over time reduce this reliance, the banking sector will in particular play
a key role in financing the medium-to-long term recovery from the COVID-19 crisis.
4.2. Specific objectives
The two general objectives pursued by this initiative can be broken down into the following
four specific objectives:
1. Strengthen the risk-based capital framework, without significant increases in capital
requirements. To ensure a resilient and stable banking system, it is essential to have a
solid prudential framework in place which ensures that risks are accurately measured and
adequately covered by capital. In particular, trust in the banking system is conditional
upon trust in the reliability of the risk-based capital framework. Internally modelled
approaches that EU banks use for calculating risk-based capital requirements should
result in adequate capital levels and produce comparable outcomes. At the same time the
prudential framework should provide robust and sufficiently risk-sensitive standardised
approaches for banks using them. However, strengthening the risk-based capital
framework should not come at the cost of significantly increasing capital requirements as
requested by the EU Parliament and the Council82
.
2. Enhance the focus on ESG risks in the prudential framework. Including a
sustainability dimension in the prudential framework would ensure a better management
of ESG risks and a better allocation of bank funding across projects, thus helping the
transition to a more sustainable economy.
3. Further harmonise supervisory powers and tools. Supervisory tools such as fit-and-
proper assessments, supervisory powers and sanctioning powers play a key role in
ensuring the safety and soundness of individual banks and the stability of the EU banking
system as a whole. Certain tools should therefore be made available to supervisors in all
Member States and applied consistently. This would also help reduce administrative costs
resulting from the current fragmentation.
4. Reduce banks’ administrative costs related to public disclosures and improve access
to banks’ prudential data. Public information on individual banks that is easily
accessible and comparable should enhance the ability of bank clients, investors and other
market participants to monitor and exert market discipline on banks’ behaviour. Banks in
turn would benefit from a more efficient system that integrates supervisory reporting and
disclosure, and thereby reduces their administrative burden.
82
See https://www.europarl.europa.eu/doceo/document/TA-8-2016-0439_EN.pdf for the EP and
https://www.consilium.europa.eu/media/22659/st11052en16.pdf for the Council.
29
5. WHAT ARE THE AVAILABLE POLICY OPTIONS?
5.1. What is the baseline from which options are assessed?
The baseline option from which the considered policy options are assessed assumes no
legislative change to the prudential framework applicable at Union level.
Under this option, the structural shortcomings of internal models of the current prudential
framework as described in Section 2.1.1 would remain unaddressed, and the Commission
would solely rely on the supervisory initiatives taken by the EBA and the ECB under their
current remits to improve the situation. In addition, the EBA will continue performing its
annual supervisory benchmarking exercises on credit and market risk internal models to
highlight the degree of variability of EU banks’ internal models. The EBA and ECB
initiatives could achieve to some extent a reduction of the variability in capital requirements
calculated based on internal models for credit, counterparty and market risks83
. While acting
as important complements, these supervisory initiatives cannot substitute for the necessary
reforms of the binding requirements included in the current prudential framework. Without
those reforms, the problems described in Section 2.1.1 would continue to exist.
In the same vein, without changes to the standardised approaches, they would remain
insufficiently risk-sensitive. Since those standardised approaches are legally binding, they are
virtually identical for all banks that apply them. Therefore initiatives employed by
supervisory authorities cannot be used to tackle the deficiencies identified in Section 2.1.1.
Moreover, under this scenario, the only binding requirement related to ESG risks that would
apply would be the requirement for large banks to disclose information on those risks from
end-June 2022 onwards, as highlighted in Section 2.1.2. While competent authorities will
continue to be able to exercise their Pillar 2 powers to require banks to address ESG risks,
due to the lack of an explicit reference to those risks in the CRD, those powers will not be
applied systematically and consistently. Any additional requirements that the EBA may
propose in the reports due in 2021 and 2025 (see Section 2.1.2) would require legislative
action.
Not changing legislation would also mean that divergences among MS in the area of
supervisory powers made available to competent authorities under the CRD, identified in
Section 2.1.3, would persist. For example, the prudential framework would still not require
MS to give competent authorities powers to sanction certain types of regulatory breaches.
Furthermore, there would be no legal requirement for an intervention in the case of specific
situations that could raise prudential concerns, such as the acquisition of material holdings in
entities other than banks, material transfers of assets and liabilities, and (de-)mergers. MS
would still have ample leeway to grant the competent authorities these supervisory powers at
their own discretion. The CRD would also still not require competent authorities to assess the
suitability of key function holders. At the same time, the prudential framework would
continue to lack specifications on how competent authorities should conduct fit-and-proper
assessments. As a result, the rules would remain subject to broad margins of interpretation by
83
Internal models used to calculate capital requirements for operational risk are not covered by TRIM.
30
MS, leaving clearly identified prudential concerns unaddressed. The initiatives conducted by
the EBA and the ECB/SSM (see Section 2.1.3) could help increase the harmonisation of the
fit-and-proper assessment across Member States but, only if MS would empower supervisors
by amending their national frameworks. In absence of such national empowerments,
inadequate supervision of key function holders would persist in some MS, as associated with
the risks of employing unsuitable individuals as members of the management body.
Finally, under this scenario of no change to the current prudential framework, banks’
investors and other stakeholders interested in banks’ prudential information would still find it
burdensome to collect such information on individual banks’ platforms. In addition, banks
would continue to have to follow two separate processes to report and disclose the required
information, which would continue to generate an undue administrative burden for them, as
described in Section 2.1.4.
5.2. Description of policy options
5.2.1. Improve the current framework for calculating risk-based capital
requirements
Option 1 - Implement the Basel III reforms in full alignment with the BCBS standards and
implementation timelines
This option would implement in Union law the final elements of the Basel III reform
(adopted by the BCBS between December 2017 and July 2020) in full alignment with the
standards and the timelines agreed by the BCBS. The agreement was the result of a strategic
review of the international prudential standards for banks, which was conducted by the BCBS
in the wake of the GFC, with a view to improving the balance between simplicity,
comparability (mainly of the internal model approaches) and risk-sensitivity (mainly of the
standardised approaches) of those standards.
This option would entail implementing the final elements of the Basel III reform agreed in
December 2017, namely:
 the revisions to the standardised approach for credit risk (SA-CR) to improve the
robustness and risk sensitivity of the existing approach;
 the revisions to the IRB approaches for credit risk to reduce unwarranted variability in
banks’ calculations of RWAs;
 the minimum haircut floors for non-centrally cleared securities financing transactions84
(SFTs) to limit the pro-cyclicality of these transactions and the build-up of excessive
leverage in the financial system;
84
SFTs are secured funding or lending transactions that imply a temporary exchange of assets with one leg of
the transaction serving as a guarantee (collateral). Repurchase agreements (repos) constitute the most important
category of SFTs in terms of outstanding amounts and turnover. They are generally motivated by the need to
borrow cash. From the borrower's point of view, the transaction consists of selling securities against cash, while
agreeing in advance to buy back the securities at a predetermined price. The sold securities serve as collateral
for the buyer (provider of cash) in the repo. Securities lending, the second largest category of SFTs, is primarily
driven by market demand for specific securities, e.g. for short selling or settlement purposes. In this type of
31
 the revisions to the CVA risk framework consisting of the removal of the use of an
internally modelled approach and the introduction of a new basic approach (BA-CVA) as
well as revisions to the standardised approach for CVA (SA-CVA) to enhance the risk
sensitivity, strengthen the robustness and improve the consistency of the framework;
 the new standardised approach for operational risk (SA-OR), replacing all the existing
standardised and internal model approaches for this risk to simplify the framework and
increase comparability; and
 the aggregate output floor (OF) to limit the unwarranted variability in the regulatory
capital requirements produced by internal models and the excessive reduction in capital
that a bank using internal models can derive relative to a bank using the revised
standardised approaches.
In addition, this option would implement the revised85
(i.e. January 2019) version of the
original (i.e. January 2016) market risk standards, known as the ‘fundamental review of the
trading book’ (FRTB), for the purpose of calculating capital requirements. Most of the
revised FRTB standards have already been implemented in EU law as part of the CRR II.
Following an agreement between the European Parliament and the Council, they were
implemented for reporting purposes only (i.e. banks are not required to use them to determine
their capital requirements). Under this option they would be converted into a capital
requirement, fully aligned with the final 2019 standards.
transaction, one counterparty lends securities for a fee against collateral in the form of cash or other securities
given by another counterparty.
85
Apart from modifying the calibration of the original FRTB standards, the revised version also aligned the
implementation date of the standards with the implementation date of the overall framework (the date was
originally set to January 2019).
32
Table 1 below presents a more detailed list of the key elements of the reforms included in the
December 2017 agreement, as well as the revised market risk framework adopted in 2019.
This option would address the main deficiencies, identified in Section 2.1.1, with the current
prudential framework for calculating risk-based capital requirements applicable to EU
banks86
. At the same time, this option would entail no adjustments to the final Basel III
standards to cater for specificities of the EU economy and would also remove some of the
EU-specific rules currently in place to fully align the EU prudential framework with those
standards (e.g. it would remove the exemptions from the CVA risk charge and the small and
medium-sized enterprise (SME) supporting factor).
86
Note that the final elements of the Basel III reform were not specifically intended to address the problems
identified with the risk-based capital requirements of EU banks; the same problems have been identified with
their international peers with similar business models and activities. When developing the reform, the BCBS
took a rather global approach in addressing those problems, therefore not necessarily taking into account the
specificities of the banking sector of each of the BCBS members.
33
Table 1: Overview of the main revisions to the Basel framework introduced by the final
elements of the Basel III reform.
Risk area Main revisions
Credit risk –
standardised
approach
 For rated exposures to banks, some of the RWs have been recalibrated. In addition,
the RW treatment for unrated exposures to banks is more granular than the existing
flat RW, which depends on the RW applicable to the central government of the
Member State in which the bank is established.
 For exposures to corporates, a more granular RW treatment has been developed. In
addition, a specific treatment for exposures to project finance, object finance and
commodities finance was developed.
 For real estate exposures (both residential and commercial), more risk-sensitive
approaches have been developed to better reflect different funding models and stages
in the construction process.
 For retail exposures, a more granular treatment was developed, which distinguishes
between different types of retail exposures and reflects FX risk.
 For subordinated debt and equity exposures, a more granular and generally stringent
RW treatment was developed.
 For off-balance sheet items, a more risk-sensitive treatment was developed, which is
more stringent for unconditionally cancellable commitments.
Credit risk –
internal
models
approach
 The possibility to use of internal models was either limited or altogether removed for
portfolios and risk parameters where the BCBS had concluded that the available data
was insufficient to ensure reliable modelling (i.e. exposures to financial institutions
and large corporates, equity exposures).
 New minimum values (‘input floors’) were introduced for banks’ estimates of the
probability of default, loss-given default and exposure at default (EAD).
 The option for banks to pick and choose between the use of internal models and the
standardised approach per asset class was introduced.
Market risk
(FRTB)
 More objective rules were introduced to allocate transactions either to the trading
book, or to the banking book.
 Both the standardised approach and the internal model approach were be completely
overhauled to better capture market risk.
 New tests were introduced to ensure the robustness of the internal models and leave
less flexibility for banks to use their own modelling assumptions.
CVA risk  Internal models were replaced by standardised approaches, leaving banks with a
choice between a more sophisticated and a simpler approach.
 For banks with non-centrally cleared derivatives contracts with a combined notional
value of less than EUR 100 bn, a simplified approach was made available.
Securities
Financing
Transactions
 For certain non-centrally cleared SFTs with certain counterparties, minimum haircut
floors were introduced; as a result SFTs which do not meet the haircut floors must be
treated as unsecured loans.
Operational
risk
 The current internal model approach and the three existing standardised approaches
were replaced with a single risk-sensitive standardised approach to be used by all
banks.
 The capital requirement under the new standardised approach depends on the size of
the bank (expressed in terms of a refined measure of gross income) and the bank’s
operational risk-related loss history.
Output floor  A revised output floor was introduced. The floor sets a lower limit to the capital
requirements that are produced by a bank’s internal model at 72.5% of the capital
requirements that would apply if the bank would calculate its capital requirements
using standardised approaches87
.
87
For more details on the level of application see section “Flexibility in the Basel III standards” below.
34
Option 2 - Implement the final Basel III reforms with EU-specific adjustments and in
alignment with the BCBS implementation timelines
Similar to option 1, option 2 would also implement all the final elements of the Basel III
reform. Compared to option 1, this option would include a number of targeted adjustments to
cater for the specificities of the EU banking sector and the funding structure of the EU
economy, and taking into account the context of the recovery, with the objective to avoid
disproportionate impacts or unintended consequences of the reforms on essential activities
and financial services provided by EU banks. In fact, the Basel standards are designed to
capture common financial risks that can be observed across the world. They are calibrated
based on averages of data collected across banks and financial markets located in different
regions of the world. As a result, the capital requirements under some Basel standards may
not capture more specific financial risks appropriately which could lead to disproportionate
impacts on the corresponding financial activities. In addition, a few other targeted
adjustments under this option would help to ensure an international level playing field for
trading activities. Finally, this option would also make use of the flexibility the international
standards provide in order to harmonise their application across the Union, in line with the
objectives set out for this legislative proposal.
Specificities of the EU banking sector and EU economy
EU businesses (and in particular SMEs, see also Section 3 of Annex 6) rely heavily on bank
lending to finance their investment and working capital needs, much more than in other major
jurisdictions. However, the international standards do not always sufficiently take into
account the specific financing structures and risk management strategies used in the EU. To
address this issue, option 2 includes several targeted adjustments:
 Treatment of unrated corporates: corporate lending in the EU is predominantly provided
by banks using IRB models. With the implementation of the OF those banks would also
need to apply the SA-CR which relies on external ratings to determine the credit quality
of the corporate borrower. Most EU corporates, however, do not typically seek external
credit ratings, due to the cost of establishing a rating88
and other factors89
. Given that
capital requirements calculated under the SA-CR are, on average, more conservative for
unrated corporates than for corporates that have a rating,90
the implementation of the OF
could cause substantial increases in capital requirements for banks using internal models
(because the standardised approach would be used to calculate the OF). To avoid
disruptive impacts on bank lending to unrated corporates and provide enough time to
88
For example, according to one provider of credit ratings the average cost of obtaining a rating for an SME is
approximately between EUR 40000 and 50000 for the initial evaluation, and then EUR 30000 to 35000 annually
for keeping the rating updated. However, these figures are only indicative, as the cost depends on various
factors, such as the complexity of the company, its financial structure, and the size of the debt issue.
89
For example, according to one ratings provider some of the other reasons why SMEs do not seek to obtain
ratings are the availability of financing from banks (ratings are usually sought when debt is sold in the markets),
unmet expectations about the quality of the assigned ratings (ratings turn out worse than the company issuing
the debt expects), and reluctance to make financial data available.
90
A bank’s exposure to an unrated company is assigned a 100% risk weight under the SA-CR, whereas an
exposure to a company with a good credit rating can attract a lower risk weight (20% in case of the highest
rating).
35
establish public and/or private initiatives aimed at increasing the coverage of credit
ratings, option 2 would introduce a transitional period. During this period banks using
internal models could apply a favourable treatment when calculating their OF for
exposures to unrated corporates. This transitional arrangement would be coupled with an
empowerment for the Commission to further extend the length of the period, based on a
report by the EBA. This would ensure sufficient access to bank funding by unrated
corporates during the transition period, as banks could continue to apply lower capital
requirements whilst initiatives to foster widespread use of credit ratings would be
established. After the transition period banks would refer to credit ratings to calculate
capital requirements for most of their exposures to corporates in accordance with the
Basel III standards. More details about this specific issue and the dedicated adjustment to
address it are provided in subsection 1.1.1 of Annex 5.
 SME supporting factor: Given their fundamental role in creating jobs and economic
growth in the EU, EU co-legislators decided that capital requirements for SME exposures
should be lower than those for large corporates to ensure appropriate bank financing of
SMEs. As a result, an SME supporting factor was introduced in the CRR and its scope
extended in CRR II91
. Option 2 would maintain this SME supporting factor in the
prudential framework, which would result in lower capital requirements for SMEs than
the specific treatment provided by the Basel III standards.
 Infrastructure supporting factor: bank financing of infrastructure and other specialised
projects is also a defining characteristic of the EU economy, as compared with other
jurisdictions where such projects are predominantly financed by capital markets. Large
EU banks are major providers of funding for specialised projects92
, objects finance93
and
commodities finance94
, in the EU and globally. They have developed a high level of
expertise in those areas. A preferential treatment has been introduced in CRR II to foster
bank finance and private investment in high quality infrastructure projects (‘infrastructure
supporting factor’). Option 2 would maintain this treatment, which would result in lower
capital requirements for infrastructure projects than the specific treatment provided by the
Basel III standards. Furthermore, a new preferential treatment under the standardised
approach for “high quality” object finance would be introduced. It would apply where
financial risks are specifically managed. Conflicting signals to banks active in this market
segment should be avoided.95
This option would also empower the Commission to adopt
delegated acts that would adjust the internal models approach, if such adjustment would
91
As a result of CRR and CRRII, banks can now apply a 23.81% discount when computing their capital
requirements on SME exposures of up to EUR 2.5mn EUR whereby the part of an SME exposure exceeding
EUR 2.5mn EUR are subject to a 15 % reduction in capital requirements (so-called SME supporting factor).
92
Namely, loans funding long-term important infrastructure or industrial projects.
93
Namely, loans funding the acquisition of physical assets such airplanes, ships, satellites, railcars, fleets, etc.
94
Namely, financing exchange-traded commodities like crude oil, metals or crops.
95
This would avoid undermining incentives for proper risk-mitigation of those transactions, for instance through
close monitoring and various forms of collateralisation. The EBA would be mandated to develop criteria to
determine what constitutes a high-quality project and to determine the calibration of the applicable RW.
36
be found appropriate based on a comprehensive assessment by the EBA during the
implementation period.
 Equity exposures: Many EU banks hold long-standing, strategic96
equity participations in
financial and non-financial corporates. The final Basel III standards increase the RWs for
all kinds of equity exposures over a 5-year transition period without providing a specific
treatment for strategic equity investments. Applying the more conservative approach
embedded in the Basel III standards to the whole stock of existing equity holdings could
jeopardise the economic viability of existing strategic relationships. Option 2 would
exclude equity holdings in entities within the same banking group or covered by the same
institutional protection schemes (IPS)97
from the application of the more conservative
treatment. In addition, it would grandfather existing strategic participations where banks
exercise influence, including via holdings in insurance undertakings, whilst applying the
new, more conservative treatment to new equity exposures. More details about this
specific issue and the dedicated adjustment to address it are provided in subsection 1.1.3
of Annex 5.
 Treatment of Collective Investment Undertakings98
(CIUs) used for trading purposes:
CIUs play a crucial role in facilitating the accumulation of personal savings, whether for
investments or for retirement. The seamless provision of CIUs as investment product
hinges on banks’ ability to continuously offer to their clients the possibility to buy or sell
back those instruments. For that purpose, banks must keep inventories of CIUs in their
trading books. The revised market risk standards adopted in 2019 rely on a number of
conservative assumptions and complex operational requirements99
that could increase
significantly the capital requirements for those instruments, therefore restricting their
supply. To avoid this unintended effect on those trading activities, Option 2 would
provide a number of adjustments to the treatment of CIUs under the market risk rules.
More details about this specific issue and the dedicated adjustment to address it are
provided in section 1.3 of Annex 5.
 Treatment of financial products based on the EU emission trading scheme (ETS): banks
play an important role in providing liquidity to the EU market for carbon emissions
allowances. Banks typically fill their clients’ estimated demand for allowances at a future
date via derivatives (‘forward’) transactions. Under the revised market risk rules, the
exposures to carbon emission allowances are assimilated to electricity contracts, and
96
E.g. investments in equities of corporates with which the bank has a long-term business relationship.
97
An institutional protection scheme (IPS) is defined in the CRR as a contractual or statutory liability
arrangement which protects its member institutions and in particular ensures that they have liquidity and
solvency needed to avoid bankruptcy where necessary.
98
Under CRR, a “CIU” means an Undertakings for Collective Investments in Transferable Securities (UCITS)
as defined in Article 1(2) of Directive 2009/65/EC of the European Parliament and of the Council or an
alternative investment fund (AIF) as defined in point (a) of Article 4(1) of Directive 2011/61/EU of the
European Parliament and of the Council.
99
As described in Annex XX, these requirements include the restricted permission to capitalise exposures to
CIUs under the internal model approaches only if the bank can look through the CIUs’ composition and the
conservative calibration of some of the standardised approaches available for those exposures.
37
therefore get allocated to the same risk weight (60%). In light of the historical price
volatility of EU ETS, this risk weight appears excessively high. Furthermore, in its
Communication100
on fostering openness, strength and resilience of the European
economic and financial system, the Commission announced its intention to support
further ETS trading activity in the EU, notably as part of the ‘green’ transition101
. Option
2 would therefore introduce a specific category for ETS allowances, distinct from
electricity, for which RWs would be calibrated to reflect the actual price volatility of this
commodity in the EU ETS market. More details about this specific issue and the
dedicated adjustment to address it are provided in section 1.3 of Annex 5.
 Exemptions from capital requirements for CVA risk: When implementing the initial
Basel III reforms in Union law through the CRR, the EU co-legislators exempted certain
transactions102
from the calculation of capital requirements for CVA risk. These
exemptions were agreed to prevent a potential excessive increase in the cost of some
derivative transactions triggered by the introduction of the capital requirement for CVA
risk, particularly when banks could not mitigate the CVA risks of certain clients103
. While
the introduction of the revised capital requirement for CVA risks adopted as part of the
final elements of the Basel III reform would improve to some extent the risk-sensitivity of
the standardised approaches for CVA risks, the level of capital requirements would still
remain very high for the exempted transactions, notably due to the removal of the internal
model approach for CVA risk. In this context, Option 2 would maintain the existing CRR
exemptions. To help supervisors monitoring the CVA risks arising from the exempted
transactions when they are excessive, option 2 would require institutions to report to their
supervisors the calculation104
of capital requirements for CVA risks of the exempted
transactions. In addition, option 2 would introduce EBA guidelines to help supervisors to
identify excessive CVA risk. More details about this specific issue and the dedicated
adjustment to address it are provided in section 1.5 of Annex 5.
 Introduction of the minimum haircut floor framework for non-centrally cleared SFTs:
SFT markets play an essential role105
in the EU financial system by allowing financial
institutions to manage their own liquidity position and support their securities market-
making activities, as well as central banks to transmit, via financial institutions, their
monetary policy plans to the real economy. However, SFTs can also enable market
participants to recursively leverage their positions by reinvesting cash collateral and re-
using non-cash collateral, respectively. To address some concern with respect to the risk
100
COM(2021) 32 final.
101
For specific policy options to deliver on the EGD by addressing ESG risks see next section.
102
The exemptions cover derivative transactions with certain non-financial companies, governments, pension
funds, but also intragroup transactions within the same banking group.
103
These situations arise where banks could not put exchange collateral on derivative transactions with their
clients or where they cannot find guarantee provided by third-parties (e.g. via credit derivatives) to protect them
from the non-payment of the clients obligations under the derivative transactions.
104
That is the calculation of capital required for CVA risks if the transactions were not exempted under CRR.
105
As an example of the importance of the EU SFTs market, the total value of the EU repo market (the most
widely traded form of SFTs in the EU) amounted to around EUR 8.3 trillion at the end of 2019, according to the
ESRB.
38
of build-up of excessive leverage outside the banking sector, the Financial Stability Board
(FSB) published106
in 2013 a recommendation to its member jurisdictions to introduce
minimum collateral haircuts for some non-centrally cleared SFTs traded between banks
and non-banks, either, at the discretion of each jurisdiction, directly via a market
regulation or indirectly via a more punitive capital requirement that was later developed
by the BCBS107
. Presently there is still a lack of certainty about the impact of
implementing this FSB recommendation on the EU SFTs market and whether its
prudential objective could be attained without creating undesirable consequences. In this
context, option 2 would propose to delay its implementation in the EU until the EBA and
ESMA provide in the coming years a joint report to the Commission assessing its impact
and recommending the most appropriate approach. More details about this specific issue
and the dedicated adjustment to address it are provided in section 1.6 of Annex 5.
International level playing field for trading activities.
Banks trading activities in wholesale markets can easily be carried out across borders (for
certain activities, even between the EU and non-EU countries). The capital requirements
applied to these activities should therefore converge as much as possible across jurisdictions
to avoid a potential competitive advantage for those banks for which the domestic rules are
more lenient.
In this context, option 2 would turn the existing reporting requirement for market risk based
on the BCBS FRTB framework into a capital requirement, as proposed under option 1.
However, option 2 would contain a safeguard that would allow addressing disruptions to the
playing field for EU banks’ trading activities that could materialise if other major
jurisdictions would delay the implementation of the FRTB framework or adjust its
calibration108
. Specifically, option 2 would introduce an empowerment for the Commission to
delay, if necessary, the application of the capital requirement based on the FRTB framework
and/or to adjust its calibration considering international developments. More details about
this specific issue and the dedicated adjustment to address it are provided in section 1.3 of
Annex 5.
A second adjustment under option 2 would address the conservative calibration of the
standardised approach for counterparty credit risk (SA-CCR) currently applied to derivative
transactions and already transposed109
in Union law by means of the CRR II. At the time of
adoption, the EU co-legislators requested the EBA to report by June 2023 on the current SA-
106
FSB: Strengthening Oversight and Regulation of Shadow Banking, 29 August 2013.
107
The implementation of this FSB recommendation has been aligned with the implementation of the Basel III
reforms, including the one-year postponement to 1 January 2023.
108
Hong Kong and Singapore publically announced the application of the final FRTB standards as a reporting
requirement from 1 January 2023 and committed to implement the standards as a capital requirements at a later
stage. Other jurisdictions have already publically indicated a delay of the application of the final FRTB
standards as capital requirement, as compared to the BCBS recommended implementation date: Q3 2023 for
Japan; 1 January 2014 for Canada and Australia. Finally other major jurisdictions (e.g. US, CH) have publically
announced their commitment to implement the FRTB framework as capital requirements without more details at
this stage.
109
The Basel standards for SA-CCR were adopted in 2014.
39
CCR calibration. Subsequently, in the Capital Market Recovery Package110
they requested
the Commission to review the appropriateness of the SA-CCR calibration by June 2021.
Considering that at least one major jurisdiction111
has already lowered the calibration of SA-
CCR for certain types of derivatives transactions, option 2 would temporarily lower the
existing calibration of SA-CCR for all derivatives transactions when calculating the OF. This
would provide sufficient time to further discuss this issue at international level. More details
about this specific issue and the dedicated adjustment to address it are provided in section 1.7
of Annex 5.
Flexibility in the Basel III standards
The Basel standards usually leave some flexibility for their local implementation, either by
explicitly allowing jurisdictions to choose between different implementation options at their
own discretion or by implicitly not providing all the technical details for the
operationalisation of the standards. Option 2 proposes to make use of this flexibility and
would implement those discretions in a harmonised manner.
First, the introduction of the OF in the prudential framework represents one of the key
elements of the final Basel III reform, aimed at reducing the excessive variability of banks’
capital requirements calculated with internal models and thereby enhancing the comparability
of capital ratios. The Basel III standards arguably leave some room for interpretation as
regards the requirements112
to which the OF should apply and, in case of banking groups, the
level113
at which it should apply. Under option 2, the OF would include all the existing capital
requirements in scope of Union law, including the systemic risk buffer (SyRB) requirement
and the P2R imposed on EU banks by the relevant authorities (i.e. competent authorities or
designated authorities). This is coherent with the current prudential framework and consistent
with the objective of the OF. In order to avoid disproportionate capital impacts, while still
strengthening financial stability and complying with the Basel III standards, option 2 would
also prescribe that any overlap between the risks captured by the OF and the risks captured by
any of those two requirements must be avoided114
.
Moreover, the Basel standards, including the OF, apply foremost at the level of a banking
group (consolidated level). In the EU prudential framework, capital requirements usually
apply both at the level of individual banks/subsidiaries (individual/solo level) and at
110
See EUR-Lex - 32021R0337 - EN - EUR-Lex (europa.eu)
111
In their implementation of SA-CCR adopted in November 2019, the US authorities introduced a number of
adjustments to the Basel standard which would reduce the capital requirements of some derivate transactions
with corporates by about 30%.
112
More specifically the Basel III standards refer to the Pillar 1 requirements, the capital conservation buffer
requirement, the countercyclical capital buffer requirement, as well as the buffer requirements for global
systemically-important and, respectively, other systemically-important institutions (G-/O-SIIs) and the total
loss-absorbing capacity (TLAC) requirements. However, they do not include a reference to the systemic risk
buffer requirement (SyRB) and the Pillar 2 requirement (P2R), as these are not implemented, or not
implemented in comparable ways, in all member jurisdictions of the Basel Committee.
113
Capital requirements can be calculated at the level of individual banks (“individual level”) or at the level of a
banking group (“consolidated level”). The Basel standards, including the OF, apply foremost on a consolidated
level. The requirements in the CRR are principally applied at both individual and consolidated level.
114
The relevant authority would do this by adjusting the calibration of the requirement that would be found to
double-count the risks already covered by the OF.
40
consolidated level. Some concerns have been raised that certain EU banking groups would
incur an excessive increase in capital requirement due to the introduction of the OF if it were
applied at solo level, in addition to its application at consolidated level. In this context, option
2 would introduce the OF at consolidated level only. However, to adequately capture the risks
of both parent entities and their subsidiaries, whilst remaining consistent with the logic of the
Single Market, option 2 would require any additional capital resulting from the application of
the OF at consolidated level to be distributed fairly across the various entities of the group
according to their risk profile as if the OF was applied at individual level115
.
More details about the impacts of the output floor and the different implementation options
are provided in section 1.8 of Annex 5.
In addition, the revised standardised approach for operational risk (SA-OR) introduced a
discretion to allow jurisdictions to disregard the inclusion of banks’ own historical losses
related to operational risk through the Internal Loss Multiplier (ILM) indicator in their
calculations of capital requirements for operational risk under this approach116
. While there is
empirical evidence showing that banks experiencing greater operational risk losses
historically are more likely to experience operational risk losses in the future, the events that
have led to the largest operational losses are less amenable to prediction based on historical
loss data than for other types of risks. For this reason, option 2 would exercise the discretion
provided by the Basel III standards and set the ILM to 1. More details about this specific
issue and the dedicated adjustment to address it are provided in section 1.4 of Annex 5.
Finally, option 2 would also exercise the flexibility provided in the Basel III standards to
clarify that holdings of unlisted equities with a holding period of at least 3 years would not be
considered as speculative holdings and would therefore not be subject to the most
conservative treatment.
Option 3 - Implement the Basel III reforms with EU-specific adjustments and transitional
arrangement adapted to the COVID-19 crisis
This option would mirror option 2, but with a later date of application of the reform. Instead
from 1 January 2023, the reform would apply from 1 January 2025, followed by a 5-year
transitional period as proposed by the BCBS. This would lead to the full application of the
reform by 1 January 2030.
Option 3 would fulfil EU’s commitment to implement the international standards, and
provide certainty for banks’ capital planning and lending decisions, whilst at the same time
leaving them more time to comply with the revised capital requirements. The extended
implementation period would allow banks to focus on managing their financial risks
115
This means that the distribution key for any additional capital required by the OF would depend on the
contribution of each entity to the consolidated floor requirement.
116
The inclusion of banks’ own historical losses through the ILM indicator would either increase their capital
requirement for operational risk in case the banks suffered large operational risk losses in the past (in this case
ILM would be higher than 1) or decrease it if banks did not suffer such losses (in this case ILM would be lower
than 1). A supervisory discretion introduced in the Basel III standards allows supervisors to set ILM to 1 for all
banks in their jurisdictions, in order to disregard banks’ own historical losses as a driver of the level of their
capital requirement for operational risk.
41
stemming from the COVID-19 crisis and financing the recovery and give them enough time
to adjust before the reform would reach its full effect. In addition, to reinforce the signal that
banks would have ample time throughout the recovery phase to adjust to the new rules and
thereby help avoid that other market participants would put pressure on banks (in particular
the few most impacted banks) to frontload117
the new requirements, this option would entail
dedicated communication efforts to explain the additional implementation period.
5.2.2. Dedicated capture of ESG risks in the prudential framework
Option 1 - Introduce measures for a better management of ESG risks by banks
Under this option, several measures would be introduced to improve the management of ESG
risks by banks and to reinforce the specific review by bank supervisors as well as the degree
of market discipline, without directly targeting banks’ minimum capital requirements. These
measures would aim to improve the resilience of banks to ESG risks and increase bank
funding of sustainable activities by means of an improved understanding of the risks involved
and an anticipation of expected market pressures.
As regards risk management, there is currently no explicit requirement for banks to have in
place internal processes to manage ESG risks, nor an explicit requirement for ESG risks to be
part of the supervisory review and evaluation process (SREP). Under this option, the current
CRD V mandate for the EBA to issue a report to assess the inclusion of ESG risks in the
SREP would be reinforced by explicitly requiring supervisors to ensure that banks manage
ESG risks adequately. To the same end, the EBA's mandate would be clarified to require an
assessment of how such risks should be included in the SREP via guidelines. Finally, the
EBA would be mandated to specify further how ESG risks should be identified, measured,
managed and monitored. This would include internal stress tests on banks’ resilience to
climate change risks and long-term negative impacts.
The annual stress tests performed by supervisors are an important tool to gauge the viability
of banks under adverse conditions. At present, the CRD requires supervisors to perform
annual stress tests on the banks they supervise, while the EBA is mandated to define a
common stress test methodology via guidelines. Under this option, this requirement would be
extended to include regular climate change stress tests and to mandate the EBA together with
the other ESAs to develop a methodology for that purpose.
In the area of disclosure, the disclosure requirements related to the disclosure of ESG risks
would be extended to a larger universe of banks (i.e. beyond large, listed banks to whom the
existing requirement will apply from 2022) while respecting the proportionality principle.
As the EU economy is transitioning towards a sustainable economic model, while at the same
time being exposed to sustainability risks, exposures due to the financing of sustainable
117
NB: Large banks and their supervisors have started to prepare for the implementation of the final elements of
the Basel III reform soon after their adoption by the Basel Committee in 2017. This frontloading behaviour is
also confirmed by the EBA’s Basel III monitoring exercises, which show a steady decline in capital shortfalls at
EU banks with respect to the requirements implied by the Basel III reform (see for instance also
https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/dutch-banks-unflustered-
by-front-loading-of-capital-rules-54955966). The presentation of the Commission proposal is hence not going to
cause any additional or accelerated frontloading but rather slow it down.
42
activities might be expected to be less risky for banks than exposures financing unsustainable
activities. While this option would not include comprehensive adjustments to capital
requirements for these exposures, it would contain a specific review clause that would allow
such adjustments to be made in the near future, once sufficient evidence would be
available118
. In addition, the deadline for the EBA to deliver its report on the prudential
treatment of these exposures would be advanced from 2025 to 2023 in order to ensure greater
timeliness of any changes to the prudential rules that may be needed.
Option 2 - Adapt minimum capital requirements to reflect ESG risks
Option 2 would adapt the minimum capital requirements under so-called “Pillar 1” of the
prudential framework for the financing of certain activities and/or products where specific
evidence exists that they are more or less risky than comparable exposures as a result of ESG
factors. For the exact delimitation of environmentally sustainable activities deemed to be of
lower risk based on such evidence, the Taxonomy Regulation and its delegated acts would be
used.119
Under this option, capital requirements for sustainable exposures would be lowered,
while capital requirements for unsustainable activities would be increased, to reflect the
differences in ESG risks inherent in the two types of exposures. As under option 1, the
deadline for the EBA to deliver its report would be advanced from 2025 to 2023.
5.2.3. Improve the consistency in the application of supervisory powers
Option 1 - Clarify and complement certain provisions on supervisory and sanctioning powers
while leaving ample flexibility to Member States
Under option 1, several elements of the prudential framework related to supervisory and
sanctioning powers would be clarified compared to the status quo in order to ensure a more
consistent application of the supervisory toolkit. However, this option would still grant
flexibility to MS to detail certain supervisory and sanctioning powers in national laws.
As regards supervisory powers, this option would introduce harmonised obligations for banks
to notify competent authorities ahead of specific events with prudential relevance
(acquisitions of holdings, transfers of assets and liabilities, mergers and demergers). To avoid
placing an unnecessary burden on competent authorities and banks alike, the notification
obligation would be subject to a materiality threshold. This option would abstain from
specifying relevant related powers or obligations for the competent authorities. This means
that MS would be left with the discretion to grant competent authorities ex ante supervisory
powers to oppose or to approve these events.
118
Such evidence would primarily come from the EBA report mandated under Article 501c of the CRR.
119
At present, the work on the taxonomy related to environmental risks is the most advanced one: a first
delegated act on sustainable activities for climate change adaptation and mitigation objectives (see
https://ec.europa.eu/info/publications/210421-sustainable-finance-communication_en#taxonomy) was formally
adopted on 4 June 2021 for scrutiny by the co-legislators. A second delegated act for the remaining objectives
will be published in 2022. On 12 July 2021, the Platform on Sustainable Finance has published two draft reports
on the potential extensions of the taxonomy framework to cover i) social objectives and ii) activities that are
significantly harmful to environmental sustainability, and those that have no significant impact on it (see
https://ec.europa.eu/info/publications/210712-sustainable-finance-platform-draft-reports_en).
43
As regards sanctioning powers, this option would introduce a generic sanctioning provision,
giving competent authorities a general power to sanction all possible breaches of the
regulatory framework120
. This option would also include a clarification of the distinction
between the enforcement dimension (e.g. compelling entities to comply with the rules) and
the punitive dimension (sanctioning a breach or a misconduct) of sanctioning powers. Lastly,
this option would mandate the EBA to harmonise the basis for the calculation of pecuniary
sanctions applicable to EU credit institutions (e.g. the total annual net turnover) by means of
regulatory technical standards.
Concerning the fit-and-proper framework, this option would introduce harmonised rules for
banks by requiring them to carry out an assessment of members of the management body and
of key function holders before they take up their positions. This would be mandatory for all
the banks in the group in which those persons are supposed to hold their functions. In
addition, the option would address the assessment procedure in order to make it more
reliable. This would include a specification of competent authorities’ powers and processes
for the assessment of members of the management body121
but not for key function holders as
this category comprises very different roles122
.
Option 2 - Ensure a greater level of harmonisation of the provisions on supervisory and
sanctioning powers by narrowing down the flexibility of Member States
This option would go a step further compared to option 1. It would frame the current
flexibility of Member States in determining which powers and tools to grant supervisors in
national laws.
As regards supervisory powers, based on the notification requirement already foreseen in
option 1, option 2 would introduce in the CRD explicit powers for competent authorities to ex
ante oppose or approve events with prudential relevance (e.g. acquisitions of material
holdings, material transfers of assets and liabilities, mergers and demergers).
As regards sanctioning powers, compared to option 1, the list of key CRD/CRR breaches
subject to administrative sanctions would be completed based on a risk-based approach123
.
The list of sanctionable breaches would be expanded (e.g. breaches of additional reporting
requirements and capital requirements124
would be included). In this regard, this option would
ensure that the breaches to these important regulatory requirements would fall under the
scope of the sanctioning regimes of all Member States. Like option 1, this option would
introduce a clarification between enforcement and punitive dimension of sanctioning powers.
But in addition to that it would grant an additional enforcement tool (periodic penalty
120
This option would also include a general obligation for Member States to ensure that breaches of all relevant
CRD and CRR provisions are sanctioned
121
For instance, competent authorities should assess them prior to their appointment (and not ex post).
122
Ranging from e.g. chief financial officers to persons in any other control function.
123
The additional breaches would concern only elements of the regulatory regime applicable to supervised
banks which are, according to national and European competent authorities, as the most sensitive from a
prudential perspective.
124
Financial sanctions would be applicable exclusively to the members of the management bodies of institutions
and not to the institutions themselves.
44
payments125
) to competent authorities in order to reinforce their ability to ensure a strict
application of prudential requirements. Furthermore, this option would include a
harmonisation of the definition of total annual net turnover by using the indicator currently
used in the calculation of capital requirements for operational risk126
in order to foster a
comprehensive and consistent application of administrative penalties across the EU and
ensure comparability of sanctions.
Finally, under this option, the obligation for competent authorities to assess members of the
management body and key function holders before they would occupy their positions would
be limited to positions in the parent entity and material subsidiaries of large banks only (i.e.
those powers would not be extended to small banks) following a risk-based approach. This
would allow both supervisors and banks to focus their resources on the most important
appointments. As with option 1, EU law would specify the procedural requirements for the
fit-and-proper assessment, irrespective of whether the assessment is done ex ante or ex post.
5.2.4. Reduce disclosure costs and improve market access to bank prudential
information
Option 1 - EBA provides a single electronic access to EU banks’ quantitative disclosures
Under this option, the EBA would provide investors and other stakeholders with a single
electronic web-based access to quantitative information that EU banks are required to
disclose. Specifically, the EBA would publish this information on its website. The data would
be sourced directly from the supervisory data that banks are required to report to their
competent authorities, with the frequency determined by the disclosure rules. Specifically,
they would be sourced from the EUCLID platform which is expected to be launched in 2021.
This would be similar to what the EBA does as part of its EU-wide Transparency Exercises.
It is important to highlight that the EBA would only provide the platform for the centralised
disclosure; the ownership of the data and the responsibility for its accuracy would remain
with the banks that produce it. Under this option, any qualitative information that banks have
to disclose would not have to be published on the centralised platform; the disclosure of that
information would be left to banks to manage.
Option 2 - EBA provides a single electronic access to EU banks’ quantitative and qualitative
disclosures.
Under this option, the EBA would provide investors and other stakeholders with a single
electronic web-based access to both quantitative and qualitative information that EU banks
are required to disclose. As under option 1, the quantitative information would be sourced
from the EUCLID platform. Conversely, the qualitative information would be sent to the
EBA by banks. The qualitative information could be simply sent in the format that
institutions currently use (e.g. in the form of a pdf document; that document would then be
125
The institution concerned has to pay a daily amount – up to 5% of its average daily turnover – for every day
the infringement continues during a maximum period of six months.
126
as defined in Article 316 of the CRR
45
published on the centralised platform). Subsequently, the format could be amended127
in line
with developments related to other initiatives, e.g. the European Single Access Point (ESAP).
As under option 1, the ownership of the information and the responsibility for its accuracy
would remain with the banks that produce it.
6. WHAT ARE THE IMPACTS OF THE POLICY OPTIONS AND HOW WOULD THEY COMPARE?
In this section, the policy options identified to address each problem in Section 5 are assessed
against three criteria:
 effectiveness: the extent to which the different policy options would achieve the
objectives;
 efficiency: the analysis of the costs versus the benefits of the different policy options;
and
 coherence: the coherence of the different policy options with the overarching
objectives of EU policies
Based on the analysis provided, a score is assigned to each policy option for each criterion.
This helps to understand the selection of the preferred policy option, i.e. the policy option
with the highest overall score.
6.1. Improve the current framework for calculating risk-based capital
requirements
As explained in Section 5.2.1, option 1 would address the main outstanding deficiencies of
the prudential framework identified after the GFC, by strengthening the calculation of risk-
based capital requirements and ensuring more comparability in this calculation across banks.
Despite the ongoing COVID-19 crisis, these reforms are still needed since they address
structural shortcomings of the prudential framework. Those shortcomings undermine the
reliability of banks’ risk measurement and calculation of capital requirements. This can, in
turn, have negative consequences on financial stability in situations of future financial crises
or wider economic downturns. In its response to the CfA published in December 2020, the
EBA showed that the reforms would meet their purposes to reduce the variability across
banks’ internal models (due to the introduction of new constraints in using internal models)
and to provide banks with more risk-sensitive standardised approaches.
However, the implementation of the final elements of the Basel III reform without
adjustments would affect the overall level of EU banks’ minimum capital requirements. The
EBA’s updated impact analysis, which uses the latest available estimates (based on Q4 2019
data), confirmed that implementing the final Basel III reforms under option 1 (i.e. in full
alignment) would significantly increase the overall minimum capital requirements for EU
banks when the reforms apply in full in January 2028 (i.e. once the transitional period would
end). By this date, EU banks included in the EBA sample128
would face an average129
127
Please note that this would not require any changes to the CRR.
128
99 EU banks representing 75% of all EU bank assets according to the EBA.
129
The EBA impact analysis also shows the distribution of banks’ individual total impact in minimum capital
requirements as a result of implementing the final Basel III reforms under option 1. It can be noted that a quarter
46
increase of 18.5% in total minimum capital requirements130
, with 13 out of the 99 banks in
the EBA sample that would have a combined capital shortfall131
of EUR 52.2bn, all else
equal (see Table 2). As shown in
of EU banks in the EBA sample will incur a total impact in minimum capital requirements lower than +2.2%,
while another quarter of these EU banks will incur a total impact in minimum capital requirements higher than
+20.5%.
130
The EBA‘s methodology estimates the impact of the Basel III reforms on EU banks‘ minimum capital
requirements, i.e. taking into account the Pillar 1 minimum requirement, the Pillar 2 requirements and the fully
loaded combined buffers requirement.
131
Banks incurring a capital shortfall as the result of implementing the final Basel III reforms would have to
procure collectively that capital amount by the date of application of the reforms to meet the revised minimum
requirements introduced by the reforms. The calculation of capital shortfalls in the EBA’s methodology
therefore does not take into potential capital management buffers that banks often hold in addition to the
minimum required capital amount. A potential management buffer could in theory be used to compensate the
capital shortfall incurred by the implementation of the final Basel III reforms.
47
Table 4, this impact would be driven by the introduction of the output floor (contributing to
an average increase of 6.7% in total minimum capital requirements), the revisions to the
operational risk framework (+3.8%), the revisions to the credit risk framework (+2.6% for the
IRB and +2.4% for the SA) and the revisions to the CVA risk framework (+2.1%).
In the updated impact analysis published in December 2020, the EBA also estimated, based
on a smaller sample of 45 banks132
out of the 99banks of the EBA sample, the total shortfall
in eligible liabilities (TLAC and MREL requirements) resulting from the introduction of the
final Basel III standard under option 1: between EUR 7bn to EUR 8.6bn (for the purposes of
comparison, the combined capital shortfall for these 45 banks represents EUR 41bn out of the
EUR 52.2bn combined capital shortfall for the 99 banks of the EBA sample). Naturally,
institutions could not only use own funds, but also MREL-eligible instruments to cover this
shortfall. It has to be noted, however, that the shortfalls calculated are an approximation and
these estimates should be considered with great caution133
.
The impacts of option 1 would be less significant in January 2023, when the revised rules
would start to be phased in under the transitional arrangements, mainly due to the lower value
of the output floor (i.e. 50%). However, they would remain relatively important: there would
be an average increase of 11.8% in total minimum capital requirements, with 10 out of the 99
banks in the EBA sample having a combined capital shortfall of EUR 27.6bn.
Table 3 below highlights the profile of the EU banks that would incur a capital shortfall under
option 1. The vast majority of the combined capital shortfall in 2028 is due to those EU banks
that would continue to use internal models under the Basel III standards and for which the OF
would become the binding capital requirement134
. It is important to note that the capital
shortfall of those banks would build up progressively during the transitional period. In
addition, the EBA updated impact analysis published in December 2020 indicates that the
combined capital shortfall under option 1 would be concentrated within the largest banks in
the EU, while small and medium-sized banks would incur negligible capital shortfalls or no
shortfalls at all (as highlighted in Section 2 of Annex 6, capital requirements of small banks
would even decrease on average as a result of the reform). Due to their simpler business
models and usually very limited use of internal model approaches, small and medium-sized
banks would be mainly affected by the revisions to the standardised approach for credit risk.
Indeed, for these banks, the impacts of the revision would remain relatively contained, as the
increases for some types of credit risk exposures would be offset by capital requirements
decreases for other types of credit risk exposures.
132
The reduced sample included 45 of the 99 banks of the EBA sample used to calculate the estimates of the
final Basel III reforms impacts on own fund requirement, accounting for roughly 85% of the total RWAs of
these 99 banks (see Annex 5 of the CfA December 2020 report)
133
For instance, the calculations do not take into account the significant discretion of a resolution authority to
adjust MREL decisions upwards or downwards, which is meant to ensure that MREL remains a bank specific
requirement. In addition, any changes introduced from BRRD2 besides the subordination requirements have
been excluded from the analysis.
134
A bank will be bound by the OF where its total minimum capital requirements calculated by its internal
models would be lower than 72.5% of its total minimum capital requirements calculated under the standardised
approaches, for the same exposures.
48
Although the updated analysis shows that the overall impacts would decrease compared to
the previous EBA impact analysis135
, option 1 would still not meet the specific objective of
“no significant increase” in the minimum capital requirements of EU banks. As a
consequence, EU banks that would have a substantial capital shortfall under this option might
find it difficult over the next few years to build up136
the amount of capital required under the
revised rules, especially in the current low profitability environment. Consequently, EU
banks might be obliged to significantly reduce their activities in certain segments, or sell
existing assets (“deleverage”), which may be detrimental to the real economy. Therefore,
option 1 would not meet one of the general objectives of this legislative initiative, i.e. to
contribute to the steady financing of the EU economy in the context of the recovery post
COVID 19 crisis.
In the two public consultations launched by the Commission services in 2018 and 2019 on
the implementation of the final elements of the Basel III reform, most respondents from the
banking sector and some banks’ clients raised concerns regarding the increase in capital
requirements resulting from the implementation of the reform without any adjustments (see
Annex 2 for a full summary of the responses). In its responses to the Commission’s CfA on
the impact of the reform, the EBA supported the overall implementation of the final elements
of the Basel III reform under option 1. While Member States share the overall view that those
reforms are necessary to address the outstanding deficiencies of the prudential framework
(see Annex 2), some of them also expressed concerns about the impacts if the international
standards would be implemented without adjustments.
The introduction of EU specific adjustments in the implementation of the final Basel III
reforms as proposed under option 2 would more than halve the estimated impact of option 1,
as shown in Table 2. In fact, when the reforms would apply in full in 2028, the estimated
average increase in total minimum capital requirements under this option would be between
6.4% and 8.4%, with 10 banks out of 99 banks that would have a combined capital shortfall
of less than137
EUR 27bn. The lower impact of option 2 would be even more pronounced at
135
In its report published in December 2020, the EBA also provided the impacts on the same sample of 99
banks but based on Q2 2018 data which was used in their previous impact analysis. From Q2 2018 to Q4 2019,
the total increase in minimum capital requirements decreased by over 5 percentage points (i.e. from +24.1% to
+18.5%), while the capital shortfall across these banks has more than halved (from EUR 109.5 bn to EUR 52.2
bn). According to the EBA, this reduction can be mostly explained by the strengthening in the total capital
positions of EU banks between the two dates, but also by the reduction in the overall impact of the output floor
for few large banks and the revision of the calibration of the CVA risk framework adopted by the BCBS in July
2020.
136
Banks can usually build up additional amount of regulatory capital by either retaining more earnings or by
issuing new common shares or other forms of regulatory capital. While the former strategy is inherently difficult
in a low profitability environment, the later strategy can also be challenging because the future expected
profitability of a bank is reflected in its share price. The lower the profitability outlook, the lower the share price
and the larger the number of new shares that have to be issued to raise a given amount of capital, making it more
difficult to reach a given new issuance target.
137
The impact of option 2 in terms of % change to the total MRC includes the Commission estimates for some
of EU specific adjustments proposed in Section 5.2.1 that the EBA has not been able to quantify in its impact
study (see
Table 4 for the breakdown of these estimates). However, the Commission services did not have the ability to
reflect these estimates in the TC shortfall under this option which would require to have access to individual
banks data. Therefore, the TC shortfall amounts shown in this table, which only reflect the EU specific
49
the beginning of the transitional period (i.e. in 2023): the estimated average increase in total
minimum capital requirements would range between 0.7% and 2.7%, with only 7 out of 99
banks that would have a combined capital shortfall of less than EUR 7.5bn.
adjustments quantified by the EBA, should be interpreted as an upper bound of the actual TC shortfall incurred
by banks in the EBA sample.
50
Table 4 below provides more details on the mitigating impacts of the various EU specific
adjustments under option 2 as compared to option 1.
Under option 2, the estimated shortfall in eligible liabilities would also reduce: between less
than EUR 2bn and less than EUR 2.01bn for the 45banks analysed.
The introduction of EU specific adjustments would not jeopardise the overall objective of the
Basel III reform, i.e. to address the outstanding deficiencies of the prudential framework. At
the same time, option 2 would implement the reform in a way that would meet the specific
objective of “no significant” increase in capital requirements across EU banks, as highlighted
by the above analysis.
To put the capital shortfalls under the two options into perspective, the 99 banks included in
the EBA sample held a total amount of regulatory capital worth EUR 1414bn at the end of
2019 and had combined profits of EUR 99.8bn in 2019. Knowing that option 2 would halve
the capital shortfalls of EU banks as compared to option 1, these banks would be in a better
position138
to build up the amount of capital required under the new rules over the next few
years under option 2, without the need to abruptly reduce their exposures, particularly in
certain financing activities that are key to the EU economy.
Option 2 is broadly aligned with the views expressed by the bank respondents to the two
public consultations: they also proposed some specific adjustments when implementing the
final elements of the Basel III reform in the EU. After a careful assessment, the adjustments
that were deemed justified and appropriate have been included under option 2 (e.g. specific
treatment for certain equity and specialised lending exposures, postponement of the
implementation of the haircut floor framework, etc.). Other EU specific adjustments proposed
under option 2 would simply maintain previously agreed rules already catering for EU
specificities (e.g. SME supporting factor and the CVA exemptions). Mixed views have been
expressed by the EBA, the ECB, Member States and national supervisors during expert group
meeting organised by the Commission on the specific adjustments proposed under option 2.
The views of Member States generally depended on the extent to which the EU specificities
identified in Section 5.2.1 are present in their banking sector.
Table 2: Summary of overall key impact estimates of the final Basel III reforms on EU
banks, under both the implementation policy options 1 and 2.
Impact in 2023 at start of application
(beginning of transitional period)
Impact in 2028 under full
application (end of transitional
period)
Average % change in
total MRC139
Combined TC
shortfall (in
EUR bn)
Average % change
in total MRC
Combined TC
shortfall (in
EUR bn)
Option 1: Full alignment with
Basel III standards +11.8% 27.5 +18.5% 52.2
138
Banks without capital shortfalls would also be in a better position to maintain their current level of capital
ratio over the next few years under option by building the required amount of capital to do so.
139
Minimum Required Capital.
51
Option 2: Implementation with
EU specific adjustments
Between +0.7% and
+2.7%
Below 7.5
Between +6.4% and
+8.4%
Below 26.3
Sources: Basel III reforms impact study, EBA, December 2020; European Commission estimates.
Table 3: Number and profile of EU banks incurring a capital shortfall with the full
application of the final Basel III reforms in 2028, under the implementation policy options 1
and 2.
Profile of banks
incurring a capital
shortfall
Number of banks incurring a capital
shortfall (out of 99 banks in EBA
sample)
Combined TC shortfall (in EUR bn)
In 2023 In 2028 In 2023 In 2028
Option
1
Option
2
Option
1
Option
2
Option
1
Option
2
Option
1
Option
2
Using only the
standardised approaches
4 4 4 4 0.7
Below
0.6
0.7
Below
0.6
Using
internal
model
approaches
Bound by
the OF
0 0 6 4 0 0 42.5
Below
22.4
Not bound
by the OF
6 3 3 1 26.8
Below
6.9
9
Below
3.3
Total
10 7 13 10 27.5
Below
7.5
52,2
Below
26.3
Sources: Basel III reforms impact study, EBA, December 2020.
52
Table 4: Breakdown of the impacts of the individual elements of final Basel III reforms
under options 1 and 2 in 2028140
and of the individual EU specific adjustments considered
under option 2.
% change in
MRC under
option 1 (across
all risks and per
risk type)
Individual impact of EU specific
adjustments under option 2
% change in MRC
under option 2
(across all risks
and per risk type)
Quantified in
EBA impact
analysis (in
percentage points
(pp))
Not quantified in
EBA impact analysis
and based on
Commission
estimates (in
percentage points
(pp))
Across all
risks
+ 18.5% Between +6.4% and
+8.4%
Credit risk
(=IRB + SA)
+5% (=2.6%+2.4%) SME supporting
factor: -2pp
Unrated
corporates: -1.5pp
Treatment of
equities: -1pp
+0.5%
Market risk +0.8% +0.8%
Operational
risk
+3.8% ILM=1: -2.1pp +1.7%
CVA risk +2.1% CVA exemption &
proportionality:
-1.6pp
+0.5%
Output floor +6.7% EU implementation
of the output floor:
at least141
- 1pp
+5.7%
Other risk
(Securitisation
and Leverage
ratio)
+0.2% +0.2%
Broad impact
estimates of
other
adjustments
Market risk (treatment
of CIUs and calibration
of EU ETS), credit risk
(infrastructure
supporting factor,
specialised lending),
the output floor
(SACCR calibration in
OF) and postponement
of minimum haircut
floors: -1pp to -3pp
-1% to -3%
Sources: Basel III reforms impact study, EBA, December 2020; European Commission estimates.
The above impact estimates provided by the EBA are based on Q4 2019 data. They
implicitly142
assume that the economic activity and EU banks’ balance sheets would recover
140
The breakdown of these individual impacts in 2023 is basically the same, expect the impact of the output
floor which reduces to 0% since its lower value of 50% does not bind EU banks.
141
In the “EU single stack” approach proposed in this note, supervisors will be able to further adjust the overall
than was estimated by the EBA in its impact assessment.
142
These impacts estimates are calculated by the EBA under a ‘static balance sheet’ assumption, meaning that
they only capture the impacts of a change in the prudential framework at the date they have been calculated.
Therefore, the impact estimated presented in this impact assessment implicitly assumes banks‘ balance sheet
53
to pre-crisis levels by the time the final elements of the Basel III reform would start applying,
i.e. by January 2023. However, it cannot be ignored that over this horizon, banks’ balance
sheets might still be affected by the consequences of the COVID-19 crisis.
To this end, the EBA’s updated impact analysis also provides the Commission with a
qualitative and a quantitative analysis of the combined effect of the reform and the potential
consequences of the COVID-19 crisis over the short-term, i.e. at the start of the application of
the reforms in 2023.
First, one key conclusion of the qualitative analysis performed by the EBA is that the effects
of the COVID-19 crisis would not necessarily lead to higher capital impacts under the final
Basel III standards than they would do under the current prudential framework. Indeed, the
EBA expects an increase in banks’ capital requirements as a result of the expected
deterioration in ratings, higher probabilities of default and higher expected losses caused by
the COVID-19 crisis. In the short-term, this increase would occur under the current
prudential framework irrespective of whether the final Basel III standards would be
implemented and would, to a certain extent, mitigate the capital impact due to the reform. For
instance, for banks using internal models under the Basel III standards, the impact of
introducing the output floor might be mitigated by an increase in the capital requirements
generated by internal models, which might happen in the coming years due to the higher
credit risk of banks’ borrowers.
Second, the quantitative analysis performed by the EBA defines two hypothetic, adverse
economic scenarios which would imply a significant deterioration of the financial situation of
EU banks’ borrowers over the short-term horizon as a potential negative consequence of the
COVID-19 crisis (the two scenarios differ in terms of how severe143
this deterioration and the
resulting increase of their non-performing loans would be, all other risks of EU banks being
equal). Under each scenario, the EBA recalculated the average change in the minimum
capital requirements and the resulting capital shortfall of EU banks only under option 2 and
only in the short-term, i.e.at the start of application of the reforms in 2023.
As compared to the impact of option 2 (i.e. average increase in banks’ minimum capital
requirements between +0.7% and +2.7% and a combined capital shortfall of less than EUR
7.5bn as shown in Table 2), the average increase in banks’ minimum capital requirements
under the less (resp. more) severe if the adverse economic scenarios in the short-term would
go up to between +4% and +6% (resp. +5% and +7%) leading to a capital shortfall of EUR
30.4bn (resp. EUR 59.8bn) .
As recognised by the EBA in its report, the impact estimates under these two adverse
scenarios are more significant than using the Q4 2019 data but the assumptions and the
143
The first adverse scenario applies a stress effect on the EU banks’ credit risk provisions and their credit risk
capital requirements to all their borrowers, based on the hypothetical shock arising from the 2018 stress test; the
second adverse scenario cumulative the stress effect of the first scenario with more specific stress effects applied
to bank’s exposures from economic sectors that are the most affected by the COVID-19 crisis. This
methodology, which has previously been used by the EBA thematic note on the impact of COVID-19 in the EU
banking sector published in May 2020 (see https://www.eba.europa.eu/risk-analysis-and-data/risk-assessment-
reports), is described in Annex 6.
54
methodology used by the EBA in these scenarios were very conservative and need to be
interpreted with caution. In fact, the EBA methodology uses a stress-testing approach which
assumes a simultaneous deterioration in the financial situation of all borrowers of EU banks,
i.e. even for those borrowers that do not currently experience difficulties. Second, the higher
combined capital shortfall under the adverse scenarios would not be only due to higher
capital shortfalls incurred by banks under option 2 based on Q4 2019 data, but also due to
more banks that would incur a shortfall under that scenario. Some of the banks that would
incur a capital shortfall under the adverse scenarios would also incur a shortfall if the current
prudential framework was used instead of the final Basel III standards (the EBA analysis
does not disentangle the two effects – the COVID-19 effect and effect of the final Basel III
reforms).
Taking into account these caveats, the EBA analysis still provides a useful indication of what
the upper bound of the impacts of the final elements of the Basel III reform could be if the
financial situation of EU banks were to significantly deteriorate over the next few years. The
continuing EBA monitoring of the impacts of the reform on EU banks will be particularly
useful to inform EU co-legislators during the first stage of negotiations of this legislative
initiative about the evolution of the impacts of those reforms with more concrete first signs of
the consequences of the COVID-19 crisis on EU banks’ balance sheets.
Option 3 would lead to the same overall impacts on total capital requirements as option 2 but
would give EU banks two more years to comply with the new capital requirements. Due to
the uncertainty with the evolution of the financial situation of EU banks’ clients, as shown in
the above analysis, this delay would give banks time to absorb potential losses coming from
the most fragile borrowers that are (or will be) affected by the COVID-19 pandemic, while
still leaving them enough room to support the financing of the EU economy during the
recovery phase.
Option 3 would provide much needed certainty to the banks that the impact of the EU
implementation of Basel III is manageable. Banks usually refer to the EBA’s estimates on
how much capital requirements would increase if the reforms were implemented in full
alignment with the Basel III standards. Given the lack of clarity about the EU’s
implementation approach and missing certainty on the timeline, banks expect a significant
increase in capital requirements as a result of the implementation and the most impacted or
weakest amongst them could see this as another reason144
to hold back from using their
capital to lend. Coming forward with option 3 for the implementation would signal that the
impact would be quite limited and provide certainty for banks’ capital planning and lending
decisions throughout the recovery phase while reaffirming the EU’s international
commitment to the Basel III implementation. In addition, clear communication on the
difference between entry into force and effective application of the new requirements would
144
Recent market observations (e.g. ECB’s lending survey or EBA’s risk and vulnerabilities assessment)
indicate that lending conditions remained broadly favourable in 2020 but started to tighten. This is mainly
driven by banks’ assessment of the risk related to the deteriorating creditworthiness of borrowers affected by the
pandemic, whereas banks’ capital position remains strong and did not contribute to the tightening. In the Euro
area, banks do not expect that regulatory or supervisory action will constrain their capital positions or lead to a
decrease in their total assets.
55
help reinforce the signalling effect. Postponing further, by contrast, would nurture
speculations about the EU’s commitment to implement the final elements of the Basel III
reform, damage the EU’s reputation as a reliable partner in international fora/negotiations,
and be likely interpreted as a sign that the EU banking sector is too weak to accommodate the
Basel III reforms (with potential negative consequences for EU banks’ market valuations and
funding costs).
In their communications with the Commission, a good part of the banking sector and some of
their clients have been asking for a postponement of this legislative proposal implementing
the final elements of the Basel III reforms. Option 3, while not entailing further postponement
of the legislative proposal, but given the extended implementation timeline, would largely
meet this demand. Member States and supervisors were more supportive of the idea of
extending the implementation timelines as an alternative to structural deviations from the
final Basel III standards. Most Member States and key MEPs have recently restated their
support for a timely and faithful implementation of the final Basel III reforms – taking
account of EU specificities – notwithstanding the COVID-19 crisis. They expect the
Commission to table a legislative proposal by mid-2021.
In light of the above analysis, which led to the overall score of each policy option in Table 5
below, option 3 is deemed the preferred policy option to improve the current framework for
calculating risk-based capital requirements.
Table 5 : Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 + - + ≈
Option 2 ++ + ++ +
Option 3 ++ ++ ++ ++
Magnitude of impact as compared with the baseline option (the baseline is indicated as 0): ++ strongly positive; + positive;
– – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
6.2. Dedicated capture of ESG risks in the prudential framework
Option 1 would provide incentives for banks to improve the management of ESG risks by
reinforcing banks’ obligations as regards the management of ESG risks as well as the
supervisory review thereof. This would help ensure that banks would be able to handle their
exposures to ESG risks more effectively and aligning their investment strategies accordingly,
in line with the stated objective pursued by this initiative. In addition, the suggested
reinforcement of disclosure requirements would allow market participants to scrutinise the
degree of exposure of banks to ESG risks as well as how close those banks are to delivering
on any sustainability commitments they had already made (or would make in the future).
By introducing a dedicated review clause to adapt capital requirements based on concrete
evidence, option 1 would pave the way for better aligning capital requirements with the
riskiness of ESG assets.
56
Through the envisaged change to bring forward the delivery date for the EBA report, option 1
would allow to minimise delays in effectively addressing any additional underlying problems
that the report may identify. At the same time, it would ensure that any changes in capital
requirements would be based on adequate evidence, which would be coherent with the
principles of risk-based capital requirements and thus the objective of financial stability.
Option 1 would result in some costs for banks as they would have to adapt their risk
management systems and processes and collect the necessary data. To the extent that the data
must be obtained from customers, the latter would also incur additional costs as a result.
Supervisors would incur costs as their supervisory processes would become more complex.
In contrast to option 1, option 2 would adapt capital requirements based on currently
available evidence without awaiting the EBA report on the relative riskiness of exposures. It
would thus have the advantage of effectively responding to calls for an early intervention in
view of the urgency of environmental (and more broadly sustainability) challenges. However,
research on how the riskiness of bank exposures differs based on sustainability criteria is in
its early stages and empirical evidence in this area is still limited. The available research is
focused on a very narrow subset of bank exposures, namely lending for the financing of the
construction/purchase of energy-efficient buildings or for the “upgrading” of energy
inefficient buildings. That research provides tentative evidence that such lending may be
slightly less risky than “traditional” mortgage lending145
. At the same time, other research
concludes that such differences either do not exist or can be explained by other factors than
environmental ones that are correlated with “green-ness”, such as income differences
between borrowers.
An attempt to introduce changes to capital requirements for ESG risks based on this limited
and inconsistent evidence would likely result in an inadequate calibration of such capital
requirements. This would be incoherent with the principles of risk-based capital requirements
and would negatively impact financial stability in particular if capital requirements for certain
exposures were to be too low to cover the real risks. Also, a premature change in capital
requirements would entail the risk that new evidence may subsequently emerge that
contradicts the assumptions on the basis of which the changes had been made in the first
place, thereby creating the need to undo these changes. At the same time, the available
evidence does not allow a detailed assessment of the impact that option 2 might have.
Many stakeholders recognise that prudential requirements for banks must reflect ESG risks,
with the EBA recommending “to incorporate ESG risk-related considerations in directives
and regulations applicable to the banking sector”146
. This holds true in particular with respect
to proposals to strengthen risk management requirements, supervisory review and stress
testing as well as disclosure requirements, even though with respect to the latter some
stakeholders have cautioned that these must not result in disproportionate costs.
145
Does energy efficiency predict mortgage performance?, Bank of England, 2020 (see
https://www.bankofengland.co.uk/working-paper/2020/does-energy-efficiency-predict-mortgage-performance).
146
See the EBA Discussion paper on management and supervision of ESG risks for credit institutions and
investment firms.
57
However, views vary as regards changes to capital requirements based on ESG factors. Banks
tend to be open to the idea of lower capital requirements for exposures to sustainable
activities and/or products but strongly oppose higher capital requirements for exposures to
activities and/or products deemed to be unsustainable. Civil society stakeholders tend to view
increased capital requirements for unsustainable activities and/or products more favourably,
while some consider that the potential benefit of a decrease in capital requirements for
sustainable activities and/or products would be outweighed by a potential negative impact on
financial stability. Supervisors consider that any change in capital requirements must be
based on solid evidence of risk differentials based on ESG factors, which they do not
consider to be available at present.
In light of the above analysis, which led to the overall score of each policy option in Table 6
below, option 1 is deemed the preferred policy option to introduce a dedicated capture ESG
risks in the prudential framework.
Table 6: Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 + + ++ +
Option 2 ? ? ? ?
Magnitude of impact as compared with the baseline option (the baseline is indicated as 0): ++ strongly positive; + positive;
– – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
6.3. Improve the consistency in the application of supervisory powers
On supervisory powers
In relation to supervisory powers, option 1 would draw awareness across the Union to the
importance of assessing prudentially relevant events in a timely manner. The suggested
mandatory ex-ante notification, e.g. of a merger, would allow supervisors to be informed at
an early stage and to react promptly, if deemed necessary from a prudential viewpoint. Yet,
MS would remain free to implement corresponding supervisory powers. The likely effect
would be a perpetuation of the absence of equal rules and limitations for several authorities,
including the ECB, to intervene ex ante. Option 1 would imply some costs for banks in the
form of administrative burden (due to the notification obligation) and would for individual
banks depend on whether ex ante notification obligations already exist in the relevant MS.
However, the materiality thresholds for notifications included in this option would limit those
costs, as only event exceeding the thresholds would need to be notified.
On the supervisory powers and procedures concerning the suitability assessment, option 1
would mean assessing ex ante all members of the management body by the competent
authorities, without considering the characteristics of banks or of the different entities within
the group in which those persons hold their functions. While this would ensure a high degree
of harmonisation, it would require significant additional efforts from authorities that currently
perform ex-post assessments, notably to the numerous small banks in their supervisory remit.
58
By contrast to option 1, the harmonisation of supervisory powers in EU law as suggested in
option 2 would achieve a level playing field, endowing all competent authorities with
sufficient capacity to react to prudentially relevant events. It would impact to a different
extent banks and supervisory authorities, depending on whether supervisory powers147
and ex
ante notification obligations already exist and how they are designed. The incurred costs
would in most cases remain ultimately less important than those for ex-post supervisory
assessments. As in the case of option 1, the costs would be contained due to the materiality
thresholds.
As regards the fit-and-proper assessment, under option 2, the ex-ante assessment would be
introduced only for members of the management body in the parent entity and in material
subsidiaries of large banks. Competent authorities would therefore be able to continue ex-post
assessments for smaller banks which would entail no additional costs. Option 2 would extend
the scope to key function holders and require competent authorities to assess them ex ante for
the same type of entities as for the members of the management body. The proposed
framework would also provide further specifications concerning the supervisory procedures
for the assessment of both, board members and key function holders. Furthermore, it would
set out criteria for carrying out the assessment of key function holders148
.
Overall, option 2 would achieve a more balanced reform of supervisory powers than option 1.
It would ensure a sufficient level of supervisory convergence and keep the administrative
burden to a reasonable level.
On sanctioning powers
Option 1 would clarify the distinction between enforcement measures and sanctioning tools
for supervisors. This clarification would leave nonetheless an important discretion to Member
States to introduce or not additional enforcement149
and sanctioning powers in their national
laws.
Furthermore, option 1 would achieve a significant increase of the harmonisation of
sanctioning powers by introducing a general power for supervisors to sanction all potential
breaches of the regulatory framework. However, this option might create legal uncertainty as
regards its application. A generic clause might not be effective when breaches of a bank are
not identified by national and European supervisors under a common standard. In addition,
some Member States impose the obligation to state the breach for which a sanction is
applicable150
. Therefore, introducing a general sanctioning power could potentially raise
constitutional issues in some Member States151
.
Finally, under option 1 the basis for the calculation of pecuniary measures imposed on EU
banks to sanction breaches would be specified by MS, agreeing on a common definition in a
147
Most MS have already provided their supervisors with at least some approval powers.
148
Article 91 of Directive 2013/36/EU already provides criteria for assessing the members of the management
body.
149
The possibility for supervisors to impose periodic penalty payments applicable to credit institutions
breaching their regulatory requirements
150
It is the case especially if the breach would lead to financial penalties
151
In some Member States, it would not be possible to introduce such general administrative sanctioning power
because national laws already foresee criminal sanctions for such CRD/CRR breaches
59
Level 2 text (e.g. Regulatory Technical Standards) that could leave some additional
flexibility.
None of the above elements is expected to lead to undue increases in costs for either banks or
their supervisors152
.
Option 2 would provide more legal certainty as regards breaches that would be sanctioned
than option 1. MS would implement an identical list of key CRD/CRR requirements, which
would eliminate inconsistencies as regards the scope of sanctioning powers of the competent
authorities. This option considers the proportionality principle. It increases the level of
harmonisation as regards sanctioning powers without leaving supervisors and credit
institutions with legal uncertainty which is the case for solely generic sanctioning powers
under option 1.
Like under option 1, all the important breaches would be subject to administrative sanctions
by supervisors and clarifications would be provided on the articulation between enforcement
and punitive measures taken by supervisors. However, option 2 would go beyond option 1 by
providing an additional enforcement tool to supervisors in the form of periodic penalty
payments).
Finally, option 2 suggests a harmonisation of the calculation of pecuniary sanctions based on
the notion of total annual net turnover. The use of total annual net turnover as a criterion
would benefit from a clarification on the highest level of the EU legislation (e.g. CRD),
compared to option 1 (Regulatory Technical Standards).
Similarly to option 1, the changes contemplated under option 2 would not lead to undue
increases in costs for banks or for their supervisors (for the latter, the sanctioning procedures
could stay unchanged, it is only the scope of breaches to which those procedures would apply
that would be expanded).
* * *
Most stakeholders acknowledge that differences in the powers available to supervisors and
their application across MS are contrary to the level playing field principle and effective
supervision. While supervisors (in particular the ECB) and civil society stakeholders
highlight the prudential risks and the uncertainty resulting from the lack of certain powers,
definitions and common procedures, the banking industry is concerned about possible
distortions to the competition across MS and notes that the status quo would prevent groups
from reaping the synergies expected from cross-border acquisitions.
As regards concrete policy options to address the problems, the views of MS and supervisors
are largely correlated with their current practices. In particular, those being home and/or
predominantly in charge of smaller banks are concerned about potentially increased
administrative burden. Their support is hence conditional on the introduction of materiality
thresholds which would exempt a significant number of events and the provision of targeted
flexibility (particularly regarding the scope of ex-ante fit-and-proper assessments) allowing
152
Under this new regime banks could be hit by sanctions for certain breaches, which would of course represent
a cost for those banks. However, those costs are not considered as undue.
60
for risk-based adjustments as envisaged under option 2. Some MS and the majority of banks,
by contrast, prefer limiting the flexibility left to MS and supervisors to the extent possible.
In light of the above analysis, which led to the overall score of each policy option in Table 7
below, option 2 is deemed the preferred policy option to improve the consistency in the
application of supervisory powers
Table 7 : Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 + + + +
Option 2 ++ ++ ++ ++
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly positive; + positive;
– – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
6.4. Reduce disclosure costs and improve market access to bank prudential
information
Both options would increase the efficiency and effectiveness of disclosures, particularly for
small and non-complex banks. These banks would be relieved from the burden to prepare
disclosures of prudential information153
, which will be disclosed centrally based on prudential
information provided to supervisors. For other banks, the benefits from option 1 may be
limited: given that they would still need to manage their disclosures of qualitative
information, they may simply decide to continue disclosing the required qualitative and
quantitative information as they currently do. At the same time, option 1 would not entail any
additional costs for those banks, nor it would entail any additional costs for banks or
supervisors more in general as changes to their existing systems would not be required.
For other stakeholders (e.g. investors, academics) option 1 would achieve all benefits
associated with a single, free access point to prudential data (i.e. quantitative information) on
all EU banks. It would allow them to undertake a meaningful analysis across EU banks. The
disadvantage (but not associated with additional cost) of this option for these stakeholders
would be that in order to access banks’ qualitative information, they would still need to
gather it from the websites of individual banks like they currently do.
Option 2 would entail the same benefits as option 1. In addition, it would eliminate all its
drawbacks: all banks would be able to use the centralised platform for all their disclosures
(and hence avoid duplication), while the other stakeholders would have a single point of
access to those disclosures.
In light of the above analysis, which led to the overall score of each policy option in Table 8
below, option 2 is deemed the preferred policy option to reduce disclosure costs and improve
market access to bank prudential information.
153
Following the amendments to the disclosure rules introduced by the CRR II, small and non-complex banks
are required to disclose quantitative information only.
61
Table 8 : Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 + + + +
Option 2 ++ ++ + ++
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly positive; + positive;
– – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
7. PREFERRED POLICY OPTIONS
7.1. Effectiveness
The implementation of the final elements of the Basel III reform under the preferred policy
option will address the shortcomings of risk-based capital requirements under the prudential
framework that have been identified during the GFC. This will ensure an accurate
measurement of risk and an adequate capitalisation of institutions which will in turn ensure
financial stability. A more stable and resilient EU banking sector will, in turn, effectively
strengthen the trust of global financial markets and international partners in the EU financial
system.
The preferred option will also take due account of the specificities of the EU banking sector
through a number of specific adjustments to the Basel III standards as well as a longer
implementation timeline of the reforms. In this way the preferred option will most effectively
help to mitigate the risk associated with a sharp increase in capital requirements for
institutions, especially in view of the COVID-19 –crisis. This will ensure a smooth provision
of essential financial services to the EU economy during the recovery phase and in the long
term.
The preferred policy option will enhance the focus on ESG risks in the prudential framework
with a dedicated approach to capture those risks. Improved management of ESG risks will
ensure that institutions will be better prepared to withstand those risks, in particular risks due
to climate change. Moreover, the explicit reference to ESG risks in the supervisory
framework will increase supervisors’ focus of those risks. Finally, the enhanced transparency
about institutions’ exposures to those risks will give markets the necessary tools for an
effective monitoring of the sustainability of institutions’ activities. The combination of these
measures will create the necessary incentives for institutions to allocate more financing to
more sustainable investments.
The preferred policy option regarding supervisory and sanctioning powers will further
harmonise and strengthen the toolkit available to supervisors across the Union, improving the
robustness, application and enforcement of the prudential framework applicable to
institutions. By strengthening supervisors’ powers to ensure institutions’ compliance with the
prudential framework across the Union, and by giving supervisors the necessary powers to
intervene in transactions that can have a significant prudential impact on institutions, the
preferred option will ensure a more effective supervision of institutions and therefore a safer
banking sector.
62
Next to supervision, scrutiny by market participants and other stakeholders constitutes
another important control mechanism in the prudential framework. The effective functioning
of this mechanism is conditional upon the transparency of banks’ activities, their financial
position and the risks they face. The preferred policy option would ensure that information
(i.e. qualitative and quantitative) that institutions have to disclose would be easily accessible
in one place and would be easily comparable, thus enhancing the ability of clients, investors
and other market participants to monitor and exert market discipline on institutions.
7.2. Efficiency
The preferred policy option will achieve the desired objectives with enhanced efficiency. By
adapting the final Basel III framework to several specificities of the EU banking sector, the
preferred option would avoid disproportionate capital requirements for certain financial
products or activities provided by banks and are essential to the EU economy. Without
adapting the Basel III standards to EU specificities, the resulting increase in capital
requirements would likely be significant, resulting in higher costs for institutions’ clients,
including SMEs. This could ultimately undermine the clients’ economic activities or capacity
to hedge their financial risks. The proposed two-year postponement of the date of application
of the final elements of the Basel III reform in the preferred policy option will enable banks
to support the recovery post COVID-19 crisis over the short- to medium-term whilst
providing EU banks with regulatory certainty early on, thereby allowing for proper planning
and a smooth implementation of the revised prudential framework.
The preferred policy option to address ESG risks will provide the necessary incentives for
banks and, indirectly, their clients to take due account of the sustainability of their economic
activities and will therefore ensure a more efficient allocation of economic resources. This
will, in turn, support the effort to transform the EU economy into a resource-efficient,
sustainable and competitive economy.
As regards supervisory and sanctioning powers, the preferred option addresses the current
fragmentation of supervisory powers by ensuring that scarce supervisory resources are used
in the most efficient way. This is done by allowing supervisors to focus only on events that
can materially affect the prudential standing of banks. While the preferred policy option
involves an increase in costs for at least some supervisors (especially for those that currently
do not have the powers that would be introduced under the preferred option) and the banks
they supervise, the increase in costs is limited (due to the in-built proportionality of the rules
that focuses only on material events). The costs would be outweighed by the benefits of more
harmonisation which will contribute to levelling the playing field in the single market and
render supervision in the Banking Union more efficient.
Finally, under the preferred policy option for the disclosure of prudential information, banks
will benefit from a more efficient system that integrates supervisory reporting and disclosure,
and thereby reduces their administrative burden. At the same time, access to bank data for
stakeholders will become more efficient as all the relevant information will be available in
one place.
63
7.3. Coherence
In addition to the effectiveness and efficiency of the preferred policy options chosen to
address the problems identified, the preferred options shall be coherent with each other as
well as the whole package with other policy initiatives at EU level.
The prudential framework for banks in the Union consists of three main pillars, each of which
plays a distinct, key role in ensuring the stability of individual institutions and the banking
sector as a whole. The preferred policy options propose changes to each of these pillars,
which will increase the coherence of the overall framework.
The first pillar consists of minimum capital requirements, in the form of quantitative and
qualitative rules. In 2013, in the wake of the GFC, these rules were moved from a Directive
to a Regulation to form a “Single Rule Book”, and a large number of national options and
discretions was removed. This change improved the uniformity of application of minimum
capital requirements in all MS, closed regulatory loopholes and thus contributed to a more
effective functioning of the single market for banking services. The current proposal further
improves the consistent application of these rules by limiting banks’ freedom in calculating
their capital requirements; this will make capital requirements and reported capital ratios
more comparable across the Union.
The second pillar consists of the supervisory review of banks’ activities and risks. This
review is crucial to ensure a consistent application of the prudential framework, in particular
in the Banking Union. However, where powers and tools made available to supervisors in
conducting this review differ across the Union, prudential rules are often applied
inconsistently. The preferred options will address shortcomings in respect of strengthening
supervisory powers and the sanctioning of breaches.
The third pillar consists of market scrutiny. For banks to be subject to comparable levels of
scrutiny, stakeholders must have access to comparable information. The preferred policy
options will improve such access and will also increase the comparability of the disclosed
information.
Furthermore, the preferred policy options are coherent with other policy initiatives at EU
level, in particular:
 The Banking Union aims to increase financial integration and stability in the Economic
and Monetary Union. Common supervision is a central element of the Banking Union.
However, where the ECB exercises direct supervisory powers set out in national law
transposing the CRD, the ECB does not have the same range of powers with regard to all
banks under its supervision because of differences in the transposition. This impinges on
attaining the objective of efficient and harmonised supervision within the Banking Union.
The present initiative aims at addressing some of these obstacles.
 The CMU aims to improve the access to financing for companies and projects across the
Union. This overall aim is coherent with the general objectives of the present initiative,
whereas the specific measures are complementary: banking regulation mostly relates to
bank financing, while CMU mostly concerns non-bank financing. This initiative takes
64
into account the fact that EU banks also play a role in facilitating companies’ access to
financial markets, and ensures, by considering EU specificities, that the proposed
measures do not unduly constrain this important role of banks.
 The EGD Communication announced that environmental risks would be better integrated
into the EU prudential framework, and that the suitability of the existing capital
requirements for green assets would be assessed. The present initiative puts this
announcement into practice. It will help ensure that the banking sector can play an
appropriate role in achieving the ambitious aims of the EGD.
 The ESAP aims at providing investors with easy access to regulated financial information
of companies listed on the EU‘s regulated markets. Although the scope of this initiative is
different from the scope of the ESAP, the aim of the two is fully compatible. Depending
on the final design of the ESAP, the EBA centralised disclosure platform could either
feed information into the ESAP or the ESAP could provide a gateway to the information
stored on the EBA platform.
7.4. REFIT (simplification and improved efficiency)
This initiative is aimed at completing the EU implementation of the international prudential
standards for banks agreed by the BCBS between 2017 and 2020. It would complete the EU
implementation of the Basel III reform that was launched by the Basel Committee in the
wake of the GFC. That reform was in itself a comprehensive review of the prudential
framework that was in place before and during the GFC, namely the Basel II framework (in
the EU that framework was implemented through Directive 2006/48/EC, i.e. the original
CRD). The Commission used the results of that review, together with input provided by the
EBA and other stakeholders, to inform its implementation work. A fitness check or refit
exercise of the EU implementation of the Basel III reform has not been carried out yet
because all the elements of the reform need to be put in place before one can be carried out.
Implementing the final elements of the Basel III reform with the EU specific adjustments
envisaged under the preferred option would simplify the risk-based capital framework,
notably by removing more complex internal models approaches to calculate capital
requirements in for operational and CVA risks and by limiting the scope of internal models
for credit risk. This would positively impact the recurring administrative and operational
costs of EU banks (see Section 1 of Annex 6) and facilitate their supervision.
In relation to disclosure, this legislative initiative would introduce measures to reduce
redundancies in respect of information reported to supervisors and disclosures to markets by
centralising disclosures via a European data infrastructure based on supervisory reporting
data. This would contribute to a reduction in the administrative burden of banks, in particular
small ones.
65
8. HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED
The changes contained in this legislative initiative would start applying in 2025 and become
fully applicable in 2030. After that date, an evaluation of the reform will be carried out in
principle three years after the latter date.
The below Table 9 presents some indicators that would help the Commission to monitor and
evaluate the effectiveness and the appropriateness of the proposed preferred policy options to
achieve the specific objectives mentioned in Section 4, based on the data/information
available. The Commission will mostly use data/information from the European Supervisory
Authorities (the EBA, the ESMA and the ESRB), the national supervisory authorities and the
ECB/SSM, the BCBS, and other market data indicators to monitor and evaluate the impacts
of the proposed preferred policy options.
Table 9: Summary of indicators to monitor and evaluate the impacts of the preferred policy
options
Objectives Indicators Target Source of
information/data
Strengthen risk-
based capital
framework, in
the context of the
recovery from
the COVID-19
crisis
EU banks’ revised minimum
capital requirements and capital
ratios under the preferred option
for implementing the final Basel
III reforms
No significant increase in the
revised capital requirements
over time
Gradual increase in the revised
capital ratios to comply with
the revised requirements over
time
Banks more resilient to shocks
in the future EU stress test
exercise
EBA Basel III
monitoring
exercises
EBA stress testing
Variability metrics in risk
weighted assets calculated by
internal model approach for
market and credit risks
Share of explained variability
to increase from current level.
EBA benchmarking
exercise reports on
market and credit
risk internal models
Volume of exposures subject to
standardised approaches, in
particular those for which this
legislative initiative introduces
EU specific adjustments
No significant decrease in the
share of key EU banks’
activities compared to the total
volume of banks’ activities.
EBA/ECB/SSM
reports
EU banks’ market valuations No significant decrease in
banks market valuations from
current level
Market data
providers
Incorporate
sustainability
risks in the
prudential
framework
Share of banks capturing ESG
factors for risk management
purposes
Increase in the share of banks
capturing ESG factors for risk
management purposes
EBA/ECB/SSM
supervisory reports
and public
disclosure
information
Share of banks providing
disclosure on ESG risks to
stakeholders
Increase in the share of banks
providing disclosure on ESG
risks to stakeholders
EBA/ECB/SSM
supervisory reports
and public
disclosure
information
EBA report about
integration of ESG
risks
Further
harmonise
supervisory
Number of material acquisitions
of holdings by a bank to which
the competent authority opposed
Limited number of opposition
from competent authorities as
institutions gives sufficient
importance ex ante, when
EBA/ECB/SSM
supervisory reports
and public
disclosure
66
powers and tools assessing the opportunity of a
material acquisition of holding,
to the prudential concerns the
operation could raise.
information
Number of material transfers of
assets and liabilities to which the
competent authority opposed
Limited number of opposition
from competent authorities as
institutions gives sufficient
importance ex ante, when
assessing the opportunity of a
material transfer of assets or
liabilities, to the prudential
concerns the operation could
raise.
EBA/ECB/SSM
supervisory reports
and public
disclosure
information
Percentage of decisions related to
mergers or demergers to which
the competent authority opposed
Limited number of opposition
from competent authorities as
institutions gives sufficient
importance ex ante, when
assessing the opportunity of a
merger/demerger, to the
prudential concerns the
operation could raise.
EBA/ECB/SSM
supervisory reports
and public
disclosure
information
Number of breaches effectively
sanctioned and corresponding
sanctions
Increase in the number of
breaches sanctioned by
competent authorities that do
not yet possess the new
sanctioning powers
EBA’s central
database of
administrative
penalties and
EBA’s lists of
published sanctions
ECB’s list of
published sanctions
Number of fit-and-proper
assessments
Increase in share of ex-ante fit-
and-proper assessments
performed by competent
authorities
Reduction in assessments
taking longer than six months
EBA/ECB/SSM
reports on fit-and-
proper assessments
Reducing
disclosure costs
and improving
market access to
bank prudential
information
Annual volume of visitors and
downloads from the newly
centralised disclosure platform
Gradual increase in visits to
and downloads from the
platform within the first 5 years
of its introduction
EBA centralised
disclosure platform
reports


EN EN
EUROPEAN
COMMISSION
Brussels, 27.10.2021
SWD(2021) 320 final
PART 2/4
COMMISSION STAFF WORKING DOCUMENT
IMPACT ASSESSMENT REPORT
Accompanying the documents
Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE
COUNCIL amending Regulation (EU) No 575/2013 on prudential requirements for
credit institutions as regards requirements for credit risk, credit valuation adjustment
risk, operational risk, market risk and the output floor
Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE
COUNCIL amending Directive 2013/36/EU as regards supervisory powers, sanctions,
third-country branches, environmental, social and governance risks, and amending
Directive 2014/59/EU
{COM(2021) 663 final} - {SEC(2021) 380 final} - {SWD(2021) 321 final}
Offentligt
KOM (2021) 0663 - SWD-dokument
Europaudvalget 2021
64
ANNEX 1: PROCEDURAL INFORMATION
1. LEAD DG, DECIDE PLANNING/CWP REFERENCES
This legislative proposal (CRR III/CRD VI) was prepared under the lead of DG FISMA in
association with DG JUST. Within the Agenda Planning of the European Commission, the
project is referred to under item 21. In the Adjusted Commission Work Programme for 2020,
the Commission committed under the header “An Economy that Works for People” to review
of the CRR and the CRD and adopt a legislative proposal by Q2 2020.
The Decide Planning references are:
 REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL
amending Regulation (EU) No 575/2013 (Capital Requirements Regulation - CRR) as
regards risk-based own funds requirements
PLAN/2019/5320
 DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL
amending Directive 2013/36/EU (Capital Requirements Directive - CRD) as regards
risk management and review processes
PLAN/2019/5321
In light of the COVID-19 pandemic, the preparatory work has been delayed, reflecting the
BCBS’ decision of 26 March 2020 to postpone the previously agreed implementation
deadlines for the final set of Basel III reforms by one year154
. This delay has allowed the
Commission services to focus their attention on the response to the COVID-19 crisis. It has
also allowed them to reassess the impact of the planned reforms in light of the potential
consequences of the crisis.
2. ORGANISATION AND TIMING
DG FISMA work on this legislative proposal started in spring 2018 with the publication of
the first public consultation requesting inputs from external stakeholders on the
implementation of the final elements of the Basel III reform (see Annex 3).
An Inter-services Steering Group assisted DG FISMA in the preparation of this Impact
Assessment report. The Steering Group was set up on 11 September 2019 and included
colleagues from DG ECFIN, DG GROW, DG JUST, DG COMP, and DG TRADE.
Two additional Steering Group meetings were organised on 2 December 2019 (with
colleagues from the same DGs as in the previous meeting) and on 23 January 2020 (with
colleagues from the same DGs as in the previous meeting, as well as colleagues from the
154
See https://www.bis.org/press/p200327.htm.
65
Legal Service). At each occasion, the members of the Steering Group were given the
opportunity to provide comments in writing on the draft versions of the documents presented.
A final Steering Group meeting took place on 12 February 2021 (with colleagues from the
same DGs as in the previous meeting, as well as colleagues from DG CLIMA and DG ENV)
to discuss the revised text before its submission.
All the meetings were chaired by the Secretariat General.
The contributions of the members of the Steering Group have been taken into account in the
content and shape of this impact assessment.
3. CONSULTATION OF THE RSB
A first version of the Impact Assessment report was submitted to the Regulatory Scrutiny
Board (RSB) on 12 February 2020 and discussed during a physical meeting with the RSB on
4 March 2020. The RSB gave a negative opinion on 6 March 2020, pointing to several
shortcomings in the report (see left column of Table 1 for the list).
The Impact Assessment was modified to address the identified shortcomings (see right
column of Table 1 how they were addressed) and was re-submitted via written procedure to
the RSB on 22 June 2021.
Table 1: Summary of RSB comments in its 4 March 2020 opinion
RSB comments about the first version of
the IA
How these comments have been
addressed in the present version of the IA
(1) The report should present a clear and
non-technical narrative for the main issues at
stake. It should present available evidence of
current problems with the resilience of
European banks and the banking system,
and compare against other jurisdictions
implementing Basel III. If relevant, it should
differentiate between types of banks.
The narrative of this impact assessment has
been clarified and simplified to highlight the
main problems that this legislative initiative
is addressing.
In Section 2, four main problems have been
identified and are now all included in the
main body of the impact assessment for
better readability. The different problems
related to the outstanding deficiencies of the
calculation of the risk-based capital
requirements in the current prudential
framework have been merged into one
overall problem which will make it easier to
present the implementation of the Basel III
reforms as a global policy option to address
this problem. In addition, more factual
evidence has been provided to illustrate the
problems.
66
The context section now includes
information on the state of play of
implementing the final elements of the Basel
III reform in other jurisdictions and provides
more evidence on the current situation of
EU banks.
The specific impact on the competitiveness
of EU banks (now Section 2 of Annex 6) has
been improved to provide a comparison of
the impacts of the final elements of the
Basel III reform across EU banks,
depending on different banks’ profiles, but
also between EU banks and their
international peers.
(2) The narrative should also show the
overall trade-offs involved in the decisions.
This would help to clarify the key issues to
non-expert policymakers and prioritise
elements of the report, adding structure to
the more technical analysis of components
The assessment of the different policy
options in Section 6, as well as the summary
of the assessment of the preferred policy
options in Sections 7.1 to 7.3, offers a better
understanding of the different trade-offs in
the decision making process.
(3) The report should consolidate in one
place all relevant policy objectives, some of
which are now only referred to or hinted at
later on in the report (e.g. relating to
financing of the economy and sustainable
finance). The definition of the objectives
should allow a systematic analysis of the
relevant trade-offs in the impacts sections.
All objectives, general and specific, are
presented in one place, namely Section 4.
They have been updated to take into account
the COVID-19 crisis.. The links between the
general and specific objectives as well as the
identified problems have been clarified and
presented graphically.
(4) The operational meaning of ‘level
playing field’ and other specific objectives
should be made clear, including what
success would look like. The problem
description might also clarify what the
problems are that relate to an unlevel
playing field. The report should explain to
what extent and how the proposal will result
in a level playing field in the EU in line with
the objective and with other jurisdictions.
The explanation should ideally be in terms
that can later be tested against outcomes.
The notion of level playing field has been
specified across all the sections and put into
the appropriate context.
Section 2 of Annex 6 offers a clearer
analysis of the differences in the impact of
the final elements of the Basel III reform
could affect the internal (i.e. between EU
banks) and external (i.e. between EU banks
and non-EU banks) competitiveness of EU
banks and how the preferred policy options
would address the level playing field.
(5) While it is an important objective to
contain administrative and compliance costs,
it is less clear whether this is different from
The specific objective has been refined
(focusing on banks’ administrative costs
related to public disclosures) to better
67
cost-effectiveness used to select the
preferred option. The initiative would not
appear to deliver significantly lower costs,
and cost efficiency is in any case among the
assessment criteria. The report should apply
uniform definitions of cost-effectiveness and
efficiency. The objective on legal clarity
also requires better justification
correspond to the problem (of inefficiency in
the disclosure of banks’ prudential
information) identified and to ensure they do
not overlap with the assessment of the cost-
effectiveness criteria to identify the
preferred policy option.
(6) The report should present an intervention
logic that describes the channels through
which policy measures would contribute to
better final outcomes. This would help to
better structure the report around the relative
importance of various measures and their
impacts on different elements of the EU
banking ecosystem. The logic should
connect actions to specific objectives that
relate clearly to the general objectives.
The link between the general and specific
objectives has been clarified in Section 4.
Sections 5 and 6 describe how the policy
options connect to the specific objectives
and deliver on them against the assessment
criteria (effectiveness, efficiency,
coherence), respectively.
(7) The report needs to be clearer on impacts
that do not map onto the objectives. This
includes the likely reactions from those
banks, which will need to significantly raise
capital. The report should explain the
available means for them to do so (e.g.
through retained profits, sale of equity, sale
of assets, mergers) and the likely impacts of
the different choices on the sector and on
different Member State economies.
Section 6.1 clarifies the views of the EU
banking sector on the different policy
options to implement the final elements of
the Basel III reform, the
advantages/disadvantages of different
approaches that EU banks can use to comply
with an increase in capital requirements
resulting from the reform, and their chance
to succeed for each policy option.
Section 2 of Annex 6 provides the impacts
of the various elements of the reform,
grouping banks by size, business model and
Member State of establishment.
(8) Other relevant impacts to explore may
include the impact on competitiveness of
banks and sectoral consolidation. For
example, different ways of calculating the
output floor have direct impacts on large
banks and indirect impacts on small banks.
By contrast, changes to the standardised
approach directly affect small banks. The
impact on venture capital may also be worth
exploring.
Section 2 of Annex 6 provides the impacts
of the various elements of the Basel III
reform, grouping banks by size, business
model and Member State of establishment.
(9) The report should expand the analysis of
the limits to supervisory powers in
controlling banks’ discretion in using
Sections 2.2.1., 2.2. and 5.1. better explain
the current powers of supervisors to address
the variability observed across EU banks
68
internal models to calculate capital
requirements. Any reduction of
discretionary authority of national and ECB
banking supervisors needs to be presented
transparently, including feedback from those
supervisors regarding the proposed changes.
The report should explain what the proposal
would mean for the internal market and for
the competitive situation between small and
large banks, public banks, and large or
complex banks whose failure would involve
systemic risk. It should explain the reason
for more pronounced impacts on banks in
some Member States, and whether this is
likely to affect these economies more
broadly.
internal models, including the EU-wide
initiatives conducted by the EBA and the
ECB in that respect, and their limitations.
Section 6.1. and Annex 2 provide the view
of supervisors on the proposed changes.
See also elements of replies to comments (4)
and (8), for what concerns impacts on
competitiveness and impacts on different
types of banks, respectively.
(10) The report should thoroughly analyse
the effect of the proposed measures on
SMEs. It should assess the effects of the
introduction of a higher risk weight for
credits to unrated companies under the
standard approach. This measure is likely to
affect SMEs in particular as most SMEs are
unrated and as they receive more credits
from smaller banks that apply the standard
approach to credit risk. If the analysis
assumes that a substantial part of SMEs will
use the transition period to obtain a credit
rating, it should incorporate the cost of
doing this. The possible positive effects of
the SME supporting factor should also be
developed.
Section 3 of Annex 6 on the specific impacts
of this legislative initiative on lending to
SMEs describes which policy options are
specifically related to SMEs and how they
would impact banks’ financing of SMEs.
Annex 1 provides further explanation, on
top of Section 3 of Annex 6, on the EU
specific adjustments proposed in the
preferred policy options to mitigate the
impact of the reform on banks’ lending to
SMEs, including the treatment of unrated
corporates and the existing SME supporting
factor.
(11) The report should better justify why it
proposes to maintain the existing supporting
factors for SMEs and for infrastructure
investment. It should integrate stakeholder
views, including the recommendation of the
EBA to abandon these supporting factors.
The performance of the existing supporting
factors should be at the basis for the
proposed introduction of a new green
supporting factor. The report should bring
more convincing evidence that the two types
of exposure that would benefit from it have
unique features that justify their preferential
Further justification has been provided for
the decisions involving the different
supporting factors.
69
treatment.
(12) The impact assessment should be more
transparent about data and model
limitations. For example, inferences from
the EBA sample of banks on the sector as a
whole may be more reliable for large banks
than for small ones. Estimates of the
negative impact on growth in the short and
medium term are more robust than estimates
of long-term benefits that are based on
decreased risk of full-blown banking crises
over longer time horizons. The report
appears to overplay analytical support for
the hypothesis that ‘green’ investments are
relatively lower risk, and that lower capital
requirements on certain loan types are an
effective way to stimulate more lending. The
report should discuss the EBA calculations’
robustness and relevance for assessing the
impacts of the preferred options, given the
modifications introduced after the
calculations.
Section 6.1 and Annex 7 better explain how
to interpret the estimated impacts from the
EBA and ECB respective analysis. Annex 5
provides more details about the sample used
in the EBA and ECB analysis and the
limitations of their methodologies.
The analysis related to environmental, social
and governance (ESG) risks and the
corresponding policy choices have been
updated.
(13) Some options need further clarification
or explanation why they have been
discarded. For instance, the report should
better explain why supervisory bodies
cannot be strengthened and why this option
has been discarded. This holds in particular
for the ECB, which is responsible for
supervision of the larger banks and should
have the capacity to assess and control
banks’ use of internal models to assess
portfolio risks. On credit valuation
adjustment risks, the justification for
discarding the option of postponing the
introduction of a revised framework until
BCBS has finalised its ongoing review
should be strengthened.
In Section 6, the assessment of the pros/cons
of each policy option to address the problem
it aims to address identified has been
improved, as well as the system to score
those options. These clarifications allows the
reader to understand our choice of preferred
policy options and why the other policy
options have been discarded.
4. EVIDENCE, SOURCES AND QUALITY
A number of inputs and sources of data were used in the preparation of this impact
assessment, including the following:
70
 advices from the EBA, delivered to the Commission in August and December 2019
and December 2020, and other reports of the EBA referred to in footnotes to this
impact assessment;
 information supplied in the context of the public consultation described in Annex 2;
 publications of the ECB, the ESRB, the FSB and the BCBS referred to in footnotes to
this impact assessment;
 newspaper articles, scientific journal articles, and other sources referred to in
footnotes to this impact assessment.
The vast majority of the data underpinning the quantitative analysis contained in this impact
assessment was provided by banks. Given that the data used in the EBA, ECB and BCBS
analyses underwent quality checks by those organisations, the data quality can be considered
reasonably good. Nevertheless, the figures provided by banks are (more or less accurate)
estimates based on assumptions made by banks. As such, they need to be interpreted with
caution.
71
ANNEX 2: STAKEHOLDER CONSULTATION
1. Public consultation
As part of the implementation process of the final elements of the Basel III reform in the EU,
the Commission services gathered stakeholders’ views on specific topics in the areas of credit
risk, operational risk, market risk, CVA risk, securities financing transactions as well as in
relation to the output floor.
Beyond these topics related to the Basel III implementation, the Commission services have
also consulted on certain other subjects with a view to ensuring convergent and consistent
supervisory practices across the Union and alleviating the administrative burden.
The public consultation carried out between October 2019 and early January 2020155
had
been preceded by a first exploratory consultation conducted in spring 2018156
, seeking first
views of a targeted group of stakeholders on the international agreement. The results of the
two consultations have fed into the preparation of the legislative initiative accompanying this
impact assessment.
Stakeholder groups
There were 119 responses to the public consultation. As illustrated by
155
See https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12015-Alignment-EU-rules-on-
capital-requirements-to-international-standards-prudential-requirements-and-market-discipline-/public-
consultation_en.
156
See https://ec.europa.eu/info/consultations/finance-2018-basel-3-finalisation_en
72
Figure 1 and Figure 2, most responses came from the financial industry (i.e. individual
banks, banking associations and) and half of them came from respondents established in three
Member States (Belgium, Germany, France and the United Kingdom).
Results
Stakeholders overall agreed on the necessity to complete the implementation of the Basel III
framework in the EU. While the financial industry called for several adjustments and
additional transition periods, supervisors and public authorities took a more conservative
approach and preferred an implementation of the remaining reforms closer to the
international standards.
73
Figure 1: Nature of respondents to the public consultation
Source: Commission, DG FISMA
Figure 2: Country of origin of respondents to the public consultation
Source: Commission, DG FISMA
The feedback received on the individual elements of the reforms can be summarised as
follows:
 Regarding the output floor the financial industry asked to limit the scope to the
requirements explicitly listed in the corresponding Basel standard by applying it as a
“parallel stack” and at consolidated level only. In contrast, a majority of supervisors
were in favour of a “single stack” implementation of the output floor at all levels of
consolidation.
 As regards the treatment of unrated corporates in the credit risk framework,
supervisors and the financial industry have expressed different views. Industry
advocated for a so-called “hybrid approach” while supervisors prefer to implement
3
58
40
1 4
11
2
Type of respondent
Academic/research
institution
Business association
Company/business
organisation
Non-governmental
organisation (NGO)
Other
Public authority
0
5
10
15
20
25
Country of origin of respondent
74
the Basel standard. Views were divided among supervisors on the option to remove
the SME supporting factor from the risk framework, while the financial industry was
in favour to keep it.
 On specialised lending, views were mixed between Member States and supervisors.
Some showed openness to introduce more granularity in particular with regards to
object finance than it is envisaged under the final Basel III standards. This approach
was supported by the financial industry.
 Supervisors and the industry also expressed different views on the treatment of
equity exposures. Supervisors preferred to apply the Basel treatment without
modifications while the industry and some Member States argued for a more granular
treatment for long-term equity holdings in unlisted entities, and notably a more
favourable treatment for intragroup and IPS exposures.
 There was consensus among Member States and supervisors in favour of the
continuation of the “loan splitting approach” (instead of implementing the “whole
loan approach”) for real estate exposures. The financial industry preferred to provide
flexibility for banks to choose its approach. Industry’s plea to continue allowing for
the upward revaluation of property values after origination found some (conditional)
support with Member States and supervisors.
 Several stakeholders from industry were in favour of not fully applying the new
constraints for the use of internal models for credit risk. This option found only
little support from Member States and supervisors.
 The industry favoured a delay in the implementation of minimum haircut floors for
securities financing transactions, or, as a second best, an implementation via market
regulation. Member States and supervisors were mostly silent on the issue.
 Member States and supervisors were largely in favour of taking historical losses into
account to compute large banks’ capital requirements for operational risk, while the
majority of stakeholders in the financial industry favour neutralising the impact of
past losses or taking them into account only when they have a beneficial impact.
 The consultation showed no opposition against the implementation of the simplified
standardised approach for market risk in line with the Basel calibration. Also, the
financial industry unanimously supported the need for more flexibility in the
treatment of CIUs while Member States and supervisors were mostly silent on the
issue.
 Industry and supervisors were in favour of delaying the implementation of the CVA
risk rules until the Basel standard is finalised. The industry unanimously favours
keeping the existing exemptions. MS and supervisors are split on this issue.
75
Apart from questions on the implementation of the final elements of the Basel III reform in
the EU, the consultation included some questions regarding supervisory reporting and public
disclosure as well as the fit-and-proper assessment.
Views are all in all cautiously positive on the initiative to centralise supervisory reporting
and public disclosure. A majority of industry players supported the approach but raised
some doubts as to the size of the potential reduction in their administrative costs. Supervisors
pointed to the need to address concerns about wrong expectations that the EBA would be
responsible for the quality of the information disclosed by banks.
The views of Member States and supervisors on potential changes to the fit-and-proper
assessment framework were largely correlated with their current practices. Doubts
regarding the need for changes were mainly expressed by those Member States that currently
do not assess key function holders and/or assess members of the management body after their
appointment, while others were more supportive. Similarly, industry representatives in
Member States applying only ex-post assessments were particularly concerned about
potential difficulties in terms of administrative procedure and burden that could arise under
an-ex ante system. Those industry representatives that already had experience with ex-ante
assessments of members of the management body and of key function holders and/or with
accountability regimes, generally reported a positive impact in terms of reducing risks for the
sector and creating a level playing field.
2. Public conference
On 12 November 2019, DG FISMA held a public conference to discuss the impact and
challenges of implementing the finalised Basel III standards in the EU.
More than 500 representatives of public authorities (Members of the European Parliament,
Member State governments, bank supervisors and international organisations), the financial
industry, non-financial companies, think tanks and non-governmental organisations
physically attended the conference and 618 additional representatives watched the
discussions online on that day.
The conference was comprised of three keynote speeches, delivered by staff of the European
Commission, the chair of the EBA and the chair of the Single Supervisory Mechanism, as
well as four panel discussions157
: “Basel III in a global context”, “The impacts of Basel III on
the EU economy”, “A proportionate implementation of Basel III” and “Basel III – are we
done now?”.
Panel discussions took place on Basel III implementation in a global context, on its impact on
the European economy as well as in view of proportionality. Panel discussions included also
a regulatory outlook beyond the Basel reforms, chaired by officials of the European
Commission, members of the European Parliament (ECON chair) and representatives of the
Council (Financial Services Committee chair).
76
3. Ongoing exchanges with stakeholders
Since 2018 the Commission services have repeatedly consulted Member States on the EU
implementation of the final elements of the Basel III reform and other possible revisions of
the CRR and the CRD in the context of the Commission Expert Group for Banking, Payment
and Insurance (EGBPI).
During the preparatory phase of the legislation, the Commission services have also held
hundreds of meetings (physical and virtual) with representatives of the banking industry as
well as other stakeholders.
77
ANNEX 3: WHO IS AFFECTED AND HOW?
The purpose of this Annex is to set out the practical implications for stakeholders affected by
this initiative, mainly banks, governments at the national and European level and the general
public (namely companies and consumers acting as borrowers). The initiative aims to achieve
the following objectives:
 Objective 1: strengthen the risk-based capital framework, without incurring in a
significant increase of capital requirements;
 Objective 2: enhance the focus on Environmental, Social and Governance (“ESG”)
risks in the prudential framework;
 Objective 3: further harmonise supervisory powers and tools;
 Objective 4: reduce administrative costs related to public disclosures and improve
access to banking prudential data.
In order to “strengthen the risk-based capital framework, without incurring a significant
increase of capital requirements” (objective 1), the preferred option would implement the
final elements of the Basel III reform in Union law, subject to a set of adjustments. The
proposed adjustments are intended to prevent an undue disruption of banks’ lending capacity
during the (expected) post-COVID 19 pandemic phase.
The aim of the Basel III reform is to make banks more resilient and restore confidence in the
banking system in response to the GCF. A more robust banking system has significant long-
term benefits for the economy of the Union as a whole. Better capitalised banks will be more
capable of withstanding future financial shocks and continue lending through economic
downturns, which is likely to make those future downturns shorter in length and less severe.
Hence, achieving the purpose of better capturing risks sought by the Basel III reform will
directly benefit banks and, indirectly, all other stakeholders concerned. For instance, bank
bail-outs and the recourse to governments to fund them in the event of a crisis can be
expected to be less likely. At the same time, a steadier flow of credit may reduce the
likelihood of failure for borrowers (namely businesses and households) that rely on bank
lending as an essential source of funding.
Objective 1 will be achieved by various amendments to the current prudential framework
contained in the CRR):
a) standardised approach for credit risk: changes to the regulatory capital treatment of
rated exposures to banks, exposures to corporates, real estate exposures, retail
exposures, subordinated debt and equity and off-balance sheet items;
b) internal ratings-based approach (IRBA) for credit risk: the use of internal models is
either limited or precluded for certain portfolios that cannot be reliably modelled.
Where models may be used, their parameters become subject to certain minimum
values (“input floors”);
78
c) market risk (FRTB): the current reporting requirements based on the FRTB are
transformed into substantive capital requirements;
d) credit valuation adjustment (CVA): the use of internal models for CVA is precluded
and replaced by a revised standardised approach;
e) operational risk: the use of internal models is precluded and replaced by a single new
standardised approach;
f) output floor: capital requirements that result from a bank’s internal models are floored
at 72.5% of the requirements that would result from applying the corresponding
standardised approaches.
The net effect of these changes in the CRR is an overall increase of regulatory capital
requirements on banks. The effect mainly depends on the magnitude of the use of internal
models, insofar as banks may be impacted by the output floor and/or become subject to the
corresponding (normally more conservative) standardised approach or relevant regulatory
input. As estimates show (see Section 6.1), the unfettered implementation of the final
elements of the Basel III reform would lead to an average increase of 18.5% in banks’ capital
requirements by the end implementation date (January 2028). The implementation would be
phased in during a five-year period and the increase of capital requirements at the start of that
period (January 2023) would be 11.8% on average. The impact on regulatory capital, at both
the end and start dates of the standards’ implementation, would be significant and have
considerable potential to reduce bank lending in the short term158
. This would be particularly
undesirable in the context of a post-Covid scenario when lending will be needed to fund the
economic recovery.
In order to address this concern, it is suggested to mitigate the proposal’s impact through a set
of substantive adjustments to the standards, namely:
a) provisions to cater for the “specificities” of the EU banking sector and its
economy: these provisions would adjust the Basel III standards to the distinctive
features of the EU banking sector. In particular they aim at maintaining the flow of
lending to EU businesses in general, and SMEs in particular. These include:
 maintaining certain existing preferential treatments and exemptions for key
exposures - the “SME supporting factor” and the “infrastructure supporting
factor”, which lower capital requirements for these exposures compared to the
corresponding Basel III standards, or the exemption for derivative
transactions with certain qualifying parties from the CVA requirements;
 providing a transitional period for the implementation of the OF in relation to
lending to unrated corporates – Basel III standards increase capital
requirements on lending to unrated borrowers. However, most corporates in
158
Faced with higher capital requirements, banks may choose to raise new capital to increase their ratios and/or
reduce their exposures (i.e. reduce lending) to meet the new requirements.
79
the EU (namely SMEs) are currently unrated. During the proposed transitional
period and while solutions aimed at increasing the coverage of external ratings
are rolled out, lending to unrated corporates by banks using the IRBA would
be subject to a more favourable treatment than the one provided for in the
standards (i.e. a lower risk weight under the OF);
 maintaining the existing treatment for certain types of equity exposures –the
treatment of banks’ strategic holdings of equity issued by entities within the
same banking group or covered by the same IPS would be left unchanged, and
existing strategic participations in non-financial companies where banks
exercise influence would be grandfathered. Hence, these particular equity
exposures would remain subject to the capital requirements currently
applicable under the CRR and, thus, exempted from the higher capital
requirements on equity exposures that will result from implementing the Basel
III standards;
 providing an ad hoc preferential treatment for certain exposure types under
the new market risk rules - these comprise exposures to collective investment
undertakings and financial products based on EU emission trading schemes;
and
 postponing the implementation of the FSB’s recommendation of a minimum
haircut floor for non-centrally cleared SFTs, awaiting a joint report on the
matter by the EBA and ESMA;
b) the application of certain discretions contained in the Basel III standards:
 apply the OF on the consolidated level of a banking group taking into account
all the risk-based capital requirements contained in EU law and require the
relevant authority to adjust the individual bank’s Pillar 2 requirement (P2R) or
the systemic risk buffer (SyRB) in case double-counting of risks already
covered by the OF would be detected;
 set the Internal Loss Multiplier (“ILM”) at 1 as part of implementing the new
standardised approach for operational risk. The calculation of capital
requirements for operational risks of EU banks would, thus, be based on their
Business Indicator Component (“BIC”), which takes into account the main
elements of a bank’s income and expenses. However, the banks’ historical
operational losses would be disregarded for these purposes, which would
significantly mitigate the impact of the new approach for calculating the
capital requirements for operational risk.
c) safeguards related to banks’ trading activities: in order to preserve the international
playing field for EU banks, the Commission would be empowered to delay the entry
into force of the capital requirements based on the FRTB and/or to make certain
adjustments to the framework. The Commission’s decision should, for instance,
80
consider whether major jurisdictions failed to implement the FRTB. Similarly, it is
suggested to temporarily lower the calibration of the current standardised approach for
counterparty credit risk (“SA-CCR”) for all derivatives for the purpose of calculating
the OF, taking into account international developments in this field (for instance, one
major jurisdiction has lowered the calibration of the SA-CCR for certain derivative
exposures). This would afford extra time to discuss the calibration of the SA-CCR at
international level;
d) a delayed phase-in period for the new rules, relative to the phase-in period envisaged
in the Basel III standards (from January 2023 to January 2028), as further explained
below.
The adjustments to the Basel III standards referred to in points (a) to (c) would significantly
lower the expected increase in banks’ capital requirements that results from implementing the
Basel III standards. Capital requirements would go up on average between +0.7% to +2.7% at
the start of the phase-in period (in contrast to the 11.8% increase without the adjustments),
and between +6.4% and +8.4% at the end of the phase-in period (in contrast to the 18.5%
increase without the adjustments). In this modified scenario, bank lending would not be
impeded and the prudential benefit of the reform would be preserved.
While the quantitative impact at the beginning of the phase-in period may be moderate per se,
the market may exert pressure on EU banks to start building up capital from early on to
anticipate future capital requirements. This may coincide with the recovery phase from the
COVID-19 crisis and have short term negative effects on bank lending and the wider
economy. Accordingly, it is suggested as part of the preferred policy option for Objective 1,
that the phase-in period of the new standards’ implementation in the EU would be delayed by
two years. The starting date of the phase-in period would be January 2025 (instead of January
2023 under the Basel III scenario) and the new standards would only be fully effective from
January 2030 (instead of January 2028). This additional two-year period would give banks
enough time to start building up capital without compromising their short-term lending
ability. At the same time, the completion of the bank reforms, albeit delayed, would give all
market players certainty about the final shape of the regulatory landscape.
Objective 2 of the proposal is to “enhance the focus on ESG risks in the prudential
framework”. This objective seeks to address, among others, the emerging risks that climate
change and the resulting economic transformations pose to banks, primarily in the form of
transition risk. The transition to a sustainable economy may lead to substantial shifts in the
value of assets. At the same time, more frequent and /or more severe weather events will
present new physical risks.
As explained in Section 6.2, the preferred policy option would introduce in the CRD a
general requirement for banks to manage their ESG risks. At the same time, competent
authorities would have to supervise compliance with that requirement as part of the
supervisory and review assessment process. In addition, the CRR’s requirement to disclose
ESG risks related information would be extended beyond large banks. This means that, at this
81
stage, banks would be subject to behavioural obligations in relation to ESG risks (that is,
management, governance and disclosure) as opposed to a pre-determined minimum amount
of capital to cover unexpected losses arising from those risks within the framework (i.e. no
Pillar 1 capital requirements). The introduction of ESG-targeted Pillar 1 capital requirement
could be decided at a later stage, following the publication of an EBA Report providing
quantitative evidence on the appropriate treatment of ESG risks under Pillar 1.
The above-described policy option presents a number of benefits for all stakeholders
concerned without imposing significant costs on banks in the short term. Under the preferred
approach, banks would be obliged to adapt their risk management systems and incorporate
the ESG dimension before Pillar 1 requirements are introduced. As a consequence, they
would be better prepared once Pillar 1 requirements are introduced The prudential
framework’s better capturing of ESG risks would also have positive effects for governments
and the general public as banks would be less exposed to shocks that may result from
transition and physical risks and be more likely to continue lending to the economy under
these circumstances. The proposal would also contribute to the general public policies by
facilitating a smooth transition towards a more sustainable economy.
By contrast, the costs associated with this policy option would be relatively contained and
limited to administrative costs that banks would incur to adapt their risk management,
governance and disclosure policies. Such costs should not materially affect banks’ lending
capacity.
Objective 3 of the proposal is to “further harmonise supervisory powers and tools of
banking competent authorities”. In order to achieve this objective, it is suggested to make
various amendments to the CRD to harmonise the supervisory and sanctioning powers of
those authorities as follows:
a) introduce ex-ante notification requirements for banks on “material” events with
prudential relevance, namely acquisitions of holdings, transfers of assets and
liabilities and mergers and demergers;
b) enhance the disciplinary framework whereby the list of breaches for which competent
authorities would have explicit powers to impose sanctions would be expanded;
c) introduce harmonised requirements on the assessment of the fitness and propriety of
members of banks’ management boards and key function holders before taking up
their positions.
The preferred policy option would ensure a more consistent application of the prudential
framework across the EU in general, and within the Banking Union in particular, than
currently the case. Enhanced consistency in regulatory and supervisory processes and
outcomes would be beneficial for all stakeholders concerned, namely banks that would be
able to operate across much more harmonised legal frameworks within the EU. This would
reduce the compliance costs that currently arise from the need to deal with diverse and
potentially inconsistent requirements. While some banks may initially incur some costs to
82
meet the new requirements (in particular if the national rules they are currently applicable are
less stringent than those under the preferred policy option), it is not expected that those costs
would be significant enough to offset the preferred policy option’s benefit. It should be noted,
in particular, that the most impactful set of amendments, i.e. those referred to in point (a),
would be subject to a materiality threshold.
The preferred policy option would also assist competent authorities to discharge their legal
duties in a more effective manner than they currently do, as they all would have access to the
same full set of supervisory powers (which some competent authorities currently lack) and a
more harmonised supervisory framework would mitigate the risk of regulatory arbitrage or
the existence of loopholes that banks could potentially exploit. This would, in turn, contribute
to fostering the general public’s confidence in the EU system of banking supervision.
Lastly, Objective 4 aims at “reducing administrative costs related to public disclosures
and improve access to banking prudential information”. It would be achieved through the
creation of a single electronic access to EU banks’ quantitative information that the EBA
would source from its EUCLID platform (which will be fed through the existing periodic
reporting made by banks), and qualitative information that the EBA would source from banks
(see Section 5.2.4).
The preferred option would eliminate disclosure costs for small and non-complex banks,
which are only required to disclose quantitative data. For all the other banks, the preferred
option would entail neither additional costs nor cost savings.
For other stakeholders, namely market participants who are users of information disclosed by
banks, this proposal would bring about material benefits in the form of greater market
transparency and lower costs to search for and to access prudential data.
83
OBJECTIVE 1 – STRENGTHEN THE RISK-BASED CAPITAL FRAMEWORK FOR CREDIT
INSTITUTIONS
Preferred Option – Implement Basel III reforms with EU-specific adjustments and
transitional arrangements adapted to the COVID-19 crisis
I. Overview of Benefits (total for all provisions) – Preferred Option
Description Amount Comments
Direct benefits
Implement in EU law
the set of reforms to
the risk-based capital
framework for banks
agreed at international
level (the Basel III
framework or Basel III
standards)
- The revisions to the standardised
approach for credit risk (SA-CR) will
improve the robustness and risk
sensitivity of the existing approach;
- The revisions to the IRB approaches for
credit risk will reduce unwarranted
variability in banks’ calculations of
RWAs;
- The minimum haircut floors for non-
centrally cleared securities SFTs will
limit the pro-cyclicality of these
transactions and the build-up of excessive
leverage in the financial system;
- The revisions to the CVA risk framework
as well as revisions to the standardised
approach for CVA (SA-CVA) will
enhance the risk sensitivity, strengthen
the robustness and improve the
consistency of the framework;
- The new standardised approach for
operational risk (SA-OR) will simplify
the framework and increase
comparability; and
- The output floor (OF) will limit the
unwarranted variability in the regulatory
capital requirements produced by internal
models and the excessive reduction in
capital that a bank using internal models
can derive relative to a bank using the
revised standardised approaches.
- These enhancements of the prudential
standards will make banks more
resilient and restore confidence in the
banking system and, thus, make the
financial system more stable as a
whole.
- Better capitalised banks will be less
likely to fail as a result of financial
crisis and more able to continue
lending through economic downturns.
- A steadier flow of credit to the
economy will reduce the likelihood of
borrowers failing due to a shortage of
bank funding.
- Bank bail-outs and the recourse on
governments to fund them can be
expected to be less likely in future
financial crisis.
- Economic crisis following future
financial crisis (and the political
instability and social hardship caused
by those) can be expected to last less
and be less severe.
Adjust to the Basel III
revisions to take into
account the specific
features of the EU
banking system
- The proposed adjustments will more than
halve the average Basel III standards-
induced capital increase from 18.5%to
between 6.4% and 8.4% by the end of the
phase in period.
- The adjustments are designed to cater
for the distinctive features of the EU
banking system and economy, namely
the significant reliance by SMEs in
bank lending as key source of
funding.
- The reduced impact on capital
requirements should be regarded as a
84
proportionate measure that adequately
balance the primary objective of
enhancing the banking prudential
framework while maintaining a
sufficient flow of bank lending to the
EU economy.
- Hence, the proposed adjustments do
not compromise the overall purpose
or negate the stated benefits of the
Basel III reform.
Delay the starting date
of application of the
new rules by two
years. Starting date
would, thus, be set on
1 January 2025 with a
5-year transition
period.
- No impact on banks’ capital requirements
until 1 January 2025. Full impact on
capital requirements delayed to January
2030.
- The suggested delay of the phase-in
period would prevent material
disruption of bank lending in the
short-term.
- Hence, banks’ flow of lending would
not be materially affected during the
economic recovery phase that is
expected for following the current
COVID 19 pandemic crisis.
Indirect benefits
- Implementing the Basel III reforms would meet the EU international commitments and help improve the
confidence in European banks across international markets.
II. Overview of costs – Preferred option
Citizens/Consumers/non-
financial corporates
Banks Administrations (including
competent authorities)
One-off Recurrent One-off Recurrent One-off Recurrent
Direct costs
Costs to adapt
banks’
systems to
incorporate
the changes
made to the
prudential
framework
Increased cost
of capital for
exposures that
would be
subject to
higher capital
requirements
compared to the
current rules
Costs to
adapt current
supervisory
practices and
processes to
the new
standards
Costs for
running the
new
procedures
(depending on
magnitude of
change
compared to
current
procedures)
Indirect costs Increase in the
costs for bank
loans/financial
products which
are subject to
higher capital
requirements
compared to the
current rules
(depending on the
size of the
increase in the
capital
requirements for
85
the bank loan and
the level of
competition in
the market)
OBJECTIVE 2 – INCORPORATE SUSTAINABILITY RISKS IN THE PRUDENTIAL FRAMEWORK.
Preferred Option – Introduce measures for a better management of environmental risks by
banks
I. Overview of Benefits (total for all provisions) – Preferred Option
Description Amount Comments
Direct benefits
Requirements for
banks to manage ESG
risks
- Banks would integrate ESG factors in day-
to-day decision-making.
- ESG-targeted risk management
provisions will contribute to a
more robust and resilient banking
system in the face of transition and
physical risks.
- A more resilient banking system
will, in turn, help to reinforce
overall financial stability in the
EU.
Reinforced supervisory
powers over ESG risks
- Improved supervisory monitoring of
individual banks’ exposures to ESG risks.
Ad hoc disclosures of
ESG risks by banks
- Enhanced market discipline.
- Stakeholders concerned about ESG risks
and/or ESG-related externalities may
incentivise credit institutions to better
manage ESG risks and take externalities of
their actions into account.
Indirect benefits
Better availability of
finance for sustainable
exposures
- To the extent that sustainable activities may
be less risky than non-sustainable activities,
this difference may be better reflected in
banks’ credit decision-granting and, as a
result, lead to an increase in the availability
of finance for sustainable activities.
- Increased bank funding of
sustainable activities would help
the EU reach the target of the
EGD.
II. Overview of costs – Preferred option
Citizens/Consumers/non-
financial corporates
Banks Administrations
(including competent
authorities)
One-off Recurrent One-off Recurrent One-off Recurre
nt
Reinforced
requirements
for banks to
manage ESG
risks
Direct
costs
Cost of
adjusting risk
management
systems and
processes to
the new
requirement.
Indirect
costs
Cost of
providing
86
additional
information to
banks.
Reinforced
supervisory
powers for
ESG risks
Direct
costs
Cost of
setting up
new
supervisory
processes
and
systems.
Costs
of
runnin
g the
new
proces
ses
and
system
s.
Indirect
costs
Reinforced
disclosure of
ESG risks
by banks
Direct
costs
Changes to
systems to
accommodat
e new
disclosure
templates.
Costs of
preparing the
new
information
for
disclosure.
Indirect
costs
Cost of
providing
additional
information to
banks.
OBJECTIVE 3 – FURTHER HARMONISE SUPERVISORY POWERS AND TOOLS
Preferred Option – harmonise the supervisory powers and tools of banking competent
authorities to the greatest possible degree between two available options
I. Overview of Benefits (total for all provisions) – Preferred Option
Description Amount Comments
Direct benefits
Harmonise the supervisory
powers of banking
competent authorities to
the greatest possible
degree between two
available options in
relation to:
(i) ex ante notifications
of events of
prudential relevance;
(ii) assessment of board
members and
significant function
holders
(iii) sanctions and
penalties
- A more consistent application of the
banking prudential framework across the
EU in general, and within the Banking
Union in particular.
- Less scope for regulatory arbitrage and
loopholes that limit the effective and
consistent application of the prudential
framework across the EU.
- Reduced compliance costs for banks, as
they will be able to operate across
similar legal frameworks within the EU.
- More effective and consistent
application of sanctions may
contribute to fostering confidence
in the EU system of banking
supervision and reduce the
incidence of rules breaches in the
future.
Indirect benefits
-
87
II. Overview of costs – Preferred option
Citizens/Consumers/non-financial
corporates
Banks Administrations (including
competent authorities)
One-off Recurrent One-off Recurrent One-off Recurrent
Direct costs
Administrative
costs to adjust
internal
processes to
meet new
requirements.
Administrative
costs to comply
with new ex
ante
notification and
assessment
requirements.
Scope limited
to “material”
events for ex
ante
notifications.
Costs to change
current
supervisory
procedures or to
set up new
procedures to
meet the new
requirements.
Costs to
deal on an
on-going
basis with
new ex
ante
notificatio
n and
assessment
requiremen
ts.
Indirect
costs
OBJECTIVE 4 – REDUCE ADMINISTRATIVE COSTS RELATED TO PUBLIC DISCLOSURES AND
IMPROVE ACCESS TO BANKING PRUDENTIAL DATA
Preferred Option – centralise the disclosure of both quantitative and qualitative prudential
banking disclosures
I. Overview of Benefits (total for all provisions) – Preferred Option
Description Amount Comments
Direct benefits
EBA to disclose on a
single on-line platform
the prudential data and
information of all EU
credit institutions.
- The suggested centralised provision of
prudential data and information will
significantly improve market transparency
and the comparability of that information,
and will reduce the costs for market
participants to access information that is
currently scattered.
- Reduced information costs.
- Enhanced transparency would
result in more effective and
efficient market discipline of
banks.
Small and non-
complex credit
institutions exempted
from the obligation to
disclose prudential
information (replaced
by EBA disclosures)
- Costs of disclosure reduced to zero.
Indirect benefits
-
88
II. Overview of costs – Preferred option
Citizens/Consumers/non-
financial corporates
Credit institutions Administrations (including
competent authorities)
One-off Recurrent One-off Recurrent One-off Recurrent
Direct
costs
EBA to incur
costs to build
up the systems,
processes and
get the
necessary
resources to
provide the
centralised
disclosures.
There will
be increased
on-going
costs for the
EBA to
maintain
and operate
the
disclosure
platform.
89
ANNEX 4: EVALUATION
As described in Section 1, this prudential framework applicable to banks in the EU has been
significantly revised through two waves of reforms to address a number of issues observed
following the GFC: the first wave of reforms, introduced by the CRR and the CRD IV, was
adopted in June 2013 and the second wave, introduced by CRR II and CRD V, was adopted
in May 2019.
This new legislative initiative aims to complement and finalise the above reforms with the
implementation of the final elements of the Basel III reform adopted by the Basel Committee
in December 2017. The initiative addresses the outstanding deficiencies in the prudential
framework that have not been addressed by the previous rounds of reforms.
The vast majority of the changes proposed in this legislative initiative stem from changes to
the international standards developed by the BCBS. The latter changes were adopted to
address the deficiencies that the BCBS identified when it carried out an evaluation of the
existing international standards. A number of supervisory initiatives performed at EU level,
notably the EBA benchmarking exercises (see Section 5.1), the EBA work on IRB repair and
the ECB TRIM exercise (see Section 5.1), confirmed the findings of the BCBS.
Given the reliability of the abovementioned evaluations, the Commission decided to rely on
their findings instead of carrying out its own evaluation.


EN EN
EUROPEAN
COMMISSION
Brussels, 27.10.2021
SWD(2021) 320 final
PART 3/4
COMMISSION STAFF WORKING DOCUMENT
IMPACT ASSESSMENT REPORT
Accompanying the documents
Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE
COUNCIL amending Regulation (EU) No 575/2013 on prudential requirements for
credit institutions as regards requirements for credit risk, credit valuation adjustment
risk, operational risk, market risk and the output floor
Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE
COUNCIL amending Directive 2013/36/EU as regards supervisory powers, sanctions,
third-country branches, environmental, social and governance risks, and amending
Directive 2014/59/EU
{COM(2021) 663 final} - {SEC(2021) 380 final} - {SWD(2021) 321 final}
Offentligt
KOM (2021) 0663 - SWD-dokument
Europaudvalget 2021
89
ANNEX 5: ADDITIONAL INFORMATION ABOUT POLICY OPTIONS
1. IMPROVE THE CURRENT FRAMEWORK FOR CALCULATING RISK-BASED CAPITAL
REQUIREMENTS
1.1. Credit risk framework – Standardised approach
General background
Credit risk is the risk of loss resulting from a borrower's failure to repay a loan or meet
contractual obligations on a debt (“default”). It accounts for the bulk of most banks’ risk-
taking activities and hence the bulk of their capital requirements.
The standardised approach for credit risk (SA-CR) is used by the majority of banks across the
EU to calculate the capital requirements for the majority of their credit risk exposures, even
though the majority of total EU banks’ credit risk exposures – which are held by a relatively
low number of large institutions – are treated under internal model approaches. The SA-CR is
thus highly important in its own right. In addition, the SA-CR must serve as a credible
alternative to internal model approaches and as effective backstop to them. The SA-CR’s
importance is further increased under the final elements of Basel III reform, due to (i) the
reduction of the scope of application of internal models approaches and (ii) the introduction
of the OF.
During its review of the functioning of standardised approaches, the BCBS found the current
SA-CR to be insufficiently risk-sensitive in a number of areas, leading sometimes to
inaccurate or inappropriate measurement of credit risk (either too high or too low) and hence
of capital requirements.159
These problems put into question the SA-CR’s role as approach
for measuring credit risk, including as an alternative for and a backstop to internal model
approaches. Existing supervisory or macro-prudential tools could be used to partly address
these problems, but neither are well-suited for the purpose.
One of the final elements of the Basel III reform therefore aimed to increase the risk
sensitivity of this approach. To achieve this, the Basel Committee agreed to change the SA-
CR in relation to several key aspects. These changes, if implemented in the EU, could be
particularly impactful in the following key areas (due to e.g. the amount of exposures
potentially affected, the nature of the changes or EU specificities):
 exposures to unrated corporates, including SMEs;
 exposures to project finance, object finance and commodities finance (specialised
lending);
 equity exposures; and
 exposures secured by real estate (both residential and commercial).
159
See BCBS, Revisions to the Standardised Approach for credit risk – Consultation Paper, December 2014,
https://www.bis.org/bcbs/publ/d307.pdf.
90
As outlined in Section 6.1., the preferred option is a revision of the SA-CR in line with the
Basel III standard, subject to some adjustments. The subsections below discuss each of the
aforementioned key areas and assess which adjustments are necessary in each case.
1.1.1. Unrated Corporates
Problem definition
Given the aforementioned shortcomings of the existing SA-CR, the new Basel III standard
sets out a modified treatment of corporate exposures under the SA-CR. These modifications
make the framework more risk-sensitive and take better account of the specificities of
exposures to SMEs and investment grade corporates.
The Basel III standards contain two different approaches to calculate RWs of corporate
exposures under the SA-CR. The first can be used in jurisdictions that allow the use of
external ratings (the external credit risk assessment approach, or “ECRA”), while the
alternative one can be used in jurisdictions that do not allow the use of external ratings (the
standardised credit risk assessment approach, or “SCRA”). The ECRA reflects credit risk in
banks’ capital requirements better than the SCRA as it allows for a more granular set of RWs.
Under the ECRA, corporate exposures are assigned a RW between 20% and 150% depending
on their external rating160
. However, exposures to corporates that do not have such external
ratings (“unrated corporates”) receive a RW of 100%, with the exception of corporate SMEs
(RW of 85%) and retail SMEs (RW of 75%).161
The ECRA is consistent with the way in
which standardised RWs are currently assigned in the EU; its improved risk-sensitivity would
lead to a slight decrease in RWAs for highly-rated corporates whilst the impact on the
majority of SA banks’ exposures would be marginal.
However, an unintended indirect consequence of the application of the ECRA may arise in
the EU as a result of the introduction of the OF combined with the fact that the vast majority
of EU corporates is not externally rated. Those corporates are currently being predominantly
financed by IRBA banks, and the internal models of those banks produce significantly lower
RWs for exposures to many of those corporates compared to the 100% RW applicable under
ECRA (and the current version of the SA-CR). Once those banks would be required to apply
the ECRA for the purposes of calculating the OF, there would be a material increase in
capital requirements for those exposures.
In this context, it should be noted that the CRR provides for a preferential treatment for
exposures to SMEs: the RW of an exposure to a SME is multiplied by the so-called “SME
160
The higher the credit rating, the lower the likelihood that the obligor will default, and hence the lower the risk
weight assigned to an exposure to that obligor. There is also a separate risk weight for exposures that do not
have an external rating.
161
By contrast, under the SCRA banks have to assign a 100% RW to all corporate exposures, except if the
corporate is identified as “investment grade” (RW of 65%), SME (RW of 85%) or retail SME (RW of 75%). In
order to qualify as investment grade, amongst others, corporate counterparties or their parent companies must
have securities listed on a recognised exchange.
91
supporting factor” of 0.7619 for exposures up to EUR 2.5 million. For the remaining part of
an exposure exceeding that threshold, a RW of 85% applies, in accordance with the Basel III
standard. The SME supporting factor is applicable to all exposures to SMEs (whether rated or
unrated, and whether treated under the SA or the IRBA). Concerning retail SMEs, the RW of
75% is already implemented and applicable in the EU. Consequently, all policy
considerations relating to the treatment of unrated corporates must account for the effect of
the SME supporting factor.
Policy options
Baseline option - no change to the prudential framework
 The existing RWs for corporates remain unchanged, including for unrated corporates.
 The existing SME supporting factor is kept.
 The OF is not implemented for unrated corporates.
Option 1- full alignment with Basel III
 The ECRA approach applies to all corporate exposures (including unrated
corporates), also for the purposes of the output floor.
 The existing SME supporting factor is removed.
Option 2 - implementation of ECRA in line with Basel III with a transitional treatment for
IRBA banks in relation to unrated corporates
 For unrated corporates, a transitional period lasting until 2030 is provided. During this
period, when calculating their OF, IRBA banks are allowed to apply the SCRA to
exposures to unrated corporates which have a PD corresponding to an investment
grade rating. This treatment applies to all unrated corporates, irrespective of whether
they are listed or not.
 For rated corporates, when calculating the OF, IRBA banks are allowed to use the
ECRA to calculate capital requirements.
 The Commission is empowered to extend the transitional treatment by up to three
years based on a report by the EBA.
 At the end of in the transitional period, IRBA apply the ECRA to all corporate
exposures when calculating the OF.
 The existing SME supporting factor is kept.
Impacts and comparison across options
Under the baseline option, the shortcomings in terms of risk-capture of the SA-CR for
corporates would remain unaddressed and the framework would continue to lack a backstop
(in the form of an output floor) limiting excessive variability in capital requirements. At the
92
same time, the level of capital requirements for the exposures concerned would remain
largely unchanged.
Option 1 would be fully compliant with the Basel III standards and consistent with the EBA's
advice162
. However, the removal of the beneficial treatment of SMEs that EU co-legislators
had agreed upon (in the CRR) and recently extended (in CRR II) could lead to a tightening of
financing conditions for SMEs. Indeed, this option would lead to a material increase in
minimum required capital for both SA banks (due to the removal of the SME supporting
factor) and also IRBA banks (due to the direct effect of the removal of the SME supporting
factor and, indirectly, as a result of the application of the output floor). This would, in turn,
lead to either a reduction in the amount of loans banks would be willing to provide to SMEs
(to the extent banks could not pass the increased cost of capital on SMEs via higher interest
rates) or to an increase in the interest rates banks would charge SMEs for the loans (to the
extent banks could pass on the increased cost of capital) or a combination of both.
Option 2 would preserve the use of external ratings for corporates and increase the risk-
sensitivity of their treatment under the SA-CR. This option would be in line with the final
Basel III standard, except when it comes to the EU-specific treatment of SMEs. The
transitional adjustment for IRBA banks’ exposures to unrated corporates would limit an
increase in capital requirements as compared to option 1. It would avoid disruptive impacts
on bank lending and leave sufficient time to establish public or private initiatives aimed at
increasing the coverage of external ratings for corporates. Broadening the coverage of
external ratings would also increase transparency in the EU corporate sector in the long run
and thereby foster the Capital Markets Union (CMU).
Table 1. Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 + - + +
Option 2 ++ ≈ ++ ++
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly
positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table 1,
option 2 is the preferred policy option.
162
Cf. EBA (2019) Policy advice on the Basel III reforms: Credit risk
93
1.1.2. Specialised lending
Problem definition
There is no specific treatment for specialised lending (SL) exposures under the current SA-
CR. Those exposures are treated as any corporate exposures even though they have a very
specific risk profile. The latter depends more on the type of transaction and/or collateral
provided to secure the transaction rather than on the creditworthiness of the borrower(s) since
the borrower is typically a dedicated vehicle, which secures the debt with the cash flows
generated by its assets. The lack of granularity in the current framework leads to under- or
overestimation of risks under the SA-CR and does not allow to appropriately compare related
capital requirements between SA and IRBA banks (the IRBA contains a specific treatment
for SL exposures). The SA-CR can hence not act as a credible benchmark to internal models
used for SL exposures.
To address these shortcomings of the SA-CR, the Basel III standard introduced a specific
treatment for SL exposures, distinguishing between project finance, object finance and
commodities finance based on the definitions of these three subcategories in the IRBA. Like
for corporates exposures (see Section 1.1.1 of this Annex), two approaches are available in
the Basel III SA-CR, one for jurisdictions allowing the use of external ratings for regulatory
purposes and one for jurisdictions that do not allow it. The new treatment reflects more
appropriately and accurately the risks associated with SL exposures and improves the
consistency with the already existing treatment of those exposures under the IRBA. Under the
new SA-CR, SL exposures for which no issue-specific external ratings are available would be
assigned RWs ranging from 80% to 130%. The exact RW assigned to the exposure would
depend on the relevant SL subcategory and, in the case of project finance, on the phase in
which the project is (pre-operational/operational) as well as on whether certain quality criteria
are met.163
However, similar to the case of exposures to unrated corporates, unintended consequences of
the application of this new approach may arise in the EU, for essentially the same reasons:
most SL exposures are not externally rated and are financed by IRBA banks that have in
place internal models which produce materially lower RWs than those provided by the SA-
CR. While the new standardised treatment for unrated SL exposures is more granular, it is not
sufficiently risk-sensitive to reflect the effects of comprehensive security packages usually
associated with these exposures (these packages comprise covenants and collateral subject to
dedicated monitoring). The impact may be particularly felt in the case of object finance
exposures in the context of the application of the OF. As a consequence, there could be a risk
of discontinuation of these activities.
The impact on project finance is likely to be less significant because the EU has introduced a
discount (= supporting) factor of 25% for exposures to high quality infrastructure projects
that comply with a set of eligibility criteria capable to lower their risk profile and enhance the
163
In particular, a preferential risk weight of 80% is provided for high quality project finance exposures in the
operational phase.
94
predictability of their cash flows. This treatment applies to both institutions using the SA and
institutions using the IRBA.
Policy options
Baseline option: no change to the prudential framework
 No dedicated treatment for SL exposures would be available under the SA-CR.
 The OF is not implemented for SL exposures.
 The existing supporting factor for high quality infrastructure projects is kept.
Option 1 - full alignment with Basel III
 The new SL subcategories are introduced in the SA-CR framework while maintaining
the use of issue-specific external credit ratings when available.
 The existing supporting factor for high quality infrastructure projects is removed.
 The new standardised RWs for SL exposures are used for the calculation of the OF.
Option 2 - alignment with Basel III with adjustments for project and object finance
 The new SL subcategories are introduced in the SA-CR framework while maintaining
the use of issue-specific external credit ratings when available.
 The specific supporting factor for infrastructure projects remains applicable to
complement the preferential treatment for high quality project finance which is
limited to projects in the operational phasewhilst avoiding “double discounts”164
.
 A new subcategory for high quality object finance is introduced. The EBA is
mandated to specify the relevant criteria via RTS.
 The new standardised RWs for SL exposures are used for the calculation of the output
floor.
Impacts and comparison across options
Only a small portion of SL exposures in EU banks portfolios is rated (3.62%; see below
Table 2). Among all SL exposures, non-rated project finance is the most important sub-class
(81.5%), followed by non-rated object finance (9.3%) and non-rated commodities finance
(5.6%).
164
However, the supporting factor cannot be applied to the favourable treatment for high quality project finance
to further lower the applicable RW (i.e. it is not possible to apply the discount of 25% to the preferential RW of
80% provided under Basel II for 'high quality' project finance).
95
Table 2. SL exposures under the SA-CR by sub-exposure class
Institutions
Commodity
finance
Object
finance
Project
finance
Rated
exposures
Total SL
All 5.56% 9.30% 81.53% 3.62% 100%
Large 6.02% 9.94% 80.17% 3.87% 100%
of which: G-SII 14.73% 1.63% 80.87% 2.78% 100%
of which: O-SII 0% 16.70% 78.97% 4.34% 100%
Medium 0% 2.09% 97.91% 0.00% 100%
Small 0% 0% 97.89% 2.11% 100%
Source: EBA, CfA response
Based on the EBA's analysis, the impact on exposures (classified as corporate exposures
under the current SA-CR), which would be classified as SL exposures under the revised SA-
CR, appears to be limited, due to the limited volume of specialised transactions under the SA-
CR (14% of all transactions; see Figure 1 below).
As mentioned above, most SL exposures are in the portfolios of IRBA banks. Therefore, the
new standardised RWs for SL would also indirectly impact those banks as a consequence of
the introduction of the OF.165
Figure 1. Share of SL exposures RWA by regulatory approach in the current and revised
framework
Sources: EBA 2018-Q2 QIS data and EBA calculations.
Note: Based on a sample of 204 banks: IRB (78), SA (196).
165
In its additional analysis for SL, the EBA notices that the total impact of the final Basel III reform remains
unchanged whether the LGD input floors for SL exposures are included or removed for SL exposures under IRB
(see paragraph 1.2.1 on SL under IRBA). The exclusion of the LGD input floors for SL exposures would
decrease the overall impact of the IRB reforms for SL exposures, but this lower impact would be completely
compensated by a higher impact of the OF. The exclusion of the LGD input floor for SL exposures would
benefit – in terms of capital requirements – mostly large IRBA banks. However, these benefits would not
materialise as those banks, in general, are also the ones constrained by the output floor. This key aspect also
needs to be taken into consideration for the final assessment of the impact of the calibrations of RWs for SL
exposures under the Basel III SA-CR.
96
Under the baseline option, SL would not be defined in the SA-CR. Consequently, a risk-
sensitive and granular approach could not be used for those exposures. Instead, a flat RW of
100% would continue to apply to all forms of SL unless an issue-specific rating would be
available.
Option 1 would allow to better reflect the specific risk-profile of SL under the SA-CR.
However, the removal of the existing EU-supporting factor for high-quality infrastructure
projects under this option would lower the incentives recently put in place in the legislative
framework to foster private and public investments in high quality infrastructure projects with
low risk profile166
. In addition, some forms of SL (in particular object finance) would likely
be materially impacted by the new RW calibrations, even though indirectly, i.e. through the
application of the output floor.
Under option 2, the existing supporting factor for high quality infrastructure finance would
be kept. At the same time, the lack of risk-sensitivity of the Basel treatment for unrated
object finance exposures (RW of 100%) would be addressed by a specific treatment for
“high-quality” object finance exposures and a revised calibration for those exposures,
aligning the risk sensitivity for those categories with that of project finance. The indirect
potential impact (as an effect of the output floor) for IRBA banks that have developed a SL
activity would also be less material under this option than under option 1.
Table 3. Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 + - + +
Option 2 ++ ≈ ++ ++
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly
positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table 3,
option 2 is deemed the preferred policy option
1.1.3. Equity exposures
Problem definition
The current (Basel II) treatment of equity exposures under the SA-CR is not risk-sensitive: In
particular, it does not reflect the higher loss risk of equity compared to senior exposures nor
does it differentiate between strategic and speculative (and hence riskier) investments.
Furthermore, the different methods for calculating RWs for equities under the IRBA (simple
risk weight method, internal model method, PD/LGD approach) have been found to be
unduly complex, leading to different outcomes and to undue RWA variability. Finally, the
166
This is likely the only effect of removing the supporting factor. Given that it has become applicable only
recently, it is unlikely that its removal would lead to a material increase in banks’ capital requirements.
97
current treatment allowed for regulatory arbitrage between the banking book and the trading
book.167
To address these shortcomings, the final elements of the Basel III reform amend the treatment
of equity exposures in two ways. First, banks can no longer use the IRBA for those
exposures. Second, the calibration of RWs under the SA-CR is more granular and more
conservative: the default RW for equity exposures increases from 100% to 250%. A more
conservative RW of 400% is assigned to “speculative unlisted equity exposures” (most of
those exposures are currently labelled as “high-risk” equity exposures and hence subject to a
150% RW). Those revisions can be phased-in over a five-year period. The existing 100% RW
remains available only for equity investments made pursuant to “national legislated
programmes” which meet certain eligibility conditions and have been approved by the
competent authority.
Table 4: Risk weights applicable to equity exposures during the phased-in implementation of
the Basel standards
Source: EBA, CfA response (Table 11, p. 59)
The final Basel III standard does not differentiate between the riskiness of certain types of
equity holdings existing in the EU, such as equity investments in entities that are included in
the same banking group (intragroup) or the same institutional protection schemes (IPS), or
long-term and strategic equity investments in businesses outside the banking group (including
holdings in insurance undertakings).
Policy options
Baseline option - no change to the prudential framework
 The existing RWs (100% and 150%) for equity exposures under the SA-CR are kept.
 Banks may use the IRBA for equity exposures.
Option 1 - full alignment with Basel III
 The use of IRBA for equities is removed; in turn, the SA-CR becomes the only
approach available for calculating capital requirements for the credit risk of equity
exposures.
167
In particular, banks designated their equity exposures to the banking book even though they were essentially
held for trading to avoid the much more conservative treatment under the trading book rules.
98
 For equity holdings made pursuant to national legislated programmes a preferential
RW of 100% may be applied, subject to certain eligibility criteria and supervisory
approval.
 The new RWs for speculative unlisted equity exposures (400%) and for other equity
holdings (250%) are progressively phased-in during a 3-year period (see Table 4
above).
Option 2 - implement Basel III with targeted clarifications and adjustments
 The current 100% RW remains applicable to intragroup equity exposures and equity
holdings within institutional protection schemes (IPS).
 Existing long-term and strategic equity exposures to counterparties outside the
banking sector (i.e. including in insurance undertakings) are subject to a
grandfathering regime (i.e. banks are allowed to apply the existing RWs to those
exposures).
 Only short-term equity investments with a holding period of less than 5 years are
considered as speculative exposures and assigned a steady state RW of 400%.
Impacts and comparison across options
The baseline option would leave the identified problems largely unaddressed: Overly
complex and discretionary methods under the IRBA would result in undue variability of
RWAs whilst the SA-CR would provide insufficient risk coverage. As a consequence, banks
would still have incentives to move equities from the trading to the banking book
The tightened treatment of equities under Option 1 has been identified by the EBA as a
major impact driver for increased capital requirements in the area of credit risk (it represents
2.8 pp of the overall increase in RWAs; see
99
Table 5 below) even without taking into account the increase in RWs for intra-group equity
exposures168
. This would be partly compensated by a decrease in RWAs for some of the
equity exposures migrating from the IRBA to the SA-CR (as internal modelling of equities’
credit risk would not be allowed anymore; see Table 8 below).
168
Given that the impact analysis is based on data at the highest level of EU consolidation, the increase in RWs
for intra-group equity exposures is not reflected in the estimates, which may therefore underestimate its impact.
100
Table 5: Percentage change in equity RWA (relative to total current SA RWA) for equity
exposures currently under the SA-CR, by equity category
Source: EBA, CfA response
Table 6: Percentage change in equity SA RWA (relative to total current SA RWA) for equity
exposures currently under the IRB, per equity category
Source: EBA, CfA response
The additional data collection at individual and sub-consolidated level performed by the
EBA169
shows the importance of the proportion of intragroup equity exposures at those levels
and points to an even higher RWA impact on this subset of exposures.
Table 7: Percentage of exposures to equity and exposures to equity intragroup (over total
exposure), by approach
Source: EBA response (5 March 2020) - Letter on additional analysis for the Call for Advice for the purposes of
revising the own fund requirements for credit, operational, market and credit valuation adjustment risk: output
floor and equity exposure class (Table 4, p. 14)
169
On a sample of 16 banks, see link here.
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Table 8: Percentage change in equity RWA (relative to current equity RWA by approach), by
equity sub-type
Source: EBA, Letter on additional analysis for the Call for Advice for the purposes of revising the own fund
requirements for credit, operational, market and credit valuation adjustment risk: output floor and equity
exposure class, March 2020
Table 9: Percentage change in equity RWA (relative to total current RWA), by approach
Source: EBA, Letter on additional analysis for the Call for Advice for the purposes of revising the own fund
requirements for credit, operational, market and credit valuation adjustment risk: output floor and equity
exposure class, March 2020
Applying the increased RWs to all equity exposures at all levels (i.e. individual, sub-
consolidated and consolidated level) would have a significantly higher impact than the
application at consolidated application only. This would be mainly driven by intra-group
equity exposures.
This may lead to unintended consequences (such as divestments) for existing structures and
business models if such increased RWs would be applied to intragroup and IPS equity
exposures, or to strategic investments outside the banking group (i.e. including holdings in
insurance undertakings).
The targeted adjustments envisaged under Option 2 would prevent those unintended effects
whilst addressing the shortcomings of the current treatment.
Table 10: Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 + - + +
Option 2 ++ ≈ ++ ++
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly
positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table
10, option 2 is deemed the preferred policy option.
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1.1.4. Real estate exposures
Problem definition
The GFC revealed a number of shortcomings of the current standardised treatment of real
estate exposures which the Basel III SA-CR addresses.
Income-producing real estate exposures
Evidence showed that mortgage loans the repayment of which is materially dependent on the
cash flows generated by the property securing those loans tend to be materially riskier than
mortgage loans the repayment of which are materially dependent on the underlying capacity
of the borrower to service the loan. However, under the current SA-CR no specific treatment
is foreseen for such exposures, even though this dependence is an important risk driver. This
may result in insufficient levels of capital to cover unexpected losses on this type of real
estate exposures.
In order to address this shortcoming, the final Basel III standards introduced a new category
of real estate exposures, namely income producing real estate (IPRE)170
exposures, with a
dedicated RW. This modification is intended not only to reflect more accurately the risk
associated with those exposures, but also to improve consistency with the treatment of IPRE
under the IRBA.
Land acquisition, development and construction exposures
Loans financing land acquisition, development or construction (ADC) of any properties incur
a heightened risk where the source of repayment at origination of the loan is either a planned
but uncertain sale of the property or substantially uncertain cash flows (e.g. this may happen
if the property has not yet been leased to the occupancy rate prevailing in that geographic
market for that type of property). The current SA-CR applicable in the EU provides for a flat
RW of 150% for so-called “speculative immovable property financing”. The latter category is
defined solely based on the borrower’s intention to resell the property for a profit, without
taking into account to which extent the repayment is actually uncertain. As a result of this
lack of clarity and risk-sensitivity, capital requirements for ADC exposures are currently
often deemed to be too high or too low..
To better reflect the risk of ADC financing models, the final Basel III standards introduce a
dedicated sub-exposure class, referring to loans to companies or SPVs financing any of the
land acquisition for development and construction purposes, or development and construction
of any residential or commercial property. ADC exposures are to be risk-weighted at 150%.
However, provided that certain risk-mitigating conditions171
are met, ADC exposures to
residential real estate may be risk-weighted at 100%.
170
The IPRE category is further divided in two sub-categories: income producing residential real estate (IPRRE)
and income producing commercial real estate (IPCRE).
171
The 100% RW can be applied where i) prudent underwriting standards are applied and ii) pre-sale or pre-lease contracts
amount to a significant portion of total contracts or substantial equity at risk. Pre-sale or pre-lease contracts must be legally
binding written contracts and the purchaser/renter must have made a substantial cash deposit which is subject to forfeiture if
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Whole-loan vs. loan-splitting approach
The final Basel III standards also provide two new, more granular and risk-sensitive
approaches for general172
residential and general commercial real estate exposures (GRRE
and GCRE, respectively): (i) the loan splitting approach, which splits mortgage loans into a
secured and an unsecured part and assigns a different risk weight to each of these two parts;
and (ii) the whole loan approach, which considers mortgage loans as specific products and
assigns a RW to the entire exposure based on its loan-to-value (LTV) ratio using different
LTV buckets. According to the final Basel III standards, jurisdictions can apply either of
these two approaches, but not both.
The rationale for using the LTV ratio as a risk driver for determining the applicable RWs is
that the losses incurred in the event of a default and the likelihood of a borrower’s default are
lower when the outstanding loan amount relative to the value of the real estate collateral (i.e.
the LTV ratio) is lower. However, only the loan splitting approach is also sensitive to the type
of borrower (as it applies the RW of the counterparty to the unsecured part) and reflects the
risk mitigating effects of the real estate collateral in the applicable RWs even in case of high
LTV ratios. While the loan splitting approach is currently in place in the EU, its RW
calibration has been found too conservative for mortgages with very low LTV ratios (see
Figure 2).
Figure 2: Stylised illustration – RW function for residential real estate exposures under
different approaches
Source: Commission
the contract is terminated. Equity at risk should be determined as an appropriate amount of borrower-contributed equity to
the real estate’s appraised as-completed value.
172
i.e. where the repayment does not materially depend on the cash flow generated by the property
104
Prudent valuation of property
In the aftermath of the GFC, property prices dropped significantly and progressively in
countries in- and outside of the EU. Those bank that had not revised downwards the value of
the properties securing mortgage loans on a timely basis, to reflect their reduced market
value, ended up underestimating the underlying credit risk of those loans and hence the
corresponding capital requirement. Had they updated them, the LTV ratio of those loans
would have increased thereby potentially increasing capital requirements).
To reduce the impact of cyclical effects on the valuation of property securing a loan and to
keep capital requirements for mortgages more stable, the final Basel III standards cap the
value of the property recognised for prudential purposes at the value measured at loan
origination, unless modifications “unequivocally” increase the value of the property. At the
same time, the standards do not oblige banks to monitor the development of property values.
Instead, they only require adjustments in case of extraordinary events. By contrast, the
current SA-CR applicable in the EU requires banks to regularly monitor the value of property
pledged as collateral. Based on this monitoring, banks are require to make upwards or
downwards adjustments to the property (irrespective of the property value at loan
origination). The current SA-CR does not include a mechanism addressing cyclical effects in
real estate, and hence it does not address the risk of overvaluation and volatile capital
requirements for mortgages.
Policy options
Baseline option: no change to the prudential framework
 The current loan splitting approach is kept unchanged.
 No specific treatment for IPRE and ADC exposures is provided for.
 The current rules on property value monitoring and adjustment are kept.
Option 1: full alignment with Basel III
 The loan splitting approach is kept for GRRE and GCRE exposures, but with the
revised calibration as set by the final Basel III standards.
 Specific treatments for IPRE and ADC exposures are introduced.
 Property values are capped at their value at loan origination and the current
requirement for frequent monitoring is removed.
Option 2: alignment with Basel III with adjustment for property valuation
 Specific treatments for IPRE and ADC exposures are introduced.
 The loan splitting approach is kept for GRRE and GCRE exposures, but with the
revised calibration as set by the final Basel III standards.
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 The current requirement for frequent monitoring of property values is kept, allowing
upwards adjustment beyond the value at loan origination but with a cap set at the
average value over the last 5 years.
Impacts and comparison across options
GRRE and GCRE account for the vast majority (more than 90%) of total exposures secured
by real estate, whereas all the remaining categories, i.e. IPRE and ADC exposures, together
amount to less than 10% (see Figure 3).
Figure 3: Exposure value breakdown as a percentage of total SA real estate exposure under
the revised Basel III framework
Source: EBA – Basel III reforms: impact study and key recommendations (Figure 34, p. 88)
Under the baseline option, the lack of risk-sensitivity of the current framework in particular
concerning IPRE and ADC exposures would remain, leading to inadequate levels of capital
for covering unexpected losses on real estate exposures and potentially providing
inappropriate incentives for banks’ lending decisions. Furthermore, the (pro-) cyclicality of
property valuations and, by consequence, of capital requirements would remain under the
baseline option.
As regards Option 1, while the share of exposures in each category would change slightly as
a result of the implementation of the revised SA-CR (more precisely because of the new
definitions under Option 1; see Figure 15 below), the RWs for exposures falling in the GRRE
and GCRE categories would remain largely unchanged, as the revisions in these areas are
marginal compared to the framework currently applicable in the EU.
For similar reasons, the impact of the new treatment for ADC exposures under Option 1 is
expected to be limited. The overall impact is marginal as ADC exposures account for only
2.9% of total real estate exposures treated under the SA-CR.
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By contrast, the application of the revised standardised treatment for IPRE would increase the
RWAs for IPRRE by 47.6% under Option 1. This would be the most significant impact
across all exposures secured by real estate. However, given the low share of IPRE in total
exposures, the overall impact would be limited (IPRRE accounts for 2.5% of total real estate
exposure, while IPCRE accounts for 1.1%).
Figure 4: Percentage change in exposures secured by real estate SA RWA, relative to current
sub-exposure class SA RWA (left), and relative to total current SA RWA (right)
Source: EBA – Basel III reforms: impact study and key recommendations (Figure 35 and 36, p. 88)
The (re-)valuation approach provided by Basel III (option 1) is less pro-cyclical, but also less
risk-sensitive than the current approach applicable in the EU. Under this option, banks would
not be required to adjust property values downwards based on continuous monitoring. They
would only need to make adjustments following a supervisor’s intervention or due to
extraordinary events. This option would not fit European real estate markets, where mortgage
loans usually have long(er) maturities (than in other Basel jurisdictions)173
. Moreover, it
would create perverse incentives for circumvention of the rules by repeated renewal of
mortgage contracts, as highlighted in the EBA’s advice. It would also put the burden to
require downwards adjustments of property values on supervisors and could also have a
negative effect on banks’ risk management, as it would remove the requirement to frequently
monitor property values.
Option 2 would have the same impacts as Option 1 on GRRE, GCRE, IPRRE and ADC
exposures. By contrast, Option 2 would address potential pro-cyclical effects under option 1
by limiting any upward adjustments at the average value over a certain period thereby
reducing the volatility in property values. This would address the disadvantages of the current
approach while avoiding the problems inherent in the approach contained in Option 1.
173
For example, mortgages in the US have a much shorter average maturity (about 7 years) than in the EU,
meaning the property values can be updated when the loans are rolled over.
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Table 11: Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 ++ - + +
Option 2 ++ + ++ ++
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly
positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table
11, option 2 is deemed the preferred policy option
1.2. Credit risk framework – Internal model approach
General background
As an alternative to using the SA-CR, banks may also use one of the two approaches based
on internal models, the so-called internal ratings-based (IRB) approaches, to calculate capital
requirements for credit risk (subject to supervisory approval). The advanced IRB (AIRB)
approach allows modelling of all key risk parameters, whereas the foundation IRB (FIRB)
approach is somewhat more restrictive as modelling is allowed for only one out of the three
key risk parameters174
.
The IRB approaches are complex and are therefore used primarily by large, sophisticated
institutions. However, given the large market shares of these institutions, the capital
requirements for the majority of credit risk exposures in the EU banking sector are calculated
using the IRB approaches (see
174
Under the AIRB approach, the obligor‘s probability of default (PD), loss given default (LGD), and exposure
at default (EAD) are allowed to be modelled, while under the FIRB approach only the PD is allowed to be
modelled.
108
Figure 5 below).
109
Figure 5: Exposure value: SA versus IRB composition (% of total credit risk exposure value)
Source: EBA 2018-Q2 QIS data and EBA calculations. Note: Based on a sample of 189 banks.
The GFC highlighted important deficiencies of the IRB approaches. A range of studies
conducted at both international and EU level found an unacceptably wide variation in capital
requirements across banks that cannot be explained solely by differences in the riskiness of
banks’ portfolios. This is undesirable, as it hinders the comparability of capital ratios and
impacts the level playing field among banks. Also, the crisis has revealed instances where the
losses incurred by banks on some portfolios were significantly higher than the model
predictions, which resulted in insufficient levels of capital held by individual banks.
The December 2017 Basel III agreement aimed to address these deficiencies primarily by
limiting banks’ flexibility in calculating their capital requirements for credit risk175
:
 the possibility to use internal models was either limited or altogether removed for
portfolios and risk parameters where the BCBS had concluded that the available data was
insufficient to ensure reliable modelling (i.e. exposures to financial institutions and
exposures to large corporates fall in the first category, while equity exposures fall in the
second one);
 new minimum values (‘input floors’) were introduced for banks’ estimates of the
probability of default (PD), loss-given default (LGD) and exposure at default (EAD).
As outlined in Section 5.1., the preferred option for the implementation of the final elements
of the Basel III reform in the area of credit risk is a revision of the IRB approaches in line
with the Basel III standard with some adjustments. The subsections below discuss each of the
aforementioned key areas and assess which adjustments are necessary in each case (if any).
1.2.1. Reduction in the scope of internal modelling
175
Other changes included a modification of the “roll-out” requirement: The principle that those banks that
intended to use the IRB approach for some of their exposures are obliged to roll it out to all exposures was
modified so that this obligation applies separately for each exposure class.
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Problem definition
The GFC has revealed that in some cases banks have used the IRB approaches even though
the respective portfolios were unsuitable for modelling due to insufficient amounts of
relevant data being available. This had detrimental consequences for the robustness of the
capital requirements produced by those models and thus on financial stability. Banks were
able to continue using models for those portfolios because the applicable framework
contained insufficient limits as regards the availability of IRB approaches for exposures
classes that are difficult to model.
Specifically, banks’ exposures to other banks, other financial sector entities and large
corporates typically exhibit low levels of default. For such low-default portfolio (LDP)
exposures, it has been shown that the low number of observed defaults makes it difficult for
banks to produce reliable LGD estimates. Banks have tried to compensate for this lack of data
by employing different statistical techniques, but this has resulted in an undesirable level of
dispersion across banks in the level of estimated risk.
Moreover, where banks use internal models to calculate the capital requirements for credit
risk of equity exposures, they typically base their risk assessment on publicly available data.
Since all banks have access to pretty much the same public data, it is hard to justify the
differences one can observe in capital requirements produced by banks’ models for those
exposures. Also, the internal modelling of equity exposures entails a level of complexity that
may not be justified in light of the relatively low amounts of equity exposures held by banks
in their banking books.
In view of the above, the final Basel III standards limit the exposures classes for which
internal models can be used to calculate capital requirements for credit risk. Specifically, it
allows the use of internal models only for those exposure classes for which robust modelling
is possible. The abovementioned exposure classes are, in contrast, “migrated” to less
sophisticated approaches:
 for exposures to large corporates with total consolidated annual sales greater than EUR
500 million, for exposures to banks and for exposures to financial institutions (including
financial institutions treated as corporates), the use of the AIRB approach is no longer
available: for those exposures banks can only use the FIRB approach176
;
 for equity exposures, the IRB approaches are no longer available: banks must use the SA-
CR.
The BCBS’ decision is based on the consideration that disallowing the use of certain
modelling approaches in this manner would remove an important source of undue RWA
variability and thereby improve the comparability of capital requirements. In addition, it
would remove a source of unnecessary complexity from the framework.
176
See footnote 163 for an explanation of the difference between the two approaches.
111
However, an unintended consequence of this “migration” may arise in the EU for exposures
to public sector entities (PSEs) and regional governments and local authorities (RGLAs).
Under the current IRB approach, exposures to PSEs and RGLAs are treated either as
exposures to central governments or as exposures to banks. For the purpose of RWA
calculation, it is of relatively limited significance into which category a PSE and RGLA fall,
as the applicable rules are broadly similar.
Under the final Basel III standards, exposures to PSEs and RGLAs can continue to be treated
either as exposures to central governments or as exposures to banks. However, given that
under those standards exposures to banks are subject to significant modelling constraints,
while exposures to central governments are not, the classification of a PSE or RGLA
exposure can have potentially significant implications on the capital requirement for that
exposure.
Policy options
Baseline option: no change to the prudential framework
 All IRB approaches remain available for exposures to large corporates, banks and
other financial institutions.
 The treatment of exposures to RGLAs and PSEs remains unchanged.
Option 1: implement the key change in the scope of the IRB approaches as foreseen by the
Basel III standard
 The AIRB approach is no longer available for LDP exposures: only the FIRB
approach remains available.
 The IRB approaches are no longer available for equity exposures: banks have to use
the SA-CR.
Option 2: implement the key change in the scope of the IRB approaches as foreseen by the
Basel III standard with adjustments
 Same as Option 1.
 In addition, address the unintended consequences of Option 1 for exposures to PSEs
and RGLAs by creating a new PSE/RGLA exposure class; the AIRB approach would
remain available for those exposure classes, subject to input floors (see next section
for details on the latter).
Impacts and comparison across options
The baseline option would leave the problems identified in the current prudential framework
unaddressed (insufficient robustness of certain models, undue variability of RWAs,
inappropriate levels of capital requirements).
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The restrictions proposed under Option 1 are a key measure to strengthen the reliability of
internal models. Indeed, in its policy advice on the implementation of the final elements of
the Basel III reform, the EBA stated that “[t]his measure is consistent with the intention to
limit the variability of model outcomes, since these portfolios typically show severe shortages
of default data. In particular, the availability of empirical observations for LGD estimation is
problematic for LDPs, since the realised LGDs can only be observed on defaulted
exposures.”
Under the option, however, in line with the final Basel III standard, the use of the FIRB
approach for exposures to banks, financial institutions and large corporates is still allowed, as
valid PD modelling remains achievable in this context. The impact of Option 1, in terms of
increase in capital requirements for AIRB exposures to banks and to financial institutions,
would be among the highest of all the impacts due to the implementation of the final elements
of the Basel III reform (80% and 30% increase in RWAs, respectively, see Figure 6 below).
The migration from AIRB to FIRB is the main driver of the increase. Exposures to large
corporates would be much less affected (+5%) due to a decrease in the regulatory LGD for
these exposures under the FIRB approach compared to the current rules.
Figure 6: Marginal impact on RWAs per exposure class due to their “migration” to the IRB
approach (relative to current RWAs of AIRB exposures in each exposure class)
Source: EBA Policy advice on the Basel III reforms: credit risk, Figure 25.
For exposures to PSEs and RGLAs, the EBA has assessed that, under option 1, PSEs and
RGLAs that are currently treated as exposures to central governments, would see a decrease
in capital requirements between 10% and 28%, respectively, partly as a result of the removal
of the current 1.06 scaling factor. In contrast, exposures to PSEs and RGLAs that are
currently treated as exposures to banks would see an increase of 78%, mostly as an effect of
the of the banks’ exposure class being limited to the FIRB approach.
113
This discrepancy in impact is not justified by the underlying risk characteristics of the entities
in question. As stated by the EBA, “the inconsistent treatment of PSEs and RGLAs leads to
disproportionate impacts and adds unnecessary complexity to the framework”. Besides,
implementing this differentiated treatment could also lead to an increase in undue RWA
variability across banks, rather than a decrease, as the applicable treatment is decided by
competent authorities.
Option 2 would address the weaknesses of the IRB approach as identified by the Basel
Committee by implementing all the elements of the reform (i.e. those listed in option 1).
Compared to option 1, however, it would have the advantage of removing the unjustified
disparity in impact on exposures to PSEs and RGLAs by treating them according to the same
principles, while at the same time reducing the undue RWA variability for those exposures
(because of the application of the input floors). The increase in capital requirements for banks
arising from model “migration” would be somewhat lower under option 2 compared to option
1 as no “migration” would be imposed on any exposures to PSEs/RGLAs.
Table 12: Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-
effectiveness)
COHERENCE
OVERALL
SCORE
Baseline option 0 0 0 0
Option 1 ++ + + +
Option 2 ++ + ++ ++
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly
positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table
12, option 2 is deemed the preferred policy option
1.2.2. Input floors
Problem definition
The financial crisis revealed that the calibrations of regulatory risk parameters used as inputs
to the regulatory formula to calculate RWAs under the IRB approaches were at times not
calibrated in a sufficiently robust or conservative manner by some banks, leading to
unwarranted RWA variability and possibly insufficient capital requirements in such cases.
As a result, the final Basel III standards introduce minimum values for bank-estimated IRB
parameters that are used as inputs to the calculation of RWAs (‘input floors’). These input
floors would act as safeguard to ensure that capital requirements do not fall below prudent
levels; they would mitigate model risk due to such factors as incorrect model specification,
measurement error and data limitations; and they would improve the comparability of capital
ratios across banks.
114
In some cases, these floors consist of recalibrated values of the existing Basel II input floors,
while in most cases the input floors are new. They include PD floors for both the AIRB
approach and the FIRB approach, and LGD and EAD floors for the AIRB approach.
In order to achieve their intended aims, the input floors must be calibrated in a sufficiently
conservative manner. However, where those floors are calibrated too conservatively, this may
discourage banks from adopting the IRB approaches and the associated risk management
standards. Banks may also be incentivised to shift their portfolios to higher risk exposures
and exploit the constraint imposed by the input floors with a view to generating a higher
return. In order to avoid such unintended consequences, risk parameter floors should
appropriately reflect certain risk characteristics of the underlying exposures, in particular by
taking on different values for different types of exposure where appropriate.
Under the final Basel III standard, the PD floor is increased from 0.03% under Basel II to
0.05%. LGD floors apply to secured and unsecured exposures and range from 0% to 50%,
depending on the type of the exposure and on the type of collateral used (see Table 13).
Table 13: LGD input floors under Basel II (current) vs Basel III (new)
Source: European Commission
The final Basel III standards furthermore introduce a formula for the calculation of the input
floor for partially secured exposures. The comprehensive list of LGD floors introduced by the
Basel III standards constitute a significant change from those contained in the Basel II
standards, which apply only at portfolio level and only to exposures secured by immovable
property. No input floors apply to sovereign exposures.
While SL exposures177
have risk characteristics that differ from general corporate exposures,
the final Basel III standards apply the same input floors in both cases. The EBA’s analysis
has shown that an LGD input floor may tightly constrain banks’ own estimates for SL
exposures, due to the low levels of banks’ own LGD estimates at the reference date. The
EBA has not found conclusive evidence that the LGD input floor for general corporate
exposures is excessively conservative for specialised lending exposures, pointing to banks’
“heavy losses suffered from specialised lending under adverse market conditions”. However,
177
For a general explanation of SL exposures, see section 1.1.
115
the explanatory power of the evidence is limited by the small size of the sample used and the
complexity and idiosyncrasies of the underlying transactions, so that further analysis may be
warranted.
Policy options
Baseline option: no change to the prudential framework
 The existing Basel II PD floor of 0,03% is kept.
 The PD, LGD and EAD input floors provided by the final Basel III standards are not
introduced.
Option 1: full implementation of Basel III
 The new PD, LGD and EAD input floors provided by the final Basel III standards are
introduced.
Option 2: implementation of Basel III input floors with possibility for EU-specific
adjustments
 The new PD, LGD and EAD inputs floors provided by the final Basel III standards
are introduced.
 An empowerment allowing the Commission to adopt a delegated act is introduced to
adapt the input floors for specialised lending, based on a detailed analysis to be
conducted by the EBA.
Impacts and comparison across options
Under the baseline option, the flaws identified in the current framework would remain
unaddressed (lack of robustness of modelling approaches in certain circumstances, undue
RWA variability).
Option 1 would provide tools to address the problems identified under the current
framework. The level of the input floors contained in the final Basel III standards appear to
be calibrated in a sufficiently conservative manner to achieve this aim, while at the same time
being adapted to the risk characteristics of the underlying exposures. Concerning the impact
of this option on RWAs, the EBA has assessed that around 20% of the total increase in IRB
RWA would be due to the revised PD floor, and around 80% would be due to the LGD
floors, whereas the EAD floor would only play a “minor role”. An illustration of the impacts
by exposure class is shown in
116
Figure 7 below (see blue “Basel III central scenario”).
117
Figure 7: Percentage change in IRB RWA per exposure class excluding PD & LGD input
floors (relative to total current IRB RWA)
Source: EBA Impact Study on the Basel III reforms, Figure 52.
The potential impact of the floors on SL exposures would be particularly important (30%
increase in RWAs), mainly due to the LGD floors. In fact, SL is the exposure class that
would be the most affected by the LGD floors (see Figure 8 below), because those are
significantly higher than the LGDs currently calculated by banks.. On the one hand according
to the EBA, the aforementioned “heavy losses” incurred by SL exposures may be
insufficiently reflected in banks’ current loss estimates, which would suggest that an
increase in capital requirements would be justified. On the other hand, stakeholders have
argued that SL exposures tend to be low-risk and that the projected increase in capital
requirements would therefore be unjustified. Unjustified increases in capital requirements
would be particularly undesirable in the case of SL in view of its importance for the real
economy as they might result in undesirable constraints on such lending.
Figure 8: Marginal impact (difference between orange and blue bars) of the LGD floors per
exposure class, in terms of increase in A-IRB RWAs (relative to total current A-IRB RWAs)
[alternative scenario excludes LGD input floors for SL exposures]
Source: EBA Impact Study on the Basel III reforms, Figure 52.
118
Option 2 would be as effective as option 1 in tackling the aforementioned problems relating
to risk parameter estimation. In addition, the empowerment for the Commission would
prevent potential unintended consequences on specialised lending option 1 might entail.
Table 14: Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-
effectiveness)
COHERENCE
OVERALL
SCORE
Baseline option 0 0 0 0
Option 1 ++ - + +
Option 2 ++ ++ ++ ++
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly
positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table
14, Option 2 is deemed the preferred policy option
1.3. Market risk framework
Problem definition
Financial instruments held by banks for trading purposes (e.g. shares, bonds, derivatives), are
subject to market risk, i.e. the risk of movements in the instruments’ market prices that
impact banks' daily profits and losses. These market price movements can be large and
sudden which can affect a bank’s solvency position. Because of the idiosyncratic nature of
this risk, the CRR contains a specific treatment for the financial instruments subject to market
risk, referred to as trading book positions178
. As is the case for other types of risk, the CRR
allows banks to use two types of approaches to calculate their capital requirements for market
risk: a standardised approach and an internal model approach.
During the GFC, the level of capital required against trading book exposures proved
insufficient to absorb the losses incurred by a number of banks, both in the EU and in non-EU
jurisdictions179
. The magnitude and the severity of the adverse market movements revealed
that some banks, although fully compliant with existing market risk capital requirements, did
not, in fact, have sufficient capital to cover market risk losses that arose during the GFC. The
crisis therefore revealed a number of weaknesses in the design of the framework used for
calculating capital requirements for market risk that needed to be addressed.
178
In order to determine the relevant approach to calculate capital requirements for the positions they have,
banks are required to allocate those positions to either the trading book or the non-trading book, based on the
intention of each transaction. Non-trading book positions, often referred to as banking book exposures, are
usually financial instruments held by banks until they mature (e.g. loans) and mainly subject to credit risk. For
this reason, banking book exposures are subject to the capital requirement for credit risk.
179
See https://www.bis.org/bcbs/publ/d457_note.pdf
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In 2009, a first reform of the market risk standards (known as the 'Basel 2.5' reform) was
adopted by the BCBS. This reform focused on increasing the overall capital requirements for
market risk to address the most pressing deficiencies in the international standards in this
area. It was implemented in Union law by means of Directive 2010/76/EU180
(also known as
the third Capital Requirements Directive or CRD III) and subsequently incorporated in the
CRR.
Nevertheless, the 2009 reform did not address all the design flaws present in the market risk
framework, such as181
:
 lack of clarity in the scope of application of the capital requirements for market risk: the
lack of clear rules around instruments’ allocation to the trading book and the banking
book allows banks to engage in regulatory arbitrage182
, i.e. allocate instruments to the
‘book’ that generates the lowest capital requirements;
 insufficient risk capture: many features of market risk are not adequately reflected in the
current rules for calculating capital requirements. Consequently, the amount of capital
required for certain instruments is not aligned with the real risks that banks face when
holding these instruments183
. For some trading book positions, banks may not have
sufficient amounts of capital to absorb potential losses that may arise from adverse
changes to market conditions. This could endanger their solvency. For other trading book
positions the capital requirements may, conversely, be excessive compared to the actual
risk. This could negatively affect banks’ trading in the specific instruments and hence
have an impact on their market liquidity and transactions costs;
 high variability of modelling outcomes: as highlighted by the BCBS regulatory and
consistency assessment program184
, a high variability of outcomes across banks
worldwide using the internal model approach to calculate the capital requirements for
market risk was observed, even for identical portfolios. Similar observations were made
across EU banks following the EBA’s Market Risk Benchmarking exercises185
. The
dispersion of outcomes has been found larger for more complex trading portfolios. These
findings indicate that banks have used the leeway offered by the rules to implement
market risk internal models in different manners, using a wide range of assumptions.
180
Directive 2010/76/EU of the European Parliament and of the Council of 24 November 2010 amending
Directives 2006/48/EC and 2006/49/EC as regards capital requirements for the trading book and for re-
securitisations, and the supervisory review of remuneration policies.
181
A full overview of the weaknesses of the Basel 2,5 market risk standards has been described by the BCBS in
https://www.bis.org/bcbs/publ/d457_note.pdf.
182
For example, prior to the crisis, securitisation instruments were usually allocated to the trading book because
of the low volatility of the securitisation markets (leading to low capital requirements under the market risk
rules) even if there was no evidence of regular trading in these instruments (which made it likely that banks
holding those positions did not really actively trade them).
183
As an example, the risk of holding more illiquid instruments is not recognised since the current capital
requirements for market risk assume that all trading book positions can be extinguished within two weeks.
184
See https://www.bis.org/publ/bcbs267.htm.
185
See section on “Market risk” in https://www.eba.europa.eu/regulation-and-policy/supervisory-benchmarking-
exercises.
120
To tackle the abovementioned design flaws, after the Basel 2.5 reform, the BCBS launched a
more fundamental reform of the international standards for market risk, known as the
fundamental review of the trading book (FRTB). A first set of revised market risk standards
(hereafter ‘original FRTB standards’) was published by the BCBS in January 2016, with a
recommended implementation deadline of 1 January 2019; it addressed the above issues by:
 providing more objective rules to allocate transactions either to the trading book or to the
banking book;
 developing a revised standardised approach (‘FRTB SA’) and internal model approach
(‘FRTB IMA’) that better capture market risk;
 reducing the flexibility for banks to use their own modelling assumptions under the FRTB
IMA, while helping supervisors to assess their robustness with the help of new
quantitative tests that all FRTB IMA must fulfil.
In the course of monitoring the expected impact of the original FRTB standards, the BCBS
identified a number of issues that needed to be addressed. Following a consultation186
launched in March 2018, the BCBS changed certain elements of the original FRTB standards
and published a revised version in January 2019 (hereafter ‘final FRTB standards’), with a
new recommended implementation deadline set to 1 January 2022187
(as in the case of the
rest of the final elements of the Basel III reform, the BCBS postponed this deadline by one
year, to 1 January 2023, in light of the COVID-19 pandemic).
The Commission originally proposed to introduce binding capital requirements based on the
original FRTB standards as part of the CRR II to address the deficiencies of the market risk
framework. However, given the BCBS’s subsequent decision to revise those standards, with
timelines incompatible with the milestones in the CRR II negotiation process, the European
Parliament and the Council agreed to implement the original FRTB standards in the
prudential framework as a first step only for reporting purposes188
. Reporting were set to start
once the elements of the final FRTB standards that would be necessary for the reporting
requirements would be incorporated in Union law through secondary legislation189
. The
introduction of binding capital requirements based on the final FRTB standards was left to a
separate ordinary legislative initiative. In the meantime, EU banks will keep using the current
approaches set out in the CRR to calculate their capital requirements for market risk.
186
See https://www.bis.org/bcbs/publ/d436.htm.
187
See https://www.bis.org/bcbs/publ/d457.htm.
188
This allows banks time to prepare for implementing the new approaches (in particular banks that will be
using the FRTB IMA) and also allows for the monitoring of the functioning of the new approaches before they
will be used for the purpose of calculating capital requirements.
189
The secondary legislation comprises a delegated act specifying some technical elements of the FRTB SA,
adopted by the Commission on 17 December 2019, and a number of regulatory technical standards mandated to
EBA to specify some technical elements of the FRTB IMA, already submitted by EBA to the Commission and
which adoption is currently being processed.
121
Policy options
Baseline option – No changes to the prudential framework related to market risk
The baseline option would consist in keeping the FRTB standard as a reporting requirement,
as agreed under CRR II, and maintain the current approaches set out in the CRR to calculate
capital requirements for market risk. As a consequence, the weakness of those approaches
would be left unaddressed. The reporting requirement based on the final FRTB standards as
adopted under the CRR II would help supervisors to further assess EU banks’ exposure to
market risk based on the revised FRTB SA and FRTB IMA, but this assessment would
remain indicative. Moreover, as some important elements of the final FRTB standards, most
notably the revised scope of application of the trading book, were not yet included in the
CRR II, they would not be implemented in Union law.
Option 1 - Convert the FRTB reporting requirement into a capital requirement, fully aligned
with the Basel standards
Option 1 would implement the necessary amendments to the prudential framework to
convert the reporting requirement based on the FRTB approaches adopted in the CRR II into
a binding capital requirement fully aligned with the final FRTB standards agreed by the
BCBS. Consequently, EU banks would no longer use the current approaches for calculating
capital requirements for market risk and they would therefore no longer be exposed to the
weaknesses identified in those approaches during the GFC. The prudential framework would
also be amended to introduce the revised elements of the final FRTB standards that have not
yet been included in the CRR II for the purposes of the reporting requirements. The
amendments would include, for example, the revised standards defining the scope of
application of the trading book, the revised disclosure requirements based on the FRTB
approaches and the possibility to use a simplified standardised approach for banks with
medium-sized trading books at supervisors’ discretion.
In addition, under option 1, some of the specific adjustments to the final FRTB standards
already adopted under the CRR II to take account of EU specificities190
would be removed to
fully align the EU rules with the final Basel standards.
Option 2 - Convert the FRTB reporting requirement into a capital requirement, taking into
account EU specificities and international level playing field.
Similarly to option 1, option 2 would make the necessary adjustments to the prudential
framework to convert the reporting requirement based on the FRTB approaches adopted in
the CRR II into a binding capital requirement aligned with the final FRTB standards. EU
banks would also no longer be allowed to use the current approaches for calculating capital
requirements for market risk and would therefore no longer be exposed to the weaknesses
identified in those approaches.
190
For example, this would include the beneficial treatment of covered bonds issued by banks located in the EU
set out in Article 325ah(1) of the CRR and the beneficial treatment of foreign exchange rates composed of the
euro and the non-euro currency of a Member State set out in paragraphs 2 and 3 of Article 325av of the CRR.
122
However, unlike option 1, option 2 would maintain the specific adjustments adopted under
the CRR II to take account of EU specificities in the calculation of the binding capital
requirements under the FRTB approaches. In addition, two additional adjustments would be
introduced under option 2 to mitigate a potential excessive increase in capital requirements
for market risk under the final FRTB standards affecting key trading/market making activities
to the EU economy, specifically:
 treatment of collective investment undertakings (‘CIUs’) under both the internal
model and the standardised approaches: CIUs play a crucial role in facilitating the
accumulation of personal savings, whether for major investments or for retirement.
They are also important because they make institutional and personal savings
available to companies and projects which contribute to growth and jobs. The
seamless provision of CIUs as investment product hinges on banks’ ability to
continuously offer to their clients the possibility to buy or sell back those instruments.
For that purpose, banks must keep inventories of CIUs in their trading books. Under
the final FRTB standard, banks can use internal models to calculate capital
requirements for market risk due to exposures to CIUs only under the condition that
the bank can look through the CIUs’ composition191
. When this condition cannot be
met, banks would have to use the standardised approach, which presents much more
conservative assumptions192
, leading to a significant increase in capital requirements
for those products. A number of respondents to the consultation raised this issue and
the EBA also highlighted the risk of a potentially excessive capital impact in its
response to the Call for Advice. To ensure continued market-making in CIUs,
adjustments would be proposed to the final FRTB standard with two main objectives,
namely (i) to ensure that more CIUs could be eligible to internal model approach; and
(ii) to ensure that the treatment of CIUs under the standardised approach is less
penalising;
 treatment of carbon emissions allowances under the standardised approach: in the EU
emission trading scheme (ETS), banks play an important role in providing liquidity to
carbon emissions allowances market. They typically fill their clients’ estimated
demand for allowances at a future date via derivatives (‘forward’) transactions. Under
the SA of the final FRTB standards, the exposures to carbon emission allowances are
assimilated to electricity contracts, which could be considered too conservative in
light of historical data. A number of respondents to the consultation paper raised
concerns about the conservativeness of this treatment that does not reflect the
191
The condition requires being able to frequently access the information on all the exposures composing the
fund.
192
Under the FRTB standardised approach, the market risk capital requirements of most CIUs (all CIUs, except
those tracking recognised indices) would be based on either ‘the mandate-based’ or the ‘single-equity’
approaches, both lacking risk-sensitivity and considered too conservative by the industry. On the one hand,
under the mandate-based approach, the CIUs would be capitalised based on a hypothetical portfolio which
would produce the highest capital requirements according to the fund’s mandate. On the other hand, the ‘single-
equity’ approach would treat the CIU as an unrated equity exposure as an unrated equity exposure allocated to
the “other sector” bucket, which attracts the highest RWs (e.g. 70% for delta equity risk class).”
123
volatility of the price of carbon emission allowances, which is closer to physical
commodities than to electricity. In addition, the creation of the Market Stability
Reserve by the Commission in 2015193
, aimed at addressing the surplus of allowances
and improving the system's resilience to major shocks by adjusting the supply of
allowances to be auctioned, has stabilised the volatility of the price of ETS
allowances. This would justify creating a specific risk category for ETS allowances
under the SA, distinct from electricity, with a lower risk weight equal to 40% to better
reflect the actual price volatility of this EU-specific commodity.
In addition, as opposed to option 1, the use of the simplified standardised approach for banks
with medium-sized trading books would not be left to the discretion of supervisors, but would
rather be harmonised across the EU, consistently with the eligibility criteria agreed by co-
legislators in the CRR II to exempt banks with the same profile from the FRTB reporting
requirements194
.
Finally, monitoring the implementation of the final FRTB standards in other member
jurisdictions of the BCBS would be key to identify, and potentially address, distortions to the
playing field for EU banks’ trading activities if some of these jurisdictions would delay the
implementation of the FRTB framework or relax its calibration195
. To do so, option 2 would
introduce an empowerment for the Commission to delay, if necessary, the application of the
capital requirements based on the FRTB framework and/or to adjust its calibration based on
international developments. This empowerment would also allow the Commission to revise,
if necessary, the specific adjustments introduced as part of this legislative initiative for the
treatment of CIUs and carbon emissions allowances, based on a report mandated to the EBA.
Impacts of policy options
Under the baseline option, banks would not be subject to direct capital impacts, but they
would still incur the operational costs of implementing and maintaining the FRTB approaches
for the reporting requirements introduced by the CRR II, in parallel with the existing
approaches for calculating capital requirements for market risk.
Both options 1 and 2 would introduce more effective approaches for calculating capital
requirements for market risk by addressing the weaknesses of the current approaches. Both
193
Decision (EU) 2015/1814 of the European Parliament and of the Council of 6 October 2015 concerning the
establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme
and amending Directive 2003/87/EC (available at https://eur-lex.europa.eu/legal-
content/EN/TXT/PDF/?uri=CELEX:32015D1814&from=EN).
194
These eligibility criteria, set out in Article 325a of the CRR, would therefore fulfil their original purpose as
set out in the Commission proposal for the CRR II, before co-legislators agreed to keep the FRTB approaches
for reporting purposes only.
195
Hong Kong and Singapore publically announced the application of the final FRTB standards as a reporting
requirement from 1 January 2023 and committed to implement the standards as a capital requirements at a later
stage. Other jurisdictions have already publically indicated a delay of the application of the final FRTB
standards as capital requirement, as compared to the BCBS recommended implementation date: Q3 2023 for
Japan; Q1 2014 for Canada; 1 January for Australia. Finally other major jurisdictions (e.g. US, CH) have
publically announced their commitment to implement the FRTB framework as capital requirements without
more details at this stage.
124
options 1 and 2 would also be more cost-effective compared to the baseline by limiting the
operational costs , as banks would be required to use the same approaches (based on the final
FRTB standards) for both reporting and capital calculation purposes.
As part of its 2020 CfA response, the EBA estimated that option 1 would lead to an increase
of the 0.8% in the total capital requirements of EU banks included in the EBA sample
(roughly a 50% increase in the capital requirements for market risk). As illustrated in Figure
9 below, this impact appears more pronounced for banks using the FRTB SA as compared to
banks using the FRTB IMA. The impact also varies depending on the group of EU banks.
Figure 9: Impact of the final FRTB standards in terms of total market risk RWA (relative to
total current market RWA), by size and bank type
Source: EBA, based on data collected for the December 2020 report.
Note: this impact comes from the “reduced bias estimation” sample in which the EBA removed 3 G-SII banks
from the sample due to some concerns that they may have overestimated the impact.
As a result, EU banks particularly active in these areas would incur a large increase in the
capital requirement for trading book exposures. This would potentially lead to increased
prices, reduced trading volumes and restricted access to funding and risk management
solutions for some economic actors. However, it is important to note that the impacts of the
final FRTB standards may be overestimated in the EBA CfA QIS since some elements of the
rules that have the potential to reduce the capital requirements of EU banks under the FRTB
IMA are not yet operational (e.g. the use of data pooling services to improve the passing rate
of the assessment of model lability) or are not yet applicable (e.g. the final draft RTS on
capital requirement for “non-modellable risk factors” developed by the EBA is still in the
process of being adopted by the Commission).
Option 2 would further improve risk capture compared to option 1 by making a number of
adjustments that better reflect the market risk of certain specific instruments traded by EU
banks. However, the EBA has so far not been able to estimate the impact of those
125
adjustments196
. Therefore, option 2 would mandate the EBA to prepare a report reviewing
whether those adjustments achieve their objectives.
Table 15. Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 + - + ≈
Option 2 ++ + ++ ++
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly
positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table
15, option 2 is deemed the preferred policy option.
1.4. Operational risk framework
1.4.1. General background
Under the current prudential framework, operational risk is broadly defined as the risk of loss
resulting from inadequate or failed internal processes (resulting from either internal staff or
internal systems) or from external events197
. This risk usually encompasses a wide subset of
more specific risks related to the daily functioning of banks, such as legal risk, conduct risk,
IT risk, cyber risk and risk of fraud.
The capital requirements for operational risk under the CRR are based on the Basel II
standards that were adopted by the BCBS in 2005. Under the CRR, EU banks can calculate
their operational risk capital requirement using either an internal model approach subject to
supervisory approval (the so-called advanced measurement approach (AMA)198
) or one of the
three standardised approaches199
with varying degrees of complexity. The requirements banks
have to fulfil to use the AMA offer significant flexibility allowing banks to use a diverse
range of modelling practices.
196
Nevertheless, in its December 2019 CfA response, the EBA highlights that the impact of the final FRTB
standards may be driven by the treatment for CIUs.
197
Article 4(1), point (52) of Regulation (EU) No 575/2013.
198
The own funds requirements for operational risk are set out in Articles 312 to 324 of Regulation (EU) No
575/2013.
199
The Basic Indicator Approach (BIA) is the least complex of the three approaches, originally designed for
small and non-complex banks. Under this approach, the capital requirement is equal to a percentage of a bank’s
GI indicator. In contrast, the Standardised Approach (TSA) is more sophisticated than the BIA as it allows a
more granular treatment of the GI indicator. The alternative standardised approach (ASA), which is a variant of
the TSA, allows banks with specific business models to use a simplified method to compute operational risk
capital requirements.
126
According to the EBA Risk Assessment Report200
published in December 2020, operational
risk accounted for around 10% of the total capital requirement of EU banks in June 2020,
representing the second largest capital requirement after credit risk. The EBA also showed
that the occurrence of operational risk events has almost tripled from 2014 to 2019 (see
Figure 10 below). However, during the same period, the amount of total losses from new
events has significantly decreased: they represented 1.74% of the total CET1 amounts of EU
banks in 2014 against 0.76% in 2019.
In their responses to the autumn 2020 Risk Assessment Questionnaire (RAQ), EU banks and
analysts acknowledged the increased importance of operational risk over the last few years201
.
In their responses, banks and analysts identified cyber-risks and data security as currently the
main drivers of operational risk (other majors drivers identified include money laundering,
terrorist financing, conduct risk and legal risk). Supervisors also consider operational risk as a
key area of supervisory scrutiny, for instance as highlighted by through the key messages on
the outcome of the ECB 2019 supervisory review and evaluation process (SREP)202
.
Figure 10. Total losses from new events in operational risk as a share of CET1 capital (right-
hand side y-axis) and number of new events (left-hand side y-axis) over time.
Source: Risk Assessment of the European banking system, EBA, December 2020.
As observed by the BCBS203
, the GFC highlighted some weaknesses in the capital
requirements for operational risk under the Basel standards, which in many cases resulted in
200
See Risk Assessment of the European Banking System.
201
Over 58% of respondents share the view that the importance of operational risk has increased over recent
years, marking the highest level of that perception as collected through of the autumn RAQs over the past three
years.
202
ECB: The Supervisory Review and Evaluation Process in 2019 – Aggregate SREP outcome for 2019,
January 2020.
203
The BCBS launched a number of comprehensive data collection on banks’ operational losses after the GFC
confirming the weakness of the international standards to appropriately capture this risk (see 2008 BCBS loss
data collection exercise, 2010 BCBS QIS, 2015 BCBS QIS).
127
insufficient capital requirements to cover the actual operational risk to which banks were
exposed to. Despite a significant increase in the number and severity of operational risk
events observed after the GFC204
, EU banks’ capital requirements for operational risk have
remained relatively stable afterwards.
An important weakness identified by the BCBS is the lack of risk-sensitivity in the
calculation of operational risk capital requirements under the standardised approaches. Under
those approaches, the capital requirements for operational risk are calculated as a percentage
of the gross income (GI) indicator (basically, the positive annual gross income of a bank) to
estimate operational risk exposures. In other words, the existing approaches are based on the
assumption that banks’ potential losses related to operational risk are linearly proportionate to
their revenues. As a result, the decrease in banks’ annual gross income during the GFC led to
a mechanical decrease of the capital requirements for operational risk while at the same time
banks suffered from an increase in actual losses due to operational risk events.
A second weakness identified by the BCBS is the inappropriate capture of potential
operational risk losses by banks’ AMA. The BCBS observed a wide variability of operational
risk capital requirements calculated under banks’ AMA. This is mainly due to the significant
flexibility offered to banks in modelling AMA that led many banks to choose modelling
assumptions that ultimately underestimate the actual risks they are exposed to205
. As part of
its 2019 SREP report, the ECB confirmed206
these findings for some SI under its direct
supervision.
To address the above weaknesses of the current approaches, the BCBS adopted revised
standards for operational risk as part of the final Basel III reforms. More specifically, the
BCBS removed the use of internal models for operational risk and replaced the three existing
standardised approaches with a single revised standardised approach, known as the
Standardised Measurement Approach (SMA).
The SMA improves the risk-sensitivity of the current standardised approaches by
combining207
two components to determine the capital requirement for operational risk: the
Business Indicator Component (BIC), that takes into account the main elements of banks
incomes and expenses, and the Internal Loss Multiplier (ILM), that takes into account banks
historical operational risk losses.
1.4.2. Implementation of the Internal Loss Multiplier (ILM)
Problem definition
In the development of the revised standards for operational risk, the BCBS collected some
empirical evidence suggesting that banks that have experienced higher operational risk losses
204
For instance, the BCBS showed that fines related to misconduct rose from less than EUR 10 billion in 2008
to more than EUR 60 billion in 2014 for a sample of 111 internationally active banks. The number of those fines
surged from less than 20 in 2008 to almost 100 in 2015 (see Finalising Basel III – In brief).
205
See Basel III Monitoring report – Results of the cumulative quantitative impact studies
206
See The Supervisory Review and Evaluation Process in 2019 – Aggregate SREP outcome for 2019
207
The capital requirement for operational risk under the SMA is a simple product of the BIC and the ILM.
128
in the past were more prone to experience higher operational risk losses in the future. In light
of this observation, the BCBS proposed that a bank’s capital requirement for operational risk
under the SMA should be somewhat proportionate to the bank’s historical operational risk
losses. The loss208
data are incorporated through the Loss Component (LC) in the formula
defining the ILM. Basically, if a bank suffered large historical operational risk losses (relative
to its incomes and expenses as measured by the BIC) the ILM would be greater than 1, which
would ultimately increase the capital requirement for operational risk under the SMA.
Conversely, if a bank suffered low historical operational risk losses (relative to its incomes and
expenses as measured by the BIC) the ILM would be lower than 1 which would ultimately
decrease the capital requirement for operational risk under the SMA.
The revised Basel standards for operational risk offer a number of discretions for the
implementation of the SMA regarding the incorporation of historical operational risk losses.
First, they allow each jurisdiction to disregard the use of the historical operational risk losses
in the calculation of the capital requirements for operational risk of all ‘bucket 2’ and ‘bucket
3’ banks209
(mostly medium and large banks) by setting the ILM to 1. In jurisdictions where
this discretion would be exercised, the capital requirement for operational risk under SMA of
these banks would therefore be equal to their BIC component.
Second, the they allow each jurisdiction to incorporate the historical operational risk losses in
the calculation of the capital requirements for operational risk of all ‘bucket 1’ banks209
(mostly small banks), for which the ILM is set to 1 by default, provided that they meet some
requirements related to the collection and management of their operational risk loss data. The
BCBS deemed that incorporating by default the use of the historical operational risk losses in
the calculation of the capital requirements for operational risks under the SMA would make
the approach too complex for those banks.
In addition, in jurisdictions that allow banks to incorporate the historical operational risk
losses in the calculation of the capital requirements for operational risks, those banks may
request their supervisors to disregard some of their historical operational risk events in that
calculation. Specifically, those banks may increase the threshold to identify historical
operational risk loss events (from EUR 20 000 to EUR 100 000) or remove exceptional
events that they deem not to be representative in view of their current risk profile.
Policy options
Baseline option – Maintain the discretions of the Basel standards to implement the
historical operational risk losses
The baseline option would maintain the discretions offered to jurisdictions under the revised
Basel standards to implement the historical operational risk losses. Under this option,
208
More specifically, these loss data use the average annual operational risk losses incurred by the bank over the
previous ten years.
209
The revised Basel standards for operational risk differentiate three groups of banks based on their Business
Indicator (BI). Banks with a BI of less or equal to EUR 1 billion are assigned to bucket 1, while banks with a BI
of more than EUR 30 billion are assigned to bucket 3. All other banks are assigned to bucket 2.
129
supervisors would be allowed to disregard the use of the historical operational risk losses of
their ‘bucket 2’ and ‘bucket 3’ banks. At the same time, they would be allowed to exercise
the discretion to incorporate the historical operational risk losses of ‘bucket 1’ banks in the
calculation of their capital requirements for operational risks. Furthermore, supervisors would
be allowed to disregard some historical operational risk events and the corresponding
historical operational risk losses in the calculation of the capital requirements for operational
risk, at banks’ request.
Option 1 - Implement ILM using historical operational risk losses under the SMA for all
banks
Option 1 would exercise the discretions offered under the revised Basel standards in a
harmonised way to allow the incorporation of historical operational risk losses for all EU
banks, irrespective of their size. To recognise some differences between the operational risk
profiles of EU banks (e.g. relating to the size of an average loss), this option would still allow
supervisors to grant, under specific conditions, the permission for banks to increase the
threshold to identify common historical loss events (from EUR 20 000 to EUR 100 000).
Option 2 – Disregard historical operational risk losses in the ILM component under the SMA
for all banks
Similar to option 1, option 2 would also exercise the discretions offered under the revised
Basel standards in a harmonised way across EU Member States. However, option 2 would
propose to disregard the use of historical operational risk losses in the calculation of capital
requirements for operational risk under the SMA by setting ILM to 1 for all EU banks. Under
this option, the calculation of capital requirements for operational risks of EU banks would
simply be based on the BIC component.
Impacts of and comparison across policy options
Under the baseline option, supervisors would be allowed to exercise the discretions related
to historical operational risk losses in the revised operational risk framework for the banks
they supervise. At present, it is not possible to quantify the impact of this option since it is not
possible to predict how supervisors would exercise those discretions. However, if supervisors
would take different decisions on the matter, it would lead to a fragmentation of the
prudential framework and hence to an un-level playing field across the Union.
As compared to the baseline option, both options 1 and 2 would improve the comparability
of EU banks’ capital requirements for operational risk and maintain a level playing field
across the Union since banks would apply the same rules, irrespective of their location and
their size.
Option 1 would improve the risk sensitivity of the prudential framework since it would take
into account banks’ past operational risk losses in the calculation of the capital requirements
130
for operational risk. However, this option would lead to a material impact210
on EU banks’
capital requirements for operational risk: according to the EBA’s 2020 CfA response, it
would represent a weighted average increase of 3.8% in the total capital requirements of
banks included in the EBA sample. More granular data from the EBA’s August 2019 CfA
response shows that option 1 would represent a weighted average increase of roughly 40% in
the capital requirements for operational risk of EU banks.
As shown in the EBA’s 2020 CfA response, option 1 would have a more significant impact
on the capital requirements of large banks, particularly on G-SIIs due to high operational risk
losses over the last 10 years211
. For medium-sized banks, the impact would be almost neutral
under this option, while for small banks there would be a decrease in capital requirement for
operational risk212
.
By default, the Basel SMA sets a EUR 20 000 threshold for the collection of losses that are
used for the computation of the loss component. Under option 1, supervisors would be
allowed to raise that threshold up to EUR 100 000. In its August 2019 CfA response, the
EBA estimated that the impact of raising the threshold to EUR 100 000 for all the banks
would slightly mitigate the impact of the revised operational risk framework under option 1.
Disregarding historical losses as suggested under Option 2 would more than halve the impact
estimated for option 1: the weighted average increase in the total capital requirements of EU
banks included in the EBA sample would be reduced to 1.7%. While large banks would
benefit from a large decrease in the impact compared to option 1, medium-sized banks would,
in contrast, incur an increase in their capital requirements for operational risk compared to
that option. 2.
Option 2 would simplify to a large extent the calculation of capital requirements for
operational risk under the revised framework. However, the reduction of the operational
burden for EU banks would be limited since they would be required to gather, maintain and
disclose their operational losses history under option 2. 213
During the public consultations launched by the Commission, stakeholders expressed mixed
views on the implementation of the ILM. Option 1 received some support from some
Member States and medium-to small-sized banks, while large banks favoured option 2 (see
Annex 2 for more details).
210
This estimated impact may overestimate the actual impact since it does not take into account the flexibility of
the revised Basel standards for banks to disregard certain events in their historical operational risk losses, upon
supervisory approval.
211
It should also be noted the impact of option 1 may progressively decrease over time, since the sliding 10
years windows, of the large operational risk losses incurred by the largest EU banks occurred before 2017, by
the end of the phase-in period the LCs of those banks would no longer include those losses which, all else being
equal, should mean that their LC (and consequently their capital requirements for operational risk) would be
significantly lower.
212
Note that the estimates for small banks has to be treated with caution in view of the limited number of these
banks in the EBA sample.
213
Note that banks already collect information on all their operational losses, irrespective of their size and they
will almost certainly continue to do so in the future. So while option 2 would not decrease the administrative
burden of banks, it would not increase it either.
131
Table 16. Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 ++ - + ≈
Option 2 + + ++ +
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly
positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table
16, option 2 is deemed to be the preferred policy option.
1.5. Credit valuation adjustment risk framework
1.5.1. General background
The credit valuation adjustment (CVA) is a fair-value accounting adjustment to the price of a
derivative instrument, aiming to provision against potential losses due to the deterioration in
the creditworthiness of the counterparty to that instrument. The value of CVA depends on the
level of credit spread of the respective counterparty (an increase in the counterparty’s credit
spread would lead to an increase of CVA, and vice versa) but also on the market value of the
derivative instrument (an increase in the derivative instrument value would lead to an
increase of CVA, and vice versa). Therefore, CVA embeds several risks: the credit spread
risk associated with the creditworthiness of the counterparty, but also the market risk
associated with the derivative transaction (e.g. interest rate risk where the derivative
transaction is an interest rate swap).
CVA is generally reflected in the price that banks charge to their clients for derivative
transactions. Since CVA is a downward adjustment to the price, CVA losses are incurred by
the bank when the value of CVA increases. Therefore, reducing the CVA is beneficial for
both the bank and its clients: the bank reduces its potential future loss while the client lowers
the cost for the transaction. CVA can be reduced naturally if a client improves its
creditworthiness. But a bank may also further reduce CVA by the use of credit derivatives,
which allow it to insure itself against client’s losses, or by exchanging collateral with the
counterparty to reduce the exposure of the derivative instrument. Furthermore, CVA risk (i.e.
the risk of changes in the CVA value) can be mitigated using dynamic hedging strategies
relying on various financial instruments associated with the different risks embedded in CVA
(e.g. interest rates derivatives to hedge against the interest rate risk of CVA).
CVA, and CVA risk, are complex to model and therefore to quantify. In fact, the
quantification requires banks to model at the same time the probability of a counterparty’s
default over multiple future dates, the potential future market value of the associated
derivative instrument at those dates and the potential amount that the bank would recover
132
from the liquidation of the instrument upon the counterparty’s default. This high level of
complexity led banks to develop a wide variety of models used for accounting purposes.
During the GFC, a number of systemically important banks incurred significant CVA losses
because of the deterioration in the creditworthiness214
of their counterparties. To ensure that
banks’ CVA risk would be covered with sufficient capital in the future, the BCBS introduced
in 2011, as part of the first set of Basel III reforms, new standards to calculate capital
requirements for CVA risk215
. In line with the Basel standards for other types of financial
risk, the capital requirements for CVA risk can be calculated by banks using two different
approaches: a standardised method and an advanced method (the latter being considered as an
internal model approach). In contrast to the complexity of the modelling approaches used by
banks to calculate CVA risk for accounting purposes, the BCBS decided to develop relatively
simple standards to calculate the capital requirement for CVA risk in order to ensure a high
comparability of outcomes across banks. The relevant Basel standard was transposed in
Union law in 2013 through the CRR (hereafter ‘current CVA framework’). According to the
2020 EBA Risk Assessment Report216
, in June 2020, CVA risk accounted, on average, for
around 2% of the total capital requirements of EU banks.
After its adoption by the BCBS, the standard of capital requirement for CVA risk has been
criticised by banks and supervisors in most jurisdictions due to its inability to appropriately
capture CVA risk. On the one hand, banks highlighted the lack of risk-sensitivity of the
approaches to be used to calculate the capital requirements for CVA risk and complained
about the non-recognition of their existing CVA models developed for accounting purposes,
as well as of the hedging strategies they were using to reduce their CVA risks for accounting
purposes. In their view, this led to an overstatement of the actual level of CVA risk they were
exposed to. On the other hand, supervisors complained that the approaches only captured one
type of CVA risk (i.e. the credit spread risk of the counterparty), neglecting the potentially
material market risk embedded in the derivative transactions. In their view, this resulted in
potentially too low capital requirements for CVA risk in certain cases.
To address those concerns, the BCBS published a revised standard for the calculation of
capital requirements for CVA risk (hereafter ‘revised CVA standard’) in December 2017, as
part of the final Basel III reform. The revised CVA standards introduced three new
approaches for the calculation of capital requirements for CVA risks: the simplified
approach, the basic approach (BA-CVA), and the standardised approach (SA-CVA).
214
According to the BCBS, roughly two-thirds of losses that materialised on counterparty credit risk were
attributed to CVA losses on non-defaulted counterparties whereas one-third was attributed to actual defaults of
counterparties (see https://www.bis.org/press/p110601.pdf).
215
Basel III, A global regulatory framework for more resilient banks and banking systems, BCBS, 2011 (see
https://www.bis.org/publ/bcbs189.pdf).
216
EBA: Risk Assessment of the European Banking System, December 2020 (see
https://www.eba.europa.eu/sites/default/documents/files/document_library/Risk%20Analysis%20and%20Data/
Risk%20Assessment%20Reports/2020/December%202020/961060/Risk%20Assessment_Report_December_20
20.pdf).
133
These approaches improve the calculation of capital requirements for CVA risk by:
 enhancing its risk sensitivity by taking into account the exposure component of CVA
risk alongside with its associated hedges (in contrast to the current CVA framework
captures only the credit spread risk of CVA);
 reflecting banks’ existing CVA models developed for accounting purposes under SA-
CVA (in contrast to the current CVA framework which is based on a prescribed
formula); and
 introducing more proportionality in the prudential framework with the simplified
approach. This approach would be available for banks with relatively low volumes of
derivatives activities217
.
In the course of monitoring the expected impact of the revised CVA standard, the BCBS
identified a few issues218
that needed to be addressed. Following a public consultation219
launched in December 2019, the BCBS revised certain elements of the standard and
published a final version220
in July 2020 (hereafter ‘final CVA standard’). These targeted
revisions led to a significant decrease in the impact of the revised CVA standards and
improved the consistency of the prudential framework. As part of its 2020 CfA response, the
EBA recommended to implement those revisions in Union law. Similarly to the other
elements of the final Basel III reform, the implementation deadline of the final CVA standard
has been postponed to 1 January 2023 in light of the COVID-19 pandemic.
1.5.2. Exemptions from the current CVA framework
Similarly to the original CVA standard, the final CVA standard adopted by the BCBS
contains limited exemptions from the calculation of the capital requirement for CVA risk221
.
By contrast, when adopting the current CVA framework in Union law via the CRR, the EU
co-legislators exempted certain additional types of derivative transactions from the
calculation of capital requirements for CVA risk. These were mostly transactions with
counterparties that were exempted from the clearing/margining mandates under Regulation
(EU) No 648/2012 (also known as EMIR)222
. The exemptions were introduced to prevent a
potential excessive increase in the cost of derivative transactions triggered by the introduction
of the then new capital requirements for CVA risk.
217
Under the Basel standard, the simplified approach is restricted to banks with less than EUR 100 billion of
total nominal value of non-centrally cleared derivatives transactions.
218
More specifically, the calibration of the revised CVA standard was deemed too high, leading to significant
increase in capital requirements and not sufficiently aligned with the revised market risk framework. In addition,
the treatment of fair-valued SFTs in the scope of the capital requirements, as well as the treatment of credit and
equity indices as hedging instruments, were not considered adequate under the revised CVA standard.
219
See https://www.bis.org/bcbs/publ/d488.pdf.
220
See https://www.bis.org/bcbs/publ/d507.pdf.
221
Only derivatives transactions with qualified CCPs and with CCPs’ clients where a bank acts as clearing
member are exempted.
222
The exemptions cover derivative transactions with EU Member States, certain local authorities, most non-
financial corporates, and pension funds.
134
The exemptions did not affect the calculation of CVA under the accounting rules. Therefore,
the actual CVA risk of the exempted transactions under the CRR may still be a source of
significant risk for some banks that benefit from those exemptions; if those risks materialise,
the banks concerned could suffer significant losses. As highlighted by the EBA in its report
on CVA published in February 2015, these exemptions may have significantly decreased the
capital requirements for CVA risk223
for EU banks. . In its report, the EBA took the position,
unchanged since then, that the CVA exemptions should be removed for prudential reasons. In
2017, the EBA started developing guidelines224
on how supervisors should assess the CVA
risk of exempted transactions under the SREP; the guidelines were never finalised due to a
presumed lack of legal basis in the CRR/CRD.
The CVA exemptions are one of the main reasons why, in 2014, the BCBS judged the EU
implementation of the Basel III standards on capital requirements as materially non-
compliant225
.
Policy options
Option 1 - Remove the existing CVA exemptions
Under this option the CRR would be fully aligned with the final CVA standard, including
through the removal of the existing additional CVA exemptions.
Option 2 - Keep the existing CVA exemptions while reinforcing the monitoring of the
corresponding risks
Like under option 1, option 2 would also implement the final CVA standard in the CRR, but
would keep the existing CVA exemptions contained in the CRR. In addition, to enhance the
monitoring of CVA risk related to the exempted transactions, option 2 would require banks to
report to their supervisors the calculation226
of capital requirements for CVA risk for those
transactions. Finally, in consideration that the CRD V already clarified the rights for
supervisors to impose supervisory measures for risks exempted from Pillar 1, option 2 would
mandate the EBA to develop guidelines to help supervisors with the identification of
excessive CVA risk. The guidelines would improve the harmonisation of supervisory action
across the EU in this area.
Impacts and comparison across options
Option 1 would strengthen the capital position of EU banks by removing the current CVA
exemptions. However, it would also lead to a significant increase in the capital requirements
for EU banks: in its 2020 CfA response, the EBA estimated that removing the existing
exemptions would lead to a weighted average increase of 2.1% in the total capital
223
See The EBA advises the European Commission on Credit Valuation Adjustment (CVA) risk | European
Banking Authority (europa.eu)
224
Guidelines on the treatment of CVA risk under SREP | European Banking Authority (europa.eu)
225
See Regulatory Consistency Assessment Programme (RCAP) - Assessment of Basel III regulations -
European Union (bis.org)
226
That is the calculation of capital required for CVA risks if the transactions were not exempted under CRR.
135
requirements of EU banks in the EBA sample. This would likely lead to an increase in the
costs of derivative transactions, which may in turn lead bank clients that currently use
derivatives for hedging their financial risks to reduce their use of derivatives or even stop
using them altogether (the latter may be especially the case for those clients that cannot post
collateral on their derivative transactions due to operational constrains).
Keeping the exemptions as proposed under option 2 would significantly mitigate the impact
of implementing the final CVA standard: the EBA estimated that under this option the
weighted average increase would be reduced to 0.5% of the total capital requirements. While
option 2 would not address the issue of the CVA risk of the exempted transactions, it would
provide supervisors with additional guidance on how to address cases of excessive CVA risk
with Pillar 2 measures.
Stakeholders’ views are mixed on what to do with the CVA exemptions: Member States’
views are split, the supervisory community (including the ECB and the EBA) supports option
1, while the EP and the banking sector support option 2 (see Annex 2 for more details).
Table 17. Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 ++ - ≈ ≈
Option 2 + ++ ++ ++
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly
positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table
17, option 2 is deemed the preferred policy option.
1.6. Minimum haircut floor framework for SFTs
Problem definition
Non-bank financial intermediation can, if appropriately conducted, help to diversify the
funding sources of corporates and households. In addition, it may stimulate competition,
which ultimately supports real economic activity, and help distributing financial risks across
a wider range of investors and lenders. Since the GFC, this source of financing has become
an increasingly important alternative to banks227
.
This surge of activity outside the banking sector has raised concerns in the regulatory
community that non-bank financial intermediation may also become a source of systemic
227
The assets of the money market and investment funds and other non-bank financial institutions sector in the
EU almost doubled from EUR 23 trillion in 2008 to EUR 39 trillion by the Q3 2020 (see ECB statistical data
warehouse:
https://sdw.ecb.europa.eu/browseSelection.do?type=series&q=RAI.Q.D0.IFOFI1.Z01.QSA.E&node=SEARCH
RESULTS&ec=&oc=&rc=&cv=&pb=&dc=&df=)
136
risk, given that this sector is usually subject to less stringent supervision, if any, and hence
potentially more prone to pro-cyclicality and the build-up of excessive leverage.228
This is
particularity true if this sector engages in activities that are typically performed by banks,
such as liquidity and maturity transformation.
One element that can contribute to the potential build-up of leverage created outside the
banking sector are so-called SFTs229
. SFTs are collateralised bilateral transactions, whereby
cash, securities or commodities are transferred from one counterparty (transferor) to the other
counterparty (transferee), and the transferee provides collateral in the form of cash or
securities to the transferor. SFT markets play an essential role in the EU financial system by
allowing financial intermediaries to manage their own liquidity position and support their
securities market-making activities. They also allow central banks to transmit, via financial
intermediaries, their monetary policy to the real economy.
According to the EBA’s August 2019 CfA response, repurchase agreements (so-called
‘repos’ and their counterparts ‘reverse repos’), are the most important type of SFTs used by
EU banks in terms of trading volumes230
(see
228
See for instance, EU Non-bank Financial Intermediation Risk Monitor 2019, ESRB, July 2019
229
See Report on securities financing transactions and leverage in the EU, ESMA, October 2016.
230
A more comprehensive estimate of the European repo market (including both repos and reverse repos) is
provided by the ESBR, with a total value amounting to EUR 8.3 trillion at the end of 2019 (see EU Non-bank
Financial Intermediation Risk Monitor 2020)
137
Figure 11). Repos are particularly useful for banks as they offer a secured alternative to
unsecured interbank lending to manage their funding and liquidity needs. Institutional
investors and non-financial counterparties also use the repo markets, usually to invest their
excess cash. The second most important type of SFTs in the EU are securities lending and
borrowing. In contrast to repos, securities lending and borrowing are motivated by the
demand from financial intermediaries for a particular type of securities, instead of a funding
need.
138
Figure 11 also shows that outstanding SFT market activities are highly concentrated within
large banks, in particular within G-SIIs and O-SIIs. In addition, Figure 12 shows the wide
range of EU banks’ counterparties in SFTs, which differ significantly across SFT types.
Repos traded by EU banks, of which a significant portion is cleared through central
counterparties, has the widest range of counterparties. In contrast, securities
lending/borrowing and margin lending/borrowing transactions of EU banks are more
concentrated with one type of counterparties (other banks for the former, unregulated
financial intermediaries for the latter).
139
Figure 11: Breakdown of outstanding SFTs volumes across EU banks, by SFT type and bank
size
Source: Basel III reforms: Impact study and key recommendations, August 2019, EBA.
Note: for each type of SFTs, volumes are expressed in gross amount of one of the two legs of the SFT.
Figure 12: Breakdown of EU banks’ counterparties in their outstanding SFTs, by
counterparty type and SFT type.
Source: Basel III reforms: Impact study and key recommendations, August 2019, EBA.
Note: for each type of SFTs, the % of total gross amount of outstanding SFTs
While the merits and the importance of SFTs are widely recognised, SFTs can also enable
financial intermediaries to recursively leverage their positions by reinvesting the cash
received through an SFT to borrow new securities via other SFTs. Such strategy can create
opaque interconnectedness231
between the banking sector and the less regulated or
unregulated non-bank financial sector which could go unnoticed by supervisory authorities
and which could increase risk of financial contagion during stressed market conditions.
In order to reduce the build-up of leverage outside of the banking sector in the EU, the
Financial Stability Board (FSB) published in 2013 a number of prudential recommendations
231
An illustration of this interconnectedness has been provided by the ESRB as the volume of EU banks’ repo
liabilities to non-Money Market Funds and other financial institutions amounting to EUR 44 billion at the end of
2019 (see EU Non-bank Financial Intermediation Risk Monitor 2020).
140
for the SFT market232
. One of these recommendations was to introduce of minimum haircut
floors framework for specific SFTs between banks and non-bank financial counterparties233
,
either directly via a market regulation or indirectly via a more punitive capital treatment of
SFTs not meeting the minimum haircut floors that was developed by the BCBS. The choice
of the implementation approach was left to each FSB member jurisdiction.
More specifically, the FSB recommended to require banks that engage in non-centrally
cleared SFTs in which they provide financing to non-bank financial counterparties against
collateral other than government securities (‘in-scope SFTs’) to obtain from these
counterparties a certain minimum amount of over-collateralisation234
. This additional
collateral amount mainly would depend on the type of collateral received as well as its
remaining maturity.
For those jurisdictions that would choose to implement the SFT minimum collateral haircuts
recommendation via market regulation, banks would no longer be allowed to conduct in-
scope SFTs with non-banks financial counterparties that would not comply with the defined
minimum level of collateralisation, i.e. where non-banks financial counterparties do not
provide the minimum amount of over-collateralisation. In contrast, those jurisdictions that
would choose to implement the SFT minimum collateral haircuts recommendation via the
implementation of the Basel standard, banks would still be allowed to conduct in-scope SFTs
with non-banks financial counterparties that would not comply with the defined minimum
level of over-collateralisation, but these transactions would be treated as unsecured loans
under the Basel standard (rather than secured exposures under the normal treatment). As a
consequence, the capital requirements for the non-compliant SFTs would significantly
increase, creating a strong disincentive for banks to conduct such transactions. The final
elements of the Basel III reform published in 2017 include a detailed methodology to verify
whether SFTs comply with the minimum collateral haircuts agreed by the FSB, including for
cases where multiple SFTs are subject to a master netting agreement235
.
Due to its connection with the Basel standards, the initial implementation deadline of the FSB
recommendation has been aligned with the implementation deadline of the final Basel III
reform, i.e. 1 January 2022. The FSB later postponed the deadline by one year236
to align it
with the postponement of the deadline for implementing the final elements of the Basel III
reform decided by the BCBS in March 2020 in light of the COVID-19 pandemic.
232
FSB: Strengthening Oversight and Regulation of Shadow Banking, 29 August 2013.
233
Another FSB recommendation suggested the introduction of the same minimum collateral haircuts for
specific SFTs between non-bank and non-bank financial counterparties, but this time only via a market
regulation since no counterparties to the SFTs would be subject to the Basel standard.
234
To ensure a level playing field, the SFTs that do not meet the minimum amount of over-collateralisation (in
other words, that do not comply with the minimum haircut floors) should be identified in the same way by banks
whether their authorities decide to introduce the minimum haircut floors framework for SFTs via a market
regulation or by implementing the Basel standard.
235
While verifying the compliance with the minimum collateral haircut requirement is relatively simple for a
single SFT, it becomes more complicated where multiple SFTs are included in a master netting agreement. In
fact, in this case, compliance has to be verified at portfolio level, taking into account the various collateral types
included in all the SFT subject to the master netting agreement.
236
See FSB extends implementation timelines for securities financing transactions - Financial Stability Board
141
Policy options
Baseline option - No changes to the EU regulatory framework
The baseline option does not entail any policy changes or regulatory initiatives to reduce the
potential build-up of leverage outside of the banking sector in the EU. In this situation, the
build-up of leverage outside of the banking sector may continue to persist or even
intensify.237
Option 1 - Introduce the minimum haircut floors framework for SFTs, either via the
prudential framework applicable to banks or via a market regulation
The EU already adopted a number of the FSB recommendations in 2015 via Regulation (EU)
2015/2365238
, also known as the Securities Financing Transactions Regulation (SFTR).
However, the SFT minimum collateral haircuts framework are not yet implemented. Option 1
would therefore introduce the SFT minimum collateral haircuts framework in Union law,
either via a market regulation (requiring amendments to either SFTR or MIFIR, or introduced
via a new regulation) or via the implementation of the relevant standard of the final Basel III
reform in the CRR.
Option 2 - Postpone the introduction of the minimum haircut floors framework until
sufficient data on impacts are available
In its dedicated report on the implementation of the minimum collateral haircut framework
published239
in August 2019 as part of its CfA response, the EBA highlighted the lack of
clarity of certain aspects of the minimum haircut floors framework for SFTs, in particular
regarding the scope of SFTs that must be subject to the framework. Some of these aspects
have been clarified by the FSB in a technical guidance published240
in November 2019.
The EBA’s opinion is consistent with the conclusions of a report241
mandated by SFTR and
published by the Commission in 2017 on progress in international efforts to mitigate the risks
associated with SFTs, including on the implementation of minimum haircut floors framework
for SFTs. In this report, the Commission highlighted that it is not clear whether the prudential
objectives of the minimum collateral haircut framework (i.e. reduction of the potential
leverage outside the banking sector) could be attained without the risk of creating undesirable
consequences on EU SFT markets. This report stressed the need to assess the impacts of
introducing this framework in Union law on the basis of a wider set of more granular data
which will be available once the reporting requirements set out under SFTR become
effective. For credit institutions established in the EU, the SFTR reporting requirement
started recently, in April 2020, following the adoption of technical standards developed by
237
Available data does not suggest that the level of leverage outside the banking sector will decrease on its own
over time.
238
Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on
transparency of securities financing transactions and of reuse and amending Regulation (EU) No 648/2012.
239
See EBA: Policy Advice on the Basel III Reforms on Security Financing Transactions (SFTs), August 2019.
240
See Annex 2, in SFT minimum haircut standards - Technical Guidance (fsb.org)
241
See Register of Commission Documents - COM(2017)604 (europa.eu)
142
the ESMA specifying its operational details. The ESMA expressed a similar preference in its
2016 report on SFTs242
.
Taking into account the above elements, option 2 would propose to postpone the introduction
of the minimum haircut floors framework in Union law until EBA and ESMA jointly report
to the Commission by [one year after entry into force of CRRIII] on the appropriateness of
the two implementation approaches recommended by the FSB to implement this framework
(i.e. a market regulation or a more punitive treatment of capital requirement under the Basel
standards) to reduce the potential build-up of leverage outside the banking sector while
avoiding undesirable consequences on the functioning of the EU SFT markets. This report
will exploit as much as possible the data collected by the ESMA via the SFTR reporting
requirements.
Based on the findings of this report, the Commission would propose a new legislative
initiative by [two years after entry into force of CRRIII] to implement the minimum collateral
haircut framework for SFTs in Union law. This proposal would take the form of an
amendment to the prudential framework, in case the Commission would propose to
implement this framework via a punitive treatment of capital requirement. Alternatively, the
Commission would propose the implementation of this framework via an amendment to an
existing market regulation or, if necessary, a new market regulation.
Impacts and comparison across options
The baseline option would have no direct impact on EU banks’ capital requirements since no
change would be made to the prudential framework. However, no prudential measures would
be introduced to reduce the build-up of leverage outside of the banking sector in the EU, as
recommended by the FSB. This option would provide no further indication when the EU
would fulfil the FSB recommendation to address this issue, which may further undermine
market confidence in the EU financial system.
As shown in
242
ESMA: Report on securities financing transactions and leverage in the EU, October 2016.
143
Figure 13 below, the EBA estimated that only a small proportion of all the SFTs (i.e. 7.4% of
total gross amount of outstanding SFTs) currently traded by EU banks would qualify as in-
scope SFTs, i.e. would fall under the minimum haircut floors framework as implemented
under option 1. However, this amount would still be large when measured in terms of risk (as
shown in Figure 14 below, it represents roughly 20% of the total RWAs of outstanding
SFTs).
144
Figure 13: Proportions of in-scope SFTs, by SFT type (% of total gross amount of
outstanding SFTs).
Source: EBA, Basel III Reforms: Impact Study and Key Recommendations, August 2019.
Figure 14: Breakdown of SFTs RWA subject to the minimum haircut floors (expressed as %
of total current SFTs RWAs)
Source: EBA, Basel III Reforms: Impact Study and Key Recommendations, August 2019
Under option 1, EU banks would be subject to new regulatory constraints on their SFT
activities as compared to the baseline option which is likely to be more costly. However, the
impacts between the two possible implementation approaches would differ.
If option 1 would take the form of the implementation of the Basel standard, the EBA
estimated as part of its August 2019 CfA response that this would result in a significant
increase in the capital requirements for those SFTs that would not comply with the minimum
haircut floor framework. Specifically, it would lead to a weighted average increase in RWAs
of for those transactions of approximately 180%, representing a weighted average increase of
more than 35% on the full SFTs portfolio of EU banks in the EBA sample (see “Basel III
central scenario” in ). As estimated by the EBA, this increase would be largely mitigated if all
145
EU banks were to receive all the required additional collateral amount on the in-scope SFTs
that do not currently comply with the minimum haircut floors to be compliant (see
“Alternative scenario” in Figure 15).
If option 1 would take the form of a market regulation, EU banks would be required to
receive more collateral to continue engaging in the SFTs transactions that are currently non-
compliant with the minimum haircut floors (‘first scenario’). Otherwise, those transactions
would no longer be permitted (‘second scenario’). Therefore, the impact of this
implementation approach would fall between the impacts under those two scenarios. In case
of the first scenario, the impact in terms of capital requirements would be similar to the
impact under above-mentioned “Alternative scenario” (see Figure 15). In case of the second
scenario, the volume of SFTs that do not comply with the minimum haircut floor framework
would drop to zero, which would in turn result in a small reduction in the RWAs of the
overall SFTs portfolio (see Figure 14).
A market regulation approach to implement the minimum haircut floor for SFTs may be more
advantageous than the Basel standard approach from a level playing field perspective. In fact,
the FSB also recommended their member jurisdictions to implement the minimum haircut
floor for SFTs between non-banks. This can only be done via a market regulation since non-
banks are usually not subject to the prudential framework applicable to banks (neither in the
EU nor elsewhere). For these reasons, a number of respondents to the public consultation
supported the implementation of the minimum haircut floor for SFTs in the EU via a market
regulation that would apply to both banks and non-banks engaging in SFTs.
Figure 15. Impacts of the minimum haircut floor framework on the capital requirements of
SFTs as implemented in the prudential framework under option 1. Expressed in % change of
RWAs on individual group of SFTs (left-hand side) and on all the SFTs portfolio (right-hand
side)
Source: EBA, Basel III Reforms: Impact Study and Key Recommendations, August 2019.
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It should be noted that the above estimated impacts do not represent a comprehensive picture
of the real impact of the minimum haircut floor framework for SFTs since the sample of EU
banks providing data on the minimum haircut floor framework for SFTs as part of the CfA
QIS was relatively limited (only 39 out of the 189 banks participating to the CfA QIS). In
addition, the impact on non-banks has yet to be estimated. A reliable analysis would require
a broader data collection than the one performed by the EBA.
In addition, some respondents to the Commission’s 2019 public consultation stressed that the
minimum haircut floors framework could render some types of SFTs uneconomical due to
the nature of those transactions. In particular, securities lending transactions, which are not
undertaken to provide financing but rather to source a specific security, may be particularly
affected by this reform (as shown in
147
Figure 11, they represent the second most traded type of SFTs in the EU). Those
respondents’ concern was that a potential lender of a security, which is typically a non-bank,
could refrain from engaging in this type of transactions if its ability to apply an appropriate
haircut on the borrowing counterparty, which is usually a bank, would be restricted due to a
minimum haircut floor applied on the lending side of the transaction.243
Postponing the implementation of the minimum haircut floors framework for SFTs as
proposed under option 2 would preserve the status quo meaning that no capital or market
impact would occur for now. The additional time would allow to carry out a comprehensive
assessment by the EBA and the ESMA of the impact of the implementation of the minimum
haircut floor framework in the EU and of potential issues with the framework, based on
sufficient supporting evidence from both banks and non-banks engaging in the EU SFTs
markets. Option 2 would provide the indication to the FSB and EU banking sector that this
framework would be implemented once the assessment would be performed, so it would not
bring in question our commitment to implement the FSB recommendations.
Table 18: Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 ≈ - + ≈
Option 2 + + + +
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly positive; + positive;
– – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table
18, option 2 is deemed the preferred policy option.
1.7. Standardised approach for counterparty credit risk
Problem definition
In 2014, the BCBS adopted244
a new standardised approach to calculate the capital
requirements for counterparty credit risk of derivative transactions, the so-called standardised
approach for counterparty credit risk (SA-CCR). Under the SA-CCR, the exposure value of a
derivative transaction is given by the sum of two components, the replacement cost (RC) and
the potential future exposure (PFE), multiplied by a supervisory parameter (‘alpha’, equal to
1.4).
243
According to both the FSB recommendation and the Basel standard, the minimum haircut has to be applied
on the non-bank side of the transaction in order to reduce the amount of financing that could be obtained against
a certain amount of collateral. In the example at hand, this would be the lending side of the transaction.
244
BCBS: The standardised approach for measuring counterparty credit risk exposures, April 2014.
148
The SA-CCR addresses deficiencies identified by the BCBS in the former standardised
approaches to calculate the capital requirements for counterparty credit risk, mainly their lack
of risk sensitivity. In addition for the purpose of calculating capital requirements for
counterparty credit risk, the SA-CCR is used in other parts of the Basel framework, namely
the large exposures standard, the leverage ratio standard, the standard on capital requirements
for exposures to central counterparties and, starting from 1 January 2023, the output floor
(since the output floor relies on the capital requirements of a bank calculated using all the
standardised approaches of the Basel framework, as explained in Section 1.8 of this Annex).
In the EU, the SA-CCR was adopted in May 2019 as part of the CRR II, in full compliance
with the Basel standard. Starting from 28 June 2021, EU banks are required to use the SA-
CCR to calculate the exposure values of their derivative transactions, unless they have been
granted the permission to use the internal model approach245
for counterparty credit risk
(generally used by EU banks with the largest derivative portfolios) or are eligible to use one
of the simpler standardised approaches246
available under the CRR (generally used by EU
banks with very small derivative portfolios). In the absence of a comprehensive assessment of
the impact of the SA-CCR across the prudential framework at the time it was adopted, the
CRR2 mandated the EBA to report to the Commission on the appropriate calibration of the
SA-CCR by June 2023247
.
The EU banking sector have expressed concern about the potential impact of the SA-CCR in
their responses to the two consultations organised by the Commission. In particular,
stakeholders have called for a review of the calibration of the SA-CCR in general and of the
alpha parameter in particular. In their view, the difference in calibration between the SA-
CCR and the internal model approach for counterparty credit risk is particularly important
compared to the calibration between the standardised approaches and internal model
approaches for other risks.248
With the forthcoming implementation of the output floor into
the European prudential framework, that difference may become significant, as the
standardised approaches would potentially constrain the outcome of internal models. A
disproportionate increase in capital requirements for derivative transactions due to the
interplay between SA-CCR and the output floor might in turn translate into significant price
increases for end-user and thereby reduce their incentives to use derivative transactions to
hedge their financial risks.
245
The internal model approach for counterparty credit risk, so-called Internal Model Method (IMM) is set out
in Section 6, Chapter 6 of Title II of Part Three of the CRR. It should be noted that banks that have been granted
the use to IMM to calculate the exposure value of their derivative transactions would still be required to use
SACCR in some areas of the prudential framework, e.g. for the calculation of the leverage ratio.
246
The eligibility criteria to use those approaches are set out in Article 273a of CRR
247
See Article 514 of CRR.
248
For other types of risk, the ratio between the capital requirements produced by the standardised approach and
those produced by the corresponding internal model is, on average, around 1.5:1, whereas for counterparty
credit risk it is, on average, around 2:1.
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Against this background, the CMRP adopted by EU co-legislators in February 2021 asked the
Commission to review the calibration of SA-CCR249
before its application in Union law,
taking into account the international level playing field.
Policy options
Baseline option: No changes to the SA-CCR calibration
Under the baseline option, no changes would be made to the calibration of the SA-CCR. The
Commission would review the impact and calibration of the SA-CCR at a later stage, on the
basis of the dedicated EBA report due by June 2023, as mandated in the CRR II.
Option 1 - Revise permanently the calibration of SA-CCR
Option 1 would permanently lower the overall calibration of the SA-CCR for all derivative
transactions across the prudential framework. A simple way to lower the overall calibration
would be to reduce the value of the alpha parameter, as requested by the banking sector.
Option 2 - Adjust temporarily the calibration of the SA-CCR in the context of the output
floor only
Under option 2, the calibration of the SA-CCR would be lowered temporarily for all
derivative transactions. Like in case of option 1, this would be done by lowering the
calibration of the alpha parameter. However, the lower calibration under option 2 would only
be applied when the SA-CCR would be used in the calculation of the output floor; when the
SA-CCR would be used in other parts of the prudential framework, the calibration of the
alpha parameter would stay at 1.4 as adopted under the CRR II. Under this option, the
Commission would take into account the evidence to be collected by the EBA and the
conclusions of the report to be delivered by the EBA by June 2023, to inform its decision on
whether the calibration of SA-CCR should be permanently revised across the prudential
framework.
Impacts and comparison across options
While SA-CCR improves the calculation of the exposure value of derivative transactions
across the prudential framework, the baseline option would likely result in an increase in
capital requirements for banks using the internal model approach for counterparty credit risk
due to the use of the SA-CCR in the context of the OF250
. This could increase the costs of
derivatives transactions for end users, which could force end users to reduce the amount of
hedging they do with derivatives or potentially stop using derivatives for hedging altogether.
Compared with the baseline option, option 1 would lead to a permanent decrease in the
exposure value of derivative calculated using SA-CCR (of up to roughly 30% in case alpha
would be recalibrated to 1) across the prudential framework. As a result, the capital
requirements of derivatives transactions based on the SA-CCR would decrease, while the
249
See EUR-Lex - 32021R0337 - EN - EUR-Lex (europa.eu)
250
Banks that use one of the standardised approaches for calculating exposure values of derivatives transactions
would not be affected under the baseline scenario.
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treatment of derivatives transactions under the large exposure or leverage ratio frameworks
would become less binding. At the same time, the impact of the output floor for banks using
internal models for counterparty credit risk would be lowered. The overall impact for
individual banks would depend on the extent to which they would use the SA-CCR, which
has not been assessed by the EBA as part of the CfA QIS. The revised calibration may, in
turn, lower the trading costs for end-users (provided that banks would pass at least part of the
capital reduction on to their clients). In addition, for banks using the internal model approach
to calculate their capital requirements for counterparty credit risk, the introduction of the
output floor would, overall, be less constraining under this option. While option 1 would
address the concerns raised by the EU banking sector about the SA-CCR calibration and, to
some extent, respond to the request of the EU co-legislators to review the SA-CCR
calibration, this option would provide a blanket approach that would not be supported by
empirical evidence and hence would be difficult to justify. . In particular, the revised
calibration of SA-CCR would however not benefit from the evidence to be established by an
EBA report which is due alongside with potential recommendations, only by June 2023.
In addition, option 1 could lead to a material reduction in capital requirements for
counterparty credit risk of EU banks. The prudential framework already provides exemptions
from the capital requirements for CVA risk for an important number of derivative
transactions (see Section 1.5 of this Annex). Introducing a further deviation on those
transactions with the proposed SA-CCR recalibration under option 1 could lead to a
significant underestimation of risks associated with derivative transactions, notably in the
absence of supporting evidence, and result in unjustifiably low capital requirements for
counterparty credit risk. This could jeopardise the robustness of the capital requirement for
EU banks that are large dealers of derivative transactions. In addition, such a change in the
SA-CCR calibration would substantially deviate from the Basel standards, negatively
impacting the international level playing field.
Compared to option 1, option 2 would also lead to a decrease of the exposure value
calculated using SA-CCR (of up to roughly 30% in case alpha would be recalibrated to 1),
but only temporarily and only in the context of the calculation of the transitional period of the
output floor. Although option 2 would not lower the SA-CCR calibration across the
prudential framework in the short-term, this option would largely respond to the main
concerns raised by EU banks. In the public consultation banks stressed the potential
excessive increase in capital requirements due to the interplay between SA-CCR and the
introduction of the output floor, translating in higher trading costs for their clients. The 5-year
transitional period would offer sufficient time for an in-depth review of the calibration of
SA-CCR based on t the EBA report and to further discuss this issue at international level.
Table 19. Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
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Option 1 + ++ -- ≈
Option 2 + + ++ +
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly
positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table
19, option 2 is deemed the preferred policy option.
1.8. Output Floor
Problem definition
A range of studies251
conducted at both international and EU level found a wide variation in
capital requirements across banks using internal models that cannot be explained solely by
differences in the riskiness of banks’ exposures. This variation makes it difficult to compare
capital ratios across banks, questions their calculation and undermines confidence in capital
ratios. The studies shed a light on large discrepancies in capital requirements for the same
types of risks depending on how internal models were built and on the modelling assumptions
underpinning them. This in turn raised level-playing-field concerns across globally active
banks from different jurisdictions. It also contributed to impairing market confidence in the
capital framework. The credibility of internal models further deteriorated, after they were
identified as sources of endogenous risk and as one of the factors that fuelled the global
financial crisis.252
This was also due to the limited capacity of some supervisors to constrain
modelling, so as to ensure that models accurately reflect the riskiness of individual bank’s
activities.
The variability also highlighted the ineffectiveness of the so-called Basel I floor, a measure
that was introduced as part of the Basel II framework and has been implemented very
heterogeneously across different regions and MS. The Basel I floor was aimed at ensuring
that the capital requirements produced by internal models would not fall below 80% of the
minimum capital requirements calculated under the Basel I standardised approaches. The
Basel I floor was implemented in Union law, but expired253
by the end of 2017. However,,
the Basel I floor did not achieve to reduce the variability in RWAs, mainly because of the
way it was applied in practice.
251
See https://www.bis.org/publ/bcbs256.htm and https://www.bis.org/bcbs/publ/d363.htm for benchmarking
studies, as well as https://eba.europa.eu/regulation-and-policy/supervisory-benchmarking-exercises for EBA
benchmarking exercises.
252
Danielsson, J., Hyun S.-S., and J.-P. Zigrand, “Endogenous and systemic risk”, Quantifying systemic risk,
University of Chicago Press, Chiacgo, 2012, pp. 73-94; Eichengreen, B., “Origins and responses to the current
crisis”, CESifo Forum, Vol. 9, No 4, ifo Institut für Wirtschaftsforschung an der Universität München, Munich,
2008, pp. 6-11.
253
Article 500(1) of the CRR contained a provisional measure for a floor that prevented the capital requirements
calculated by using internally modelled approaches from falling below 80% of the minimum capital
requirements as calculated under the Consolidated Banking Directive (which transposed the capital
requirements under Basel I). The so-called “Basel I floor” which has been implemented very heterogeneously
across different regions and MS, often in ways considered ineffective, expired at the end of 2017.
152
Under the current rules, supervisors have to approve the use of internal models and assess
whether they comply with the applicable requirements. Supervisors have to assess whether
banks measure risks correctly and consistently. Where deficiencies of a model are identified,
they may require additional capital or apply other measures to address the situation case-by-
case. Significant efforts are being undertaken by the EBA254
and competent authorities
including the ECB255
to ensure a harmonised application of the rules on internal models and
to mitigate the concerns about variability in RWAs. While those efforts are improving the
situation, variability among internal model outputs (across asset classes and risk-categories)
remains thereby undermining confidence in internal models used by banks in the EU.
Policy options
Baseline option: No risk-based backstop to internal models
The baseline is the current prudential framework, which – since the expiry of the transitional
provision on the Basel I floor – does not entail a risk-based backstop that would limit the
capital benefit an institution may obtain by using internal models, compared to using the
standardised approaches.
Option 1 - Implement the OF over the 5-years phase-in at the highest level of consolidation
taking into account all the risk-based capital requirements contained in EU law
Under this option, the OF would apply to total RWAs, limiting the variations – be they
justified or not – between banks for the same underlying risks. This would produce floored
RWAs to be used for the calculation of the stack of all the risk-based capital requirements
contained in the EU prudential framework, including those that are not or not explicitly set
out in the Basel framework: the minimum capital requirement (the so-called ‘Pillar 1
requirement’), the capital conservation buffer (CCB) requirement, the countercyclical capital
buffer (CCyB) requirement, the buffer requirements for global systemically-important and
other systemically-important institutions (G-/O-SIIs), as well as bank-specific capital
requirements imposed by supervisors (‘Pillar 2 requirement’ or P2R) and the systemic risk
buffer (SyRB) requirement256
.
As the P2R and they SyRB requirement can be used to address risks that are similar in nature
to those addressed by the OF, there is a possibility that certain risks (e.g. model risk) could be
254
EBA, Progress report on IRB roadmap – Monitoring Implementation, Reporting, and Transparency, July
2019, https://eba.europa.eu/eba-publishes-report-on-progress-made-on-its-roadmap-to-repair-irb-models.
255
The ECB’s targeted review of internal models (TRIM) is a multi-year project to ensure that capital
requirements for banks using internal models are calculated correctly, consistently and in a comparable manner,
for more details see e.g.
https://www.bankingsupervision.europa.eu/press/publications/newsletter/2019/html/ssm.nl190515_6.en.html.
256
Separately, the same RWAs would also be used for the calculation of the risk-based total loss-absorbing
capacity (TLAC) requirement. In the EU, the TLAC standard adopted by the FSB has been implemented
through a minimum requirement for own funds and eligible liabilities (MREL). The MREL consists of own
funds and part of a bank's liabilities. If a bank fails and goes into resolution, the MREL acts as a buffer to absorb
losses and to provide new capital to the bank. This ensures that the costs of failure of a bank will as much as
possible be borne by the bank's investors, i.e. its shareholders and creditors. While a harmonised minimum level
of MREL for G-SIIs is introduced into CRR, the MREL for other institutions is regulated in BRRD and SRMR.
153
double-counted once the OF starts to apply. The CRR/D would therefore prescribe that any
double counting of the risks captured by the OF and the risks captured by any of the other
requirements – notably those imposed by supervisors under Pillar 2 and the macro-prudential
framework257
– must be avoided (see example in Error! Not a valid bookmark self-
reference., P2R currently addressing model risk would be consumed by the OF). In case
double-counting would be present, supervisors would need to reduce the requirements that
double-count the risks that would be already captured by the OF. The EBA's advice258
includes a specific recommendation to supervisors to this effect and calls on them, more
generally, to reconsider the appropriate level of P2R and the SyRB requirement in light of the
OF, once it would apply.259
Furthermore, any increase of the P2R and/or SyRB requirement
that do not stem from the increase in risks but from the increase in RWAs following the
introduction of the OF would need to be neutralised.
In concrete terms, the following actions would take place once an institution would become
bound by the OF:
 the P2R and the SyRB requirement would be “frozen” to avoid automatic (also referred to
as “arithmetic”) increases in the nominal amount of regulatory capital required under
those two requirements. Without this freezing, the increase in RWAs due to the OF would
also push up the EUR amount required under the SyRB and the P2R (in the latter case
only if the requirement is calculated as a percentage of RWAs; see “Basel III without
adjustments” in Error! Not a valid bookmark self-reference.).This safeguard is
justified by the fact that the increase in RWAs due to the institution becoming bound by
the OF is, all else being equal, purely arithmetic and is not reflective of an actual increase
in risks that would justify requiring additional capital from the institution260
;
 the institution’s competent authority would be required to review the calibration of the
P2R and the competent or designated authority, as applicable, will be required to review
the calibration of the SyRB requirement, respectively, to establish whether double-
counting of risk is present, and if so, to re-calibrate those requirements to avoid such
double-counting (see option 1 in Error! Not a valid bookmark self-reference.);
257
Besides the SyRB, authorities can revert to so-called “national flexibility measures” to address systemic risks
stemming from the use of internal models. Specifically, a number authorities have introduced “floors” requiring
banks that use internal models to apply minimum risk-weights to certain exposures (e.g. mortgages and/or
corporates). Those measures increase the Pillar 1 capital requirements.
258
EBA, Policy Advice on the Basel III reforms: Output Floor, August 2019.
259
In cases where the OF will increase total RWAs supervisors would need to consider the effect on the absolute
level of capital requirements.
260
Assume that today a bank needs to hold 2% of RWAs as additional capital, which amounts to EUR 1 billion
of actual capital. Now, if RWAs for that bank increase by 20% due to the new OF, the 2% might suddenly go
from EUR 1 billion to EUR 1.2 billion of actual capital. This increase would not reflect additional but represent
a purely arithmetic effect that should be neutralised in the P2R calculations, cf. "Basel III – journey or
destination?", Keynote speech by Andrea Enria, Chair of the Supervisory Board of the ECB, at the European
Commission's DG Financial Stability, Financial Services and Capital Markets Union conference on the
implementation of Basel III, November 2019,
https://www.bankingsupervision.europa.eu/press/speeches/date/2019/html/ssm.sp191112_1~01be3b89b0.en.ht
ml.
154
 the two requirements would remain frozen until the respective reviews would be
concluded and the relevant decisions on the appropriate calibration of the requirements
are announced.
Figure 16: Stylised example – functioning of the OF (option 1)
Notes: Dotted areas of the stack indicate the increase in capital demand driven by the increase in RWA due to the OF. This
increase is expected to be neutralised for P2R/SyRB requirements. “P2R – Model risk” refers to the part of current P2R that
would be removed due to an overlap with the OF.
Option 1 would also make use of the transitional arrangements for the OF provided by the
Basel III standards on an optional basis, i.e. a 5-year transitional path until 2030 (see Table
20) for institutions to grow into and adjust to the OF requirement as well as a “transitory
cap”261
that temporarily prevents RWAs from increasing by more than 25% because of the
OF.
Table 20: Phased-in implementation of the OF
1st
Jan 2025 1st
Jan 2026 1st
Jan 2027 1st
Jan 2028 1st
Jan 2029 1st
Jan 2030
calibration 50% 55% 60% 65% 70% 72.5%
261
During the phase-in period the incremental increase in a bank’s total RWAs that results from the application
of the OF would be capped. This transitional cap would be set at 25% of a bank’s RWAs before the application
of the floor.
Aritmethical increase
Double counting
155
As regards the level at which the OF would apply, option 1 would entail its application only
at the highest level of consolidation in the EU, recognising the benefits of risk diversification
across different entities and business models of entities within the same banking group. While
the potential increase in capital, required due to the application of the OF at consolidated
level, would have to be distributed fairly across the entities of the banking group taking into
account their risk profile, capital requirements at sub-consolidated and individual levels
would continue to be calculated based on RWAs that are not subject to the OF.
Option 2 - Implement the OF over the 5-years phase-in at all levels of application taking
into account all risk-based capital requirements contained in EU law
Under this option, the OF would apply to all the risk-based capital requirements contained in
EU law, including those that are not or not explicitly set out in the Basel framework.
However, it would apply at all levels of application, i.e. at the consolidated, sub-consolidated
and individual level, as it is the case for many other prudential requirements such as the
leverage ratio.
Option 3 - Implement the OF as a parallel requirement applicable at the highest level of
consolidation that takes into account only the risk-based capital requirements
provided by the Basel framework (“parallel stack approach”)
Under this option, two different overall capital requirements based on different stacks of
capital requirements would be calculated, compared, and the higher of these two amounts
would be the binding capital requirement.
- The first stack would reflect the sum of the risk-based capital requirements listed in
the Basel standards as well as some elements of the P2R (e.g. risks which are
exclusively covered under the risk-based Pillar 2 and excluded from Pillar 1 such as
interest risk in the banking book, etc., or excessive model risk that are not fully
addressed by the OF) calculated on the basis of floored RWAs;
- The second stack would represent the sum of all risk-based capital requirements
applicable in the EU calculated in accordance with internally modelled approaches on
the basis of non-floored RWAs.
The floor applies if the first stack results in a higher overall requirement (see Figure 17).
Precondition for implementing this approach would be a clear decomposition of risks to be
captured under the floored stack vs. the risks to be captured under the non-floored stack.
Figure 17: Stylised example – comparison of option 1 vs option 2
156
Notes: Dotted areas of the stack indicate the increase in capital demand driven by the increase in RWA due to
the OF. This increase is expected to be neutralised for P2R/SyRB requirements. “P2R – Model risk” refers to
the part of current P2R that would be removed due to an overlap with the OF.
Under option 3 the OF applied to the floored stack would be subject to the transitional
arrangements for the OF provided by the Basel III standards.
Option 4 - Implement the OF as a parallel requirement that takes into account only the risk-
based capital requirements provided by the Basel framework (“parallel stack
approach”) and apply at all levels
Under this option, the OF would be a parallel requirement applied only to the risk-based
capital requirements that are explicitly listed in the Basel framework, like under option 3.
However, it would apply at all levels of application, i.e. at the consolidated, sub-consolidated
and individual level, as it is the case for many other prudential requirements such as the
leverage ratio.
Impacts and comparison across options
The impact of either option ultimately depends on the extent to which supervisors actually
adjust the requirements in their remit, in particular P2R, in view of the OF, which in itself
depends on the specific risk-profile of each individual bank: Under Option 1, supervisors
would adjust P2R and SyRB / other related macro-prudential capital requirements to avoid
157
double counting of risks. Under Option 2 supervisors would address some institutions-
specific risks by imposing P2R also for the calculation of the floored stack.
If the OF were implemented without any adjustments to the current percentage levels of P2R
and/or SyRB and other related macro-prudential capital requirements, where applicable, EBA
estimates marginal increase in capital requirements in the short term (i.e. at the beginning of
the phase-in period in 2025 when the OF would be 50%) and of +6.7% in the long term at its
steady-state implementation (see Error! Reference source not found. in section 6.1.).
However, with the two-step approach (1. no-double, 2. no-arithmetical increase) proposed
under Option 1, the estimated increase would be lower, provided that supervisors make the
adjustments described above. Option 1 would have a relatively low impact in the short-term,
as the OF will be phased-in over a 5-year period. Option 1 would also limit the impact of the
OF in the long-term: less than +5.7% average increase in capital requirements (as compared
to +6.7% without the adjustments to P2R and buffer requirements). As Option 1 would
implement the OF in the existing stack of capital requirements in the EU, the framework
would be simple, transparent, and consistent with the Basel standards. The application of the
floor at the highest level of consolidation in the EU would help limiting its impact and ensure
coherence with the logic of the Banking Union where the redistribution mechanism would
provide for a fair distribution of the additional capital across the various subsidiaries of the
group according to their risk profile as if the floor would be applied at individual level262
.
Option 3 would give relatively more weight to modelling outcomes. This option would hence
be less effective in addressing the identified problems with certain internal models. It would
not fully capture banks that use more aggressive internal models, unless a specific Pillar 2
requirements would be added in the floored stack to this end, or banks with high P2R and
SyRB requirements addressing other risks (than those associated with internal models):
 if the first (floored) stack based on floored RWAs leads to higher overall requirements,
the risks supervisors have addressed through P2R or the SyRB could be effectively
ignored in the binding capital requirement, depending on the requirements of the floored
stack;
 if the second (non-floored) stack calculated on the basis of non-floored RWAs leads to
higher overall requirements, it could be argued that the OF would be ignored (even
though the OF would still be applied to the requirements set out in the Basel standards),
even where the institution’s internal model is particularly aggressive.
Furthermore, as the EBA highlighted Option 3 would increase the level of complexity as the
bank would have to calculate and disclose two risk -based capital ratios, one for each stack.
This could create confusion, in particular among investors and clients, in terms of trigger
levels, such as for the conversion/write-down of Additional Tier 1 instruments or for
calculating the minimum distributable amount (MDA). While Option 3 would allow investors
262
This means that the distribution key for any additional capital required by the OF would depend on the
contribution of each entity to the consolidated floor requirement.
158
to compare the RWAs of banks using internal models (as it is already the case for the
baseline), the comparability of their risk-based capital ratios would actually be reduced as the
binding requirement would be calculated for different capital stacks across institutions.
Options 1 and 3 would have both have a negligible impact in the short-term. Over the long-
term, the impact of option 2 is likely to be lower than option 1, leading to an average increase
in capital requirements of more than +1.5% but no more than +5.4%. Option 1 may therefore
reduce banks’ capital ratio in the steady state to a greater extent than Option 3, which might
in turn lead to more scrutiny by markets when analysing the risk profile of the bank.
In its analysis in response to the Call for Advice, the EBA has only quantified
comprehensively the impact of the implementing the OF at the highest level of consolidation
due to difficulties to perform the quantitative analysis at all levels of application.
For banking groups with several levels of application (e.g. at EU-consolidated, MS-sub-
consolidated, and individual level) the total capital impact of applying the OF at all levels as
implied by Options 2 and 4 will be higher than applying the respective approach only at the
highest level of consolidation263
. Applying the OF at all levels would likely lead to a higher
increase in capital requirements compared to its application only at consolidated level, as it
would also act on intra-group exposures and limit the possibility to consolidate risks across
different parts of the banking group. This could have a disproportionate impact on certain
group structures (e.g. regional banks in cooperative groups which use internal approaches)
and subsidiaries with specific business models (e.g. real estate lending or leasing) and cause
additional compliance burden (due to multiple calculations at parent and subsidiary level), as
highlighted by the EBA in its advice. Applying the OF at all levels could furthermore distort
the internal risk allocation of cross-border banking groups, in particular in case of large
intragroup exposures, and contribute to a fragmentation of the single market.
Overall, the EBA’s QIS results indicate that the OF complements other requirements,
resulting in a broadly comparable impact of the revised Basel III framework for most
business models. In terms of the objectives of reducing excessive RWA variability and
promoting comparability of risk-weighted capital ratios, the QIS demonstrates that the OF
under options 1 and 2 would raise the average RWs of institutions that are constrained by the
floor. As a result, the RWs become more comparable across institutions using internal
models. The QIS also show that the OF mitigates variability in internal modelling output for
various portfolio types. The floor particularly constrains those institutions that tend to have
lower RW densities264
than most of the other institutions using internal models.265
263
A simple explanation comes from a mathematical property of the maximum operator (used under the under
which the maximum of two sums of values is lower than the sum of the maximum of the values composing
264
The RWA density is computed as the ratio of the total RWA over the current total asset of each bank. As the
RWA changes under the different frameworks, the denominator is kept constant.
265
In particular, institutions that are constrained by the OF have, on average, a larger divergence between
internally modelled RWs and standardised RWs on various portfolios (e.g. residential counterparties and
specialised lending) than institutions that are not constrained by the OF.
159
Table 21: Comparison of policy options against effectiveness, efficiency and coherence
criteria
EFFECTIVENESS
EFFICIENCY
(cost-effectiveness)
COHERENCE OVERALL SCORE
Baseline option 0 0 0 0
Option 1 ++ - ++ +
Option 2 ++ -- + ≈
Option 3 + ≈ - ≈
Option 4 + ≈ - ≈
Magnitude of impact as compared with the Baseline option (the baseline is indicated as 0): ++ strongly
positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable
Preferred option
In light of the above analysis, which led to the overall score of each policy option in Table
21, option 1 is deemed the preferred policy option.


EN EN
EUROPEAN
COMMISSION
Brussels, 27.10.2021
SWD(2021) 320 final
PART 4/4
COMMISSION STAFF WORKING DOCUMENT
IMPACT ASSESSMENT REPORT
Accompanying the documents
Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE
COUNCIL amending Regulation (EU) No 575/2013 on prudential requirements for
credit institutions as regards requirements for credit risk, credit valuation adjustment
risk, operational risk, market risk and the output floor
Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE
COUNCIL amending Directive 2013/36/EU as regards supervisory powers, sanctions,
third-country branches, and environmental, social and governance risks, and amending
Directive 2014/59/EU
{COM(2021) 663 final} - {SEC(2021) 380 final} - {SWD(2021) 321 final}
Offentligt
KOM (2021) 0663 - SWD-dokument
Europaudvalget 2021
153
ANNEX 6: SPECIFIC IMPACTS OF PREFERRED POLICY OPTIONS
1. Impact on administrative and operational costs
The different policy proposals included in this legislative initiative would impact
administrative and operational costs in different ways.
Improving the current framework for calculating risk-based capital requirements would
mainly lead to one-off operational cost to develop the new systems required to calculate
the revised capital requirements introduced by the final elements of the Basel III reform.
Furthermore, it would lead to moderate variations in running operational and
administrative costs related to the prudential framework, as explained in this section.
Quantitative estimates to appropriately assess operational and administrative costs of
those processes is not available266
.The qualitative survey conducted by the EBA as part
of their first response to the Commission Call for Advice267
(CfA) highlights that the EU
banks’ estimates of their operational costs of implementing the Basel III reforms are
rather heterogeneous across the different elements of these reforms.
As shown in Figure 1 below, banks participating in the survey consider that the
implementation of reforms related to the credit risk framework (both the standardised and
the internal model approaches) and the introduction of the output floor would lead to
higher one-off operational cost than the implementation of reforms related to CVA risk,
operational risk and the minimum haircut floor framework for SFTs. According to the
survey, the estimated one-off operational costs would mainly be caused by adaptations to
IT systems and by staff costs.
Figure 1 shows that the impact of the implementation of the final elements of the Basel
III reform on recurring operational and administrative costs is considered to be low,
negligible or even negative (i.e. a decrease in costs) for the vast majority of EU banks
participating in the survey. In fact, the recurring operational and administrative costs of
those reforms should even be lower than indicated in the survey since the survey did not
take into account the EU specific adjustments268
proposed under the preferred option.
266
No comprehensive estimates of those costs have been provided by EU banks via the public
consultations launched by the Commission on the final elements of the Basel III reform.
267
Basel III reforms: impact study and key recommendations, EBA, August 2019.
268
Some of those adjustments would further reduce the recurring operational and administrative costs by
reducing the operational burden to calculate capital requirements, for instance in the area of operational
risk with the historical loss component set to 1 or in the area of the CVA risk by maintaining the
exemptions introduced in CRR.
154
Figure 1: One-off and recurring operational costs of the implementation of the final
Basel III framework (% of total responses), by risk category
Source: Basel III reforms: impact study and key recommendations, EBA, August 2019
The actual impact on recurring operational and administrative costs would largely depend
on whether EU banks would (be able to) continue to use the internal models to calculate
their capital requirements under the revised prudential framework (those will be mainly
the largest EU banks that already use internal models under the current prudential
framework). Internal models are usually more costly to maintain than standardised
approaches since they require more complex IT systems, more data processing from both
internal sources and third-party service providers and more qualified staff to analyse the
results of the models. Banks using internal models would likely see an increase in their
recurring operational and administrative costs due to the introduction of the OF because
the reform would require them to carry out additional calculations, namely of the risk-
based capital requirements using the standardised approaches.
Banks that are currently using the internal models that would no longer be available
under the new framework269
would see a reduction of their recurring costs. There would
also be a corresponding reduction in costs of supervisors for approving and controlling
those models. To the extent that banks would choose to abandon some of the models that
would still be allowed under the new framework, those costs would be reduced even
further. By contrast, banks that currently do not use internal models (the vast majority of
small and medium-sized EU banks) would likely see no material change in recurring
operational costs.270
269
The reform would limit the use of internal models for credit risk, and would no longer allow the use of
internal models for operational risk and CVA risk.
270
To the extent that a bank that currently does not use internal models would choose to do so under the
new framework (this may happen because the new rules would make it possible to introduce credit risk
internal models for just certain types of asset classes), this would of course create one off and recurring
costs for the bank. However, that would be the result of a conscious decision of the bank.
155
Incorporating ESG risks in the prudential framework would result in one-off
administrative and operational costs for EU banks in order to set up the new processes
associated with the monitoring and management of those risks. The increase in recurring
costs, by contrast, would largely depend on the availability and format of the necessary
information that banks would need to collect: the more easily available the information
would be and the more friendly its format from a point of view of allowing automated
collection and processing of that information, the lower the recurring costs for banks
would be (and vice versa). By the time the revised framework would be in place and
applicable, it is likely that the effects of some of the ongoing reforms in the ESG area
(e.g. the revision of the Non-Financial Reporting Directive, the Taxonomy Regulation)
would have put in place the necessary conditions to keep the costs of information
collection contained.
Improving the consistency in the application of supervisory and sanctioning powers
would increase to some extent the administrative and operational costs of EU banks since
they would need to develop new procedures to comply with the requests of their
supervisors that would be granted with new powers. However, a number of EU banks
would already have developed such procedures since they operate in Member States that
have already introduced similar powers in their national laws. The costs of cross-border
banking groups would likely decrease as a result of the initiative as they would be subject
to the same rules and procedures across Member States. Similarly, the initiative would
also decrease the administrative and operational costs of supervisors in the SSM, since
they would no longer have to apply 19 different national laws when exercising those
powers. On sanctioning powers, no material new costs would be involved.
Centralising banks’ disclosures at the level of the EBA based on the supervisory data
collected in the context of the EUCLID would relieve small and non-complex banks from
the administrative burden associated with mandatory disclosures, while having no cost
impact for other banks. At the same time, it would reduce search costs for market
participants.
In light of the above considerations, this legislative initiative would mainly entail one-off
operational costs, due to the implementation of the new requirements, but would overall
reduce the recurring administrative costs.
2. Impact on competitiveness
This section presents the impacts of the implementation of the final elements of the Basel
III reform in Union law on the competitiveness of EU banks within the EU banking
sector as well as between EU banks and their international peers. The other measures
proposed in this legislative initiative have a smaller impact271
on competitiveness of EU
banks since they mainly affect certain banks’ compliance costs, which remain overall
271
The measures related to supervisory and sanctioning powers would level the playing field for banks
located in Member States that have given their competent authorities powers beyond those in the list
contained in the CRD and banks in those Member States that have not done it.
156
contained, and they do not directly affect their ability to provide financial services to the
real economy.
Impacts of the final Basel III reforms on competitiveness across EU banks
To understand better the profile of EU banks that would be impacted by the final
elements of the Basel III reform, the updated EBA analysis provided a number of more
granular impacts of the reform in addition to the overall impacts shown in Section 6.1.
Three criteria272
have been used by the EBA to differentiate the impacts across EU
banks: size, business model and geographical location (i.e. the Member States in which
the bank is established). In order to identify the drivers of the impacts across the different
criteria, a breakdown of the impacts of the reforms per risk category273
is also included
(the impact of each risk category is expressed as the percentage change in the total capital
requirement (MRC) resulting from the implementation of the final elements of the Basel
III reform related to this risk category).
This section compares the impacts of two implementation options across the above three
criteria: the full alignment with the final Basel III reform option (option 1 in Section
5.2.1) and the preferred policy option (option 3274
in Section 5.2.1). The results of this
analysis need to be interpreted taking into account a number of caveats:
 limited sample of EU banks in the updated impact analysis: the sample of banks
included in the updated EBA impact analysis based on Q4 2019 data has been
significantly reduced as compared to the original EBA impact analysis based on
Q2 2018 data. As shown in Annex 7, certain categories across the three criteria
did not include a sufficient number of EU banks to lead to representative results
for these categories and are therefore not presented in the analysis of this section.
The corresponding banks are nevertheless included in the overall impacts
presented in Section 6.1. In addition, the impacts based on geographical location
should be interpreted in light of the representativeness of the EU banks included
in the EBA sample in terms of the total banking assets of its Member States,
provided in Annex 7;
 limited recognition of the EU specific adjustments: while the Commission has
broadly estimated the overall impact of the EU specific adjustments proposed
under the preferred policy options on all EU banks that have not been quantified
by the EBA (see Error! Reference source not found. in section 6.1), it was not
272
More details about the definition of those criteria, and the breakdown of banks for each related category,
are provided in Annex 7.
273
This breakdown include the following risk categories: credit risk under the standardised approach (SA),
credit risk under the internal model approach (IRB), market risk (MKT), operational risk (OP), CVA risk
(CVA), other risks including banks’ exposure to central counterparties, securitisation risk and the effect on
the leverage ratio (Other), and the introduction of the output floor (OF)
274
As explained in Section 6.1, the impact of option 3 is the same as option 2 also presented in Section
5.2.1, the only difference being the implementation period, which is 2 years longer for option 3 as
compared to option 2.
157
possible to reflect those impacts at more granular level due to the lack of the
necessary information. The more granular impacts contained in this section under
the preferred policy option therefore only include those EU specific adjustments
that have been quantified by the EBA. As a consequence, the mitigating effects of
the preferred policy option on the increase in capital requirements are
underestimated;
 limited analysis provided by the EBA in its report: the EBA provided limited
qualitative analysis on the drivers of the impacts depending on the different
characteristics of EU banks. Therefore, the EBA qualitative analysis was
complemented with the Commission service’s own qualitative analysis, which
could not benefit from access to individual banks’ data.
As illustrated in Figure 2 and Figure 3 below, the main observations of the estimated
impacts of the final Basel III reform across EU banks’ size include:
 the impact of the reform would be materially higher for large banks, with the
highest overall impact on G-SIIs, than for medium-sized and small banks under
the full alignment option. This is mainly explained by a higher reliance of large
banks on internal models to calculate capital requirements. The higher impact
would be due to changes to internal models (e.g. the introduction of input floors
or more conservative calibrations of those floors), the removal of the possibility
to use internal models for certain types of risk (e.g. operational risk) or for certain
types of exposures under the credit risk framework (e.g. equity), and the
introduction of the OF;
 Medium-sized banks would, on average, incur a small increase in capital
requirements, mostly due to the revised standardised approach for credit risk
under the full alignment option, while small banks would, on average, an overall
decrease of capital requirements, mostly due to the changes to the operational risk
rules. These findings corroborate the low impact of the final Basel III reforms
observed in the previous EBA impact analysis, based on a wider sample of small
and medium-sized banks;
 the introduction of EU specific adjustments under the preferred policy option
would mitigate the overall impact of the reform on capital requirements to a
greater extent for large banks than for small and medium-sized banks275
, which
are less impacted by the reform to begin with.
275
This observation should also be true for all the EU specific adjustments under the preferred policy
option for which impacts have not been quantified by the EBA (see the list in Error! Reference source not
found.) and hence not reflected in Figure 3 (since large banks, especially G-SIIs, tend to be more active in
specialised lending, CIU, derivative and SFT markets which are all targeted by those adjustments). The
preferred policy option would therefore have lower impacts for large banks, especially G-SIIs, than shown
in Figure 3.
158
The advantage in terms of capital requirements that banks using internal models currently
enjoy (because the use of internal models results, on average, in lower capital
requirements than the use of standardised approaches), would be partly eroded under the
preferred option. This would increase the relative competitiveness of banks not using
internal models (mostly small and medium-sized banks) when compared to banks using
those models (mostly large banks).
Figure 2: Breakdown of the impacts under the full alignment option in 2028 per risk
category and per bank size.
Sources: Basel III reforms impact study, EBA, December 2020; Commission, DG FISMA.
Figure 3: Breakdown of the impacts under the preferred policy option in 2030 per risk
category and per bank size.
Sources: Basel III reforms impact study, EBA, December 2020; Commission, DG FISMA.
As illustrated in Figure 4 and
159
Figure 5, the impact of the reforms would affect various EU banks’ business models,
with some noticeable differences:
 for mortgage banks, cross-border universal banks and local universal banks the
full alignment option would result in high increases in overall capital
requirements, mostly driven by the output floor, the modifications to the rules on
the internal model approaches for credit risk and for operational risk. It is likely
that most of the large banks have this business model, so the above explanations
of the reasons behind the impact would also apply here;
 public development banks would also incur a high impact from the full alignment
option, mostly due to the changes related to the internal model approach for credit
risk. As the result, those banks would be less bound by the leverage ratio than
currently, as demonstrated by the large decrease in the risk category “other”;
 the other business models considered would incur a lower impact under the full
alignment option (e.g. custodian banks would see a decrease in capital
requirements);
 the preferred policy option would mitigate the impact across all business models,
with the exception of public development banks, where the impact would remain
unchanged. Importantly, under this option the impact would be better aligned
across those business models which provide similar financial services (for
instance on cross border universal banks, local universal banks and mortgage
banks which all provide mortgages to their clients), maintaining a level playing
field across those business models.
Figure 4: Breakdown of the impacts under the full alignment option in 2028 per risk
category and per business model.
Sources: Basel III reforms impact study, EBA, December 2020; Commission, DG FISMA.
160
161
Figure 5: Breakdown of the impacts under the preferred policy option in 2030 per risk
category and per business model.
Sources: Basel III reforms impact study, EBA, December 2020; Commission, DG FISMA.
Finally, as illustrated in
162
Figure 6 and Figure 7, the full alignment option would have a high impact on banks in a
number of Member States (BE, DE, DK276
, ES, FR, IT, NL, SE) and relatively low
impact in others (IE, PL, PT). The preferred policy option would mitigate the impact of
the reforms across all Member States, particularly those most affected under the full
alignment option.
276
On 19 February, the Danish FSA published a press release indicating that one of the DK banks that are
included in the EBA updated impact study published in December 2020 realised that a significant error has
been included in its data submission to the EBA (see https://www.dfsa.dk/News/Press-
releases/2021/Revised_Basel_standards). Based on corrected data, the impact for DK banks would increase
from 19.7% to 36.4% under the full alignment scenario, shown in
Figure 6 and from 13.9% to 29.3% in the EU-specific scenario shown in the EBA impact study. However,
the corrected data would only slightly increase the overall impacts presented in Section 6.1 which would
not change the magnitude of those impacts nor the overall conclusions that can be drawn from their
observations.
163
Figure 6: Breakdown of the impacts under the full alignment option in 2028 per risk
category and per Member State.
Sources: Basel III reforms impact study, EBA, December 2020; Commission, DG FISMA.
Figure 7: Breakdown of the impacts under the preferred policy option in 2030 per risk
category and per Member State.
Sources: Basel III reforms impact study, EBA, December 2020; Commission, DG FISMA.
164
Impacts of the final elements of the Basel III reform on competitiveness between EU
banks and their international peers
According to the ECB Financial Stability Review277
published in November 2020,
despite the increased resilience of EU-area banks since the GFC (as shown in Section 1),
weak profitability prospects continue to weigh on bank valuations. The first half of 2020
saw a marked decline in euro area banks’ return on equity (ROE), from over 5% in the
Q4 2019 to just above 2% in the Q2 2020 (see Figure 8 belowError! Reference source not
found.) mainly because of the low interest rate environment and the relatively high costs.
Looking ahead, the ECB expects that EU banks’ profitability to remain weak and to
recover only very gradually to levels seen before the outbreak of the COVID-19
pandemic.
Figure 8: Evolution of the distribution of EU-area significant institutions’ (SI) ROE and
comparison with ROEs of listed banks in other regions of the world (left-hand side) and
drivers of change in EU-area SI ROE between Q4 2019 and Q2 2020 (right-hand side).
Source: European Central Bank (ECB) Financial stability review, November 2020.
The EU-area banks’ profitability now ranks below that of most of their international
peers (see Figure 8). However, while this decrease in EU-area banks’ profitability as
compared to international peers accelerated over the last two years, EU banks’ remained
relatively attractive to investors maintained higher dividend pay-out ratios across most of
the last decade compared to international peers, as shown in
277
See https://www.ecb.europa.eu/pub/financial-stability/fsr/html/index.en.html.
165
Figure 9.
166
Figure 9 : Evolution between 2011 and 2019 of the profits of the largest banks, and their
distributions, by region
Source: Basel III Monitoring Report as of Q4 2019, December 2020, BCBS. Note: For each region, the profit and
profit’s distribution indicators gather data from the Group 1 banks of the region participating to the regular Basel III
monitoring exercise performed by the BCBS. The dividend payout ratio is calculated as common share dividends
divided by profits after tax by using a rolling 12 months window.
In light of this context, Figure 10 shows that EU banks have built up their capital ratios
faster than their international peers over the decade following the GFC and have “closed”
the decade with, on average, higher capital ratios than their international peers.
Furthermore, Figure 10 shows that EU banks achieved this by both reducing their risk
weighted assets and by increasing their capital stock through retained earnings and new
capital issuance.
Figure 10 : Evolution between 2011 and 2019 of the Tier 1 capital ratios of the largest
banks, and drivers of that evolution, by region
Source: Basel III Monitoring Report as of Q4 2019, December 2020, BCBS. Note: For each region, the Tier 1 capital
ratios gather data from the Group 1 banks of the region participating to the regular Basel III monitoring exercise
performed by the BCBS. The figure shows the fully phased-in initial Basel III reforms for the data points up to and
including the end of 2018 and the actual prudential framework (i.e. initial Basel III reforms with regional adjustments,
if any) applicable for all the data points afterwards.
167
Despite their improved capital position, EU banks would still see a much higher average
increase in capital requirements compared to their international peers when implementing
the final Basel III reforms assuming full alignment (the average increase for US banks
would be below 2%, whereas for bank from other regions of the world there would
actually be a decrease in capital requirements, by more than 5% on average). This is
clearly shown in the latest Basel III monitoring report278
also based on Q4 2019 data (see
278
See https://www.bis.org/bcbs/publ/d512.htm.
168
Figure 11). These differences in the impacts across regions could be explained by the
following reasons:
 compared to US banks, the difference likely arise due to a combination of a different
financing model for US banks and the application, at least at this point in time, of
stricter prudential requirements in the US compared to those contained in the final
Basel III reform (and compared to those currently applied by EU banks). As shown in
169
 Figure 11, US banks would be much less impacted by the introduction of the output
floor since US rules already contain a similar mechanism, introduced by US
authorities after the GFC. In addition, US banks would be less impacted by the
changes related to credit risk due to the wider recourse to securitisation, which allows
them to remove a high portion of loans from their balance sheets. However, US banks
would be more impacted by the revised market rules on trading activities than EU
banks reflecting the high market share of those types of activities for US banks;
 compared to banks in other regions of the world279
, the differences likely arise due to
a combination of simpler business models, dominated by credit risk exposures, an
overall lower reliance on internal models to calculate capital requirements and stricter
prudential requirements compared to those contained in the final Basel III reform. As
shown in
279
This conclusion is based on the overall impacts observed in
Figure 11 for the banks in other regions of the world and does necessary apply to all the jurisdictions
included in this category, for which no conclusion could be drawn in the absence of more granular data.
170
 Figure 11, those banks would see an overall decrease of capital requirements when
implementing the final elements of the Basel III reform, mainly driven by the
changes to the credit risk capital requirements. This observation, combined with the
fact the output floor would have almost no impact on those banks, leads us to believe
that those banks use the standardised approach for credit risk for the vast majority of
their exposures. The impact of the reforms affecting the capital requirements for
trading activities (i.e. market and CVA risks) would also be very limited, which
would indicate that those types of activities account for a small portion of the overall
activities of those banks.
171
Figure 11: Breakdown of impacts of implementing the final elements of the Basel III
reform on banks’ Tier 1 MRC by region.
Source: Basel Committee on Banking Supervision, Basel III monitoring exercise, October 2019. Note:
These impacts show, for each region, the changes in the overall Tier 1 MRC of all Group 1 banks of the
region participating to the regular Basel III monitoring exercise performed by the BCBS.
The significantly higher increase in capital requirements that would be incurred by EU
banks when implementing the final elements of the Basel III reforms (under the full
alignment option) would likely lead to a further increase in their cost of capital280
and
hence to a decrease in their relative281
price competitiveness (the magnitude of the
decrease would also depend on how much of the increase in the cost of capital could be
absorbed by the banks, and not passed on to their clients). It may also lead to a temporary
decrease in the attractiveness of EU banks to investors in case banks decided to retain a
high portion of their profits to build up the necessary capital to meet the increased
requirements (although it is also possible that banks would actually keep dividend
payments high in order to attract investors to buy new capital the banks would issue to
meet those requirements).
Note that the change in the relative price competitiveness of EU bank will also depend on
the exact way in which the other jurisdictions will implement the final elements of the
Basel III reform. For example, it is not necessarily the case that those jurisdictions that
currently apply to their banks stricter requirements than those included in the final Basel
III standards would decide to lower the level of their existing requirements to the level
foreseen in those standards.
280
According to the Modigliani-Miller theorem, under certain conditions, an increase in the cost of equity
would be offset by a corresponding decrease in the cost of debt, resulting in an unchanged cost of capital.
However, since those conditions are usually not met in the real world (e.g. because of the preferential tax
treatment of debt), this offset would not be perfect, and the increased cost of equity for EU banks would
result in an increase in their overall cost of capital.
281
The competitiveness of EU banks would deteriorate in relative term, but not necessarily in absolute
terms (e.g. to the extent that EU banks currently have a more competitive price for a certain service, the
gap with the prices offered by non-EU banks may close, but not necessarily reverse).
172
To ensure that there would not be a significant deterioration in the competitive position
of EU banks as compared to their international peers the preferred policy option would
introduce a number of EU specific adjustments that would reduce the increase in capital
requirements due to the implementation of the final elements of the Basel III reform (as
shown in Section 6.1). For example, the preferred policy option would allow adjusting
capital requirements for trading activities, for which EU banks directly compete with
their international peers on the global financial markets, in case other jurisdictions would
significantly lower the capital requirements for those activities in their local
implementation of the Basel III reform. Although the adoption of the preferred policy
option would significantly reduce the impact of the reform on EU banks, the impact in
terms of capital requirements may still remain higher than in other member jurisdictions
implementing the Basel III reform. Also for this reason the preferred policy option would
give EU banks 2 additional years to comply with the revised capital requirements than
recommended by the BCBS.
The strengthened capital position of EU banks resulting from the reforms, as
implemented under the preferred policy option, would restore the market confidence in
the EU banking sector and thus increase its attractiveness for investors.
3. Impact on SMEs
As shown in Figure 12, SMEs rely heavily on banks to finance their business. It is
therefore important to ensure that the implementation of the final elements of the Basel
III reform does not result in a material deterioration in the banks’ ability to finance
SMEs.
As illustrated by Figure 13 in EU banks’ loans and advances to SMEs occurred between
June 2019 and June 2020.
Figure 12: Relevance of various financing sources of euro area SMEs.
Source: Survey on the Access to Finance of Enterprises in the euro area (SAFE survey), ECB, November 2020. The
sources of SMEs financing are gauged by the number of responses from participating SMEs to the SAFE survey
conducted by the ECB between April and September 2020.
173
Figure 13: Evolution of EU banks loans and advances (in EUR trillions), by segment,
between June 2019 and June 2020
Source: Risk Assessment of the European banking system, EBA, December 2020
As observed in
174
Figure 14, the obstacles to EU banks’ financing of SMEs have been progressively
reduced during the second half of the previous decade. It is likely that this was mainly
due to the easing of the financing conditions spurred by the economic recovery during
that period (after the severe recession during the previous years). However, it is possible
that this trend may also have been influenced282
by the introduction of policy measures in
the CRR seeking to reduce the overall banks’ capital requirements for SMEs’ exposures
(e.g. the introduction of the SME supporting factor and the exemption of derivatives
transactions with non-financial companies from the capital requirement for CVA risk).
282
While there isn’t sufficient empirical evidence to claim that those measures have actively facilitated the
easing of financing conditions for SMEs, it may be said that they likely contributed to preventing a
deterioration in those conditions (by limiting increases in banks’ capital cost associated with SME finance
following the implementation of the initial Basel III reform in the EU).
175
Figure 14: Obstacles to receiving a bank loan by euro-area SMEs (by % of SME
responses)
Source: Survey on the Access to Finance of Enterprises in the euro area (SAFE survey), ECB, November 2020.
The potentiation deterioration of EU SMEs’ financial situation as a consequence of the
COVID-19 crisis 283
may lead to an increase in SME defaults and consequently in higher
capital requirements for EU banks (non-performing exposures are subject to higher
capital requirements compared to performing ones). This effect would, in turn, tighten
the future financing conditions for the remaining SMEs (decrease the availability of
credit or increase the cost of credit).
In this context, the implementation of the final Basel III standards has been carefully
assessed in order to ensure it would not disrupt banks’ financing to SMEs. To that end,
the preferred option contains proposes a number of adjustments to the Basel standards:
 the existing SME supporting factor as well as the existing exemption of derivative
transactions with non-financial companies (including SMEs) from the capital
requirement for CVA risk would be maintained. ;
 for banks using internal models for credit risk, a transitional treatment for unrated
companies under the output floor would be introduced. This would reduce the capital
requirement for credit risk related to SMEs exposures under the output floor (the vast
majority of EU corporates, including SMEs, are unrated);
 long-term equity holdings in unlisted SMEs would not be considered as speculative
holdings. Hence, these equity holdings would benefit from the ordinary treatment of
equities, which entails lower capital requirements than speculative equity holdings.
The individual impacts of the above measures, as estimated by the EBA, are provided in
Section 6.1.
283
In its latest SAFE survey, the ECB has already observed this trend (see
https://www.ecb.europa.eu/stats/ecb_surveys/safe/html/ecb.safe202011~e3858add29.en.html)
176
The other policy measures that would be included in the legislative proposal would affect
banks’ overall day-to-day risk management and supervision, and would therefore not
have a direct impact on banks’ financing to SMEs.
4. Macro-economic costs and benefits analysis
This section presents the macroeconomic costs and benefits analysis of the
implementation of the final elements of the Basel III reform in Union law. Other
measures included in this legislative initiative were not included in the analysis because
of lack of quantitative data. Nevertheless, those measures are expected to have a positive
macroeconomic impact since they are aimed at improving banks’ risk management,
supervision and market discipline.
The analysis of the macroeconomic impacts of the implementation of the Basel III reform
has been conducted by the ECB, in collaboration with the EBA, at the request of the
Commission. The study updated284
the ECB macroeconomic costs and benefits analysis
included in the EBA’s second impact study on the final Basel III reforms published in
December 2019285
.
The ECB analysis relies on a semi-structural macroeconomic model that links the
individual balance sheets of around 100 of the largest EU banks, their capital
requirements based on a given prudential framework (either the current prudential
framework applicable under the CRR or the final Basel III framework using certain
implementation options) and a given set of forecasted macroeconomic indicators
(including the annual EU Gross Domestic Product (GDP) growth) using a set of dynamic
assumptions. The full description of the model and its specifications is included in
Section 2 of Annex 7.
The ECB has enhanced its previous analysis presented in the EBA’s second impact study
with two major improvements. First, the updated ECB analysis presented results under
two different implementation options for the final elements of the Basel III reforms
considered in Section 5.2.1, specifically the full alignment option (option 1) and the
preferred policy option (option 3). Second, in order to respond to the Commission’s
request to reflect the potential consequences of the COVID-19 pandemic on the impact of
implementing the final elements of the Basel III reform, the ECB analysis has been
performed under two different sets of forecasted macroeconomic indicators286
. The first
set has been estimated based on Q4 2019 data, i.e. before the outbreak of the pandemic287
284
In this updated analysis, the ECB was able to reflect the latest available estimates of banks’ individual
impacts of the Basel III reforms, consistent with the overall EBA impacts shown in Section 6.1, as well as
the recent ECB macroeconomic projections for the EU economy, including amid COVID-19 pandemic.
285
See EBA second impact study on the final Basel III reforms, December 2019
286
The forecasted macroeconomic indicators are consistent with the economic forecasts published by the
Commission (see https://ec.europa.eu/info/business-economy-euro/economic-performance-and-
forecasts/economic-forecasts_en).
287
For the complete set of ECB macroeconomic projections, see
https://www.ecb.europa.eu/pub/projections/html/ecb.projections201912_eurosystemstaff~c7a91336cb.en.h
tml
177
(pre-COVID scenario). The second set has been estimated based on Q2 2020 data, i.e.
after the first wave of the pandemic288
(COVID scenario).
Every year starting from one year after the envisaged date of application of the final
elements of the Basel III reform, the ECB analysis has produced two main
macroeconomic metrics to assess the macroeconomic costs and benefits of implementing
the final Basel III reforms:
 the expected impact of the reform on EU GDP growth as defined by the difference
between the expected future annual EU GDP289
growth as simulated under two
prudential frameworks (i.e. the final Basel III standards under a given implementation
option and the current prudential framework). A negative difference between two
expected future annual EU GDPs growths would imply an expected macroeconomic
cost resulting from the introduction of reforms, while a positive difference would
imply a macroeconomic benefit;
 the impact of the reform on banks’ to support EU GDP growth in case of an
economic downturn as defined by the difference between a low percentile290
of the
future annual EU GDP distribution as simulated under two different prudential
frameworks (see previous point). A positive difference between the same percentiles
of the two future annual EU GDP growth distributions would imply a
macroeconomic benefit from the introduction of the reform under an economic
downturn, whereas a negative difference would imply a macroeconomic cost under
an economic downturn. This approach is based on the so-called Growth-at-Risk
(GaR) macroeconomic concept291
which focuses on the lower tail of the simulated
annual EU GDP growth distribution in order to assess the ability of the banking
sector to uphold lending to the real economy, thereby supporting growth, during an
economic downturn.
As highlighted in the objectives, the implementation of the final elements of the Basel III
reform in the EU would increase the resilience of the EU banking system in the long
term, while giving rise to limited transitional costs in the short term. The results of the
288
For the complete set of ECB macroeconomic projections, see
https://www.ecb.europa.eu/pub/projections/html/ecb.projections202006_eurosystemstaff~7628a8cf43.en.ht
ml
289
In this context, the expected future EU GDP growth for a given year is the mathematical mean of the
distribution of the EU GDPs growth generated by the model, for a given set of model specifications (ie
given prudential framework and given set of ECB macroeconomic projections for the first three years).
290
The ECB chose the 10th percentile of this distribution in their analysis.
291
In its previous analysis presented in the EBA’s second impact study, the ECB also used another,
alternative methodology to assess the long-term benefits of the implementation of the Basel III reforms,
based on the Long-term Economic Impact (LEI) framework developed by the BCBS. The results of this
alternative methodology showed that the implementation of the Basel III reforms would lead to a 1.2%
reduction in the probability of a banking crisis within the EU financial system once the reforms are fully
applied and would translate into a long-term net benefit of around 0.6% permanent increase in the EU
annual GDP. Due to time and resource constraints, the present analysis focuses on the GaR approach to
assess the long-term benefits which has the advantage to be more intuitive than the LEI framework.
178
ECB analysis support this conclusion. Importantly, they also support the preferred policy
option.
In fact, the preferred policy option appears to strike the best trade-off in terms of limiting
the transitional costs in the short term while producing a reasonable permanent benefit
over the long term. More specifically:
 as illustrated by Figure 15 below, the expected impact of the reform on EU GDP
growth, under the pre-COVID scenario and the full alignment implementation
option, would amount to a moderate macroeconomic net cost in terms of the annual
EU GDP growth, increasing in the first three years of application (i.e. during the
transitional arrangement), with a peak size of 0.13 p.p. of annual EU GDP growth,
then decreasing to less 0.025p.p of annual GDP growth at the end of the transitional
arrangement when the reform would be fully applicable, and finally turning into a
small benefit of 0.01 p.p. afterwards. This outcome could be explained by a limited
contraction of banks’ lending during the transitional arrangement while banks adjust
their balance sheets. Under the more severe COVID-19 scenario, macroeconomic net
costs on the annual EU GDP growth would be more pronounced for a longer period
but would nevertheless remain contained, reaching a peak of 0.13 p.p. one year later
than under the pre-COVID scenario, and start to slowly decrease afterwards;
 the preferred policy option would mitigate the short term macroeconomic net costs
resulting from the full alignment option, first in terms of magnitude, and second,
because those costs would start to affect the annual EU GDP growth later as the
result of the postponement of the start of the application of the reforms to 1 January
2025. In particular, this mitigating effect reducing the cost of the reforms on the EU
GDP growth as compared to the full alignment option would last longer, at least until
the end of the transitional arrangement when the reforms are fully applicable. This is
particularly important for the recovery of the EU economy post COVID-19 in which
banks will need to play a key role.
 as illustrated by Figure 16, the impact of the reform on banks’ ability to support
EU GDP growth during economic downturns would be positive, with a
macroeconomic benefit starting 3 years after the full application of the reform, under
all the different implementation options considered. Under the pre-COVID
scenario292
, the net benefit would converge in the long term to above 0.1p.p of
annual EU GDP growth under the full alignment option against above 0.04% under
the preferred option. These results are mainly explained by the fact that better
capitalised banks (and the reform would increase capital requirements) are better
equipped to keep lending in case of an economic downturn thus avoiding (or at least
292
The ECB only provided to the Commission the impacts of the reform on banks’ ability to support EU
GDP growth under economic downturns using the pre-COVID scenario, the difference of impacts using the
COVID scenario being negligible.
179
significantly limiting) the probability of a credit crunch and the negative
consequences it has on economic activity.
Figure 15: Comparison between the expected impacts on the EU GDP growth over time
resulting from the implementation of the final elements of the Basel III reform under the
different implementation options and under the pre-COVID scenario (left-hand-side) and
COVID-scenario (right-hand side).
Source: ECB analysis of the macroeconomic costs/benefits of implementing the final Basel III reforms, 2021. Note: the
green and blue (resp. dotted) lines represent the date of full (resp. partial) application of the final Basel III reforms at
the end (resp. start) of the transitional arrangement under, respectively, the BCBS timelines, ie 1 January 2028 (resp. 1
January 2023), and under our preferred policy option, i.e. 1 January 2030, (resp. 1 January 2025).
Figure 16: Comparison between the impact of the reforms to support EU GDP growth
under an economic downturn over time resulting from the implementation of the final
elements of the Basel III reform under the different implementation options and under the
pre-COVID scenario
Source: ECB analysis of the macroeconomic costs/benefits of implementing the final Basel III reforms, 2021. Note: the
green and blue lines represent the date of full application of the final Basel III reforms at the end of the transitional
arrangement under the BCBS timelines, ie 1 January 2028, and under our preferred policy option, ie 1 January 2030,
respectively.
180
These results corroborate the conclusions of the previous ECB analysis on the
macroeconomic costs and benefits of implementing the final elements of the Basel III
reform. Despite more severe economic shocks reflected in the projected macroeconomic
indicators under the updated ECB analysis, banks’ improved capital ratios and the
reduced impact of the final Basel III reform on individual banks as compared to the
previous ECB analysis293
.
The findings presented in the updated ECB analysis are also consistent with the
conclusions of previous macroeconomic studies294,295,296
assessing the interaction
between the appropriate level of banks’ capital requirements and their capacity to
continue financing the real economy amid economic downturns.
For the sake of completeness, it is worth mentioning another study dedicated to the
macroeconomic impact of the Basel III reform on the EU economy, showing different
findings than the ECB analysis. The study297
commissioned by the European Banking
Federation and conducted by the Copenhagen Economics consultancy in 2021 concluded
that EU GDP would decrease by 0.4% points on a permanent basis due to the full
implementation of the final elements of the Basel III reform (the study also showed that
the Basel III reforms should provide societal benefits of some 0.1% of EU GDP, bringing
the total net societal costs of the package to a decrease of 0.3% of EU GDP). However,
the modelling assumptions taken in this analysis appear more conservative than in the
ECB analysis and do not take into account the specific measures adopted in the preferred
policy options to mitigate the impacts of the Basel III reforms.
293
Section 1 and Section 6.1 provide supporting evidence for these observations.
294
Impact of the Capital Requirements Regulation (CRR) on the access to finance for business and long-
term investment, London Economics Europe, 2016 (see https://londoneconomics.co.uk/wp-
content/uploads/2016/11/Assessing-the-impact-of-the-Capital-Requirements-Regulation-CRR-on-the-
access-to-finance-for-business-and-long-term-investments.pdf)
295
Optimal Bank capital, Bank of England, 2011 (see https://www.bankofengland.co.uk/external-mpc-
discussion-paper/2011/optimal-bank-capital)
296
Do Better Capitalized Banks Lend Less?, International Finance, 2014 (see
https://onlinelibrary.wiley.com/doi/full/10.1111/infi.12041)
297
See copenhagen-economics_eu-implementation-of-the-final-basel-iii.pdf (copenhageneconomics.com)
181
ANNEX 7: ANALYTICAL METHODS
1. EBA impact analysis
In May 2018, the Commission requested technical advice from the EBA on the
implementation of the final elements of the Basel III reform in the EU. The EBA
submitted its advice in two parts, on 5 August 2019 and on 4 December 2019. The first
part (‘August 2019 CfA response’) covered the areas of credit risk, operational risk,
securities financing transactions and output floor. The second part (‘December 2019 CfA
response’) covered the areas of market risk and credit valuation adjustment risk
standards, as well as a macroeconomic impact assessment carried out by the ECB. The
advice included a detailed quantitative impact analysis on the implementation of the final
elements of the Basel III reform in the EU, based on data as of end-June 2028.
This sample has been reduced from the 189 banks from 18 Member States and Norway
included in the previous EBA analysis published in the August 2019 and December 2019
CfA responses, which covered 86% the total banking assets of those countries. As the
consequence, some Member States (see
182
Table 1) and business models (see Table 3) were not represented in the sample used for
the December 2020 CfA response, while others had a much more limited representation.
In addition, the coverage in terms of small and medium-sized banks was considerably
reduced (4 small banks and 22 medium-sized banks; see Table 2).
The level of coverage varies across jurisdictions (see Error! Reference source not
found. below). It is lowest for Austria (13%) and varies from 42% to 143% of the
remaining jurisdictions. The coverage reaches above 100% in those jurisdictions where
some QIS participants are EU-located subsidiaries of non-EU controlled (e.g. US) groups
and are therefore not included in the denominator of the coverage ratio. It should be
noted that while at the EU level the reduction in coverage relative to the August 2019 and
December 2019 CfA responses is not considered material, this is not the case for some
countries. In particular, the coverage in Austria (from 74% to 13%), Luxembourg (from
103% to 65%) and Poland (from 88% to 42%) has dropped significantly. Therefore, for
those Member States the results in the December 2020 CfA response are much less
representative and are either not displayed in the country breakdowns or, if displayed,
should be interpreted with caution.
In order to avoid double-counting the impacts, banks participating in the QIS data
collection exercise were asked to report data at the highest level of EU consolidation.
Unless stated otherwise, subsidiaries of EU parents are included in the average
calculations only when impact results are presented by business model or by country,
provided that they do not belong to the same business model or country as their parent
entity.
183
Table 1: Breakdown of banks included in Q2 2018 and Q4 2019 samples of EBA
quantitative impact analysis, per Member States
Member States Number of banks Q4 2019 sample
coverage in terms of
banking assets in
Member States
Q2 2018
sample
Q4 2019 QIS
sample
AT 15 5 13%
BE 7 4 93%
DE 40 24 56%
DK 8 4 89%
EE 2 0 -
ES 10 6 79%
FI 5 1 71%
FR 14 7 87%
GR 2 3 73%
HU 1 1 75%
IE 8 8 143%
IT 24 11 89%
LU 6 2 65%
MT 1 0 -
NL 12 7 89%
NO 6 2 67%
PL 9 4 42%
PT 6 4 72%
SE 11 6 84%
Total 189 99 76%
Source: Basel III reforms impact study, EBA, December 2020
Notes: Percentages higher than 100% are due to the presence of foreign-controlled (non-EU) subsidiaries in the QIS
sample of certain EU Member States (e.g. subsidiaries of US institutions located in the EU
The EBA quantitative impact analysis used two other criteria to differentiate the impacts
of the final elements of the Basel III reform on EU banks:
 bank size - the EBA defined three size categories: large, medium and small. The
definitions of ‘large’ and ‘small’ banks were based on the respective CRR
definitions298
(‘medium’ banks, which are not defined in the CRR, are banks that
meet neither of the CRR definitions);
 bank business model - the EBA defined thirteen business model categories: cross-
border universal banks (Cross-Border U), local universal banks (Local U),
automotive and consumer credit banks (Autos & Cons), building societies
(Building Soc), locally active saving and loan associations/cooperative banks
(S&L/Coop), private banks (Private), custody banks (Custody), central
counterparties (CCP), merchant banks (Merchant), leasing and factoring banks
298
See point 146 of Article4 of the CRR for the definition of large banks and point 145 Article 4 of the
CRR for the definition of small (and non-complex) banks.
184
(Leasing), public development banks (Public Dev), mortgage banks299
(Mortgage), and other specialised banks (Other special). These categories are
further described in the August 2019 CfA response.
Table 2: Breakdown of banks included in Q2 2018 and Q4 2019 samples of EBA
quantitative impact analysis, per size
Size Number of banks
Q2 2018 sample Q4 2019 QIS
sample
Large 104 73
of which: G-SIIs 8 8
of which: O-SIIs 67 46
Medium 61 22
Small 24 4
Total 189 99
Source: Basel III reforms impact study, EBA, December 2020; European Commission estimates.
Table 3: Breakdown of banks included in Q2 2018 and Q4 2019 samples of EBA
quantitative impact analysis, per size
Business Model Number of banks
Q2 2018 sample Q4 2019 QIS
sample
Cross-border U 40 34
Local U 52 31
Auto & Cons 7 2
Building Soc 6 2
S&L / Coop 34 11
Private 8 2
Custody 7 3
CCP 1 1
Merchant 5 2
Leasing 1 0
Public Dev 10 4
Mortgage 8 5
Other special 10 2
Total 189 99
Source: Basel III reforms impact study, EBA, December 2020; European Commission estimates.
Methodology
The methodology used to calculate the impact estimates in terms of change in minimum
capital requirements, regulatory capital ratios and shortfalls remained unchanged in
relation to the estimates published in the August and December 2019 CfA responses (the
full details of the methodology used is described in the respective responses).
299
Including pass-through financing models.
185
The impact estimates are not directly comparable to those of the Basel III monitoring
report as of the same date (i.e. based on Q4 2019) which have been published by the
EBA in December 2020300
. This is due to the fact that they are based on different samples
of EU banks but also to some methodological differences, as described in the December
2020 CfA response.
In accordance with the requests of the Commission in its CfA, the impact analysis
presented in this December 2020 CfA response is based on two different implementation
options for the final elements of the Basel III reform in the EU.
The first implementation option (labelled ‘Basel III’) corresponds to the Basel III central
scenario in the August 2019 and December 2019 CfA responses. It represents the
situation as it would have been in Q4 2019 if the Basel III framework had already been
fully implemented and the transitional period had passed. The impact estimates under this
option are used to quantify the policy option 1 in Section 5.2.1.
The second implementation option (labelled ’EU-specific’) considers additional EU
specific adjustments requested by the Commission in its CfA, specifically:
 maintaining the supporting factor for exposures to SMEs as amended by the CRR
II under both the SA-CR and the IRBA301
(including for the purpose of the output
floor calculation);
 maintaining the current CVA exemptions301
;
 reusing the eligibility criteria of the original exposure method (OEM) (see Article
273a(2) of the CRR) for the eligibility criteria of the simplified method for
calculating the capital requirements for CVA risk;
 assuming that the discretion included in the final Basel III framework to set ILM
equal to 1 in the SMA for operational risk would be exercised permanently for all
‘bucket 2’ and ‘bucket 3’ banks.
The impact estimates of the EU-specific scenario included in the December 2020 CfA
response serve as a starting point to quantify the impact of policy options 2 and 3 in
Section 5.2.1. In fact, those policy options propose a number of additional EU specific
adjustments that the EBA was unable to quantify due to data constrains. Since the EU-
specific scenario does not include the additional EU specific adjustments, the impacts of
those policy options are overestimated. Therefore, in order to produce more realistic
estimates of the actual impacts of those two policy options, the Commission services
used expert judgement and additional data sources to estimate the impact of the
additional EU specific adjustments. These estimates do not have the same degree of
300
See
https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/Reports/2020/9607
97/Basel%20III%20monitoring%20report%20-%20Dec%202020.pdf.
301
In the absence of available impact estimates for this EU specific adjustment in the end-December 2019
QIS templates, the EBA use for this EU specific adjustments a proxy impact estimates based on the Q2
2018 data
186
accuracy than the quantitative estimates carried by the EBA and must be interpreted with
caution.
Furthermore, the analysis for the proposed approach to implement the output floor under
policy options 2 and 3 in Section 5.2.1 is based on the estimates of the ‘alternative
approach’ included in the December 2020 CfA response. This alternative approach
provides a good proxy for the proposed approach to implement the output floor but it
may overestimate its actual impact since the potential reduction of the P2R and the SyRB
requirement as the result of supervisory action is not quantified. As explained in Section
5.2.1, such supervisory action would be proposed in order to avoid double counting
aggressive modelling risk under the proposed approach.
It is also important to note that under both the Basel III and EU-specific scenarios used in
the December 2020 CfA response, the impact of the final CVA framework published in
July 2020 is reflected via a robust proxy (see the description of proxy in the response).
Finally, as requested by the Commission in its CfA, the EU-specific scenario also
includes the effects of some support measures that have been adopted in 2020 to mitigate
the effect of COVID-19 crisis on EU banks, specifically the frontloading of the
prudential treatment of software assets adopted as part of the CRR quick fix package and
the frontloading of the change in the P2R composition adopted by the ECB302
. In order to
assess the pure impact of the final elements of the Basel III reform under this scenario,
the EBA assumed that these policy measures were already in place in Q4 2019.
Therefore, the effect of these measures are not reflected under the impact estimates of the
EU-specific scenario published in the December 2020 CfA response303
.
With regard to the specific analysis on the combined effect of the final elements of the
Basel III reform and the potential effects of the COVID-19 crisis, the EBA had to
develop several hypothetical scenarios on the potential deterioration of the financial
situation of EU banks’ borrowers and the effects of maintaining some support measures
put in place by Member States and competent authorities should the crisis last, as
requested in the Commission August 2020 CfA. All these assumptions are extensively
described in the December 2020 CfA response. This combined effect has only been
assessed by the EBA under the EU-specific scenario.
Limitations/Caveats
The updated impact analysis contained in the December 2020 CfA response is subject to
the following limitations/caveats, which have to be taken into account when interpreting
the results of the analysis:
302
See https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr200312~45417d8643.en.html.
303
For the sake of completeness, the EBA also provided in an annex to the December 2020 CfA response a
partial set of impact estimates under the EU-specific scenario in which the effects of these support
measures are visible. However, for the sake of comparison with the Basel III scenario, in which these
support measures are not reflected, this impact assessment uses the impact estimates of the EU-specific
scenario in which the support measures are not reflected.
187
 limited sample: the sample of banks included in the December 2020 CfA
response is significantly smaller than the sample used for the August and
December 2019 CfA responses. As observed in the above description of the
sample used, EU banks in some Member States are absent from the sample and
the number of EU banks in certain categories is too limited to be representative;
 conservative assumptions for the impact estimates: as for the August 2019 and
December 2019 CfA responses, a number of simplifying and conservative
assumptions have been applied for the impact estimates in the December 2020
CfA response. These assumptions are likely to result in an overestimation of the
impacts. For instance, the EBA used the assumption of a static balance sheet
under which banks do not react to the revised requirements by adjusting their
businesses and/or managing their regulatory capital costs. Also, the EBA used
conservative proxies to estimate some impacts in the situation that the actual
impacts in the Q4 2019 data were not available (e.g. for the EU specific
adjustment on the SME supporting factor and for the impact of the final CVA
framework);
 conservative assumptions under the COVID-19 scenarios: as explained in Section
6.1, the EBA used very conservative assumptions in its specific quantitative
analysis of the combined effect on EU banks of the final elements of the Basel III
reform and the potential consequences of the COVID-19 crisis. In particular, the
EBA methodology uses a stress-testing approach which assumes a simultaneous
deterioration in the financial situation of all borrowers of EU banks, i.e. even for
borrowers that do not currently experience difficulties. Also, the most severe
COVID-19 scenario assumes two cumulative shocks, one global and one
sectorial, to infer the deterioration of the financial situation of EU banks’
borrowers. This scenario considers that the application of a sectorial shock only
would not be sufficient to assess the impacts on the sectors of the real economy
that are the most affected by the COVID-19 crisis.
2. ECB macroeconomic costs and benefits analysis
The ECB macroeconomic analysis presented in this impact assessment is an update of the
previous macroeconomic analysis published in the December 2019 CfA response.
Following the one-year delay for the implementation of the final elements of the Basel III
reform agreed by the BCBS in the wake of the COVID-19 pandemic, the Commission
asked the ECB in August 2020 to update its quantitative impact analysis with the most
recent available data, considering the potential impact of the COVID-19 pandemic on the
EU banking sector and the wider economy.
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Data sources
The structure of banks’ balance sheets is sourced from the stress test templates of the
2018 EU-wide exercise and updated with the information from FINREP / COREP based
on Q4 2019 data. Estimated impacts of the final elements of the Basel III reform are
based on the templates used for the regular Basel III monitoring exercise based on Q4
2019 data. The data sources are therefore consistent with the EBA impact analysis
presented in the December 2020 CfA response.
The bank-level behavioural dynamics and their sensitivity to external factors (e.g. IRFS 9
parameters) are estimated with the use of FINREP / COREP data, balance sheet items
(BSI) and MFI interest rate (MIR) statistics collected by euro-area central banks for
monetary policy purposes, public bank-level information, and external market data. The
macroeconomic dataset consists of the aggregate information from Eurostat on national
accounts, price indices, interest rates and central bank assets approximating the intensity
of unconventional monetary policy.
Sample of the analysis
The ECB macroeconomic impact analysis includes 100 EU banks from 19 euro-area
Member States and one Norwegian bank, reporting data of sufficient quality at the
highest level of consolidation. This sample covers over 70% of total euro-area banking
sector assets. The country breakdown of banks included in the sample is provided in
Table 4 below. No additional information about the profiles of the banks included in the
sample has been provided by the ECB. The findings of the ECB analysis included in this
impact assessment relate to both the EU and Norwegian economies but only references to
the EU economy have been included for the sake of simplicity.
Table 4 : Breakdown of banks included the Q4 2019 sample of ECB macroeconomic
analysis, per Member States and Norway
Member States
Number of banks in the
sample
AT 6
BE 6
CY 2
DE 20
DK 3
EL 4
ES 11
FI 2
FR 10
HU 1
IE 4
IT 9
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LU 5
MT 2
NL 6
NO 1
PL 2
PT 2
SE 3
SI 2
Total 101
Source: ECB
Methodology
The ECB macroeconomic impact analysis relies on the Banking Euro Area Stress Test
(BEAST) model which is a semi-structural macroeconomic model that links the dynamics
of individual banks’ balance sheets with macroeconomic indicators304
.
Using a set of dynamical assumptions, the model links the individual banks’ balance
sheets to their capital requirements based on a given specification for the applicable
prudential framework (either the current prudential framework under the CRR or an
implementation option for the final Basel III framework) and a given set of
macroeconomic indicators (including the EU Gross Domestic Product (GDP) growth).
For a given specification, the model generates multiple times the potential evolution of
the macro-economic indicators for every year over a long time horizon, leading to a
probabilistic distribution of these indicators each year. To be consistent with the official
ECB forecasted macroeconomic indicators305
, the model is calibrated to match those
forecasts over the first three years of the time horizon, and thereafter these indicators are
generated according to the model dynamics.
On the asset side of banks’ balance sheets, the model distinguishes various classes of
banks’ exposures and applies dynamical assumptions for the evolution of the IFRS 9
credit stages to those exposure classes (stage 1 to3) using endogenous transition rates that
depend on the macroeconomic indicators. The dynamics assumptions also adjust, for
each exposure class, banks’ loan volumes and the interest rates charged on those loans in
response to loan demand conditions, monetary policy rates and depending on their own
capital position, profitability or the quality of assets.
On the liability side of banks’ balance sheets, the model distinguishes various forms of
deposits and their level depending on the types of banks’ depositors. The dynamical
304
For more details in about this model, see ECB Working papers series, December 2020
(https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2469~a139d2f5cd.en.pdf?a8fe33c3c9c7d0c629daa9d9
c9b1e6b3).
305
See https://www.ecb.europa.eu/pub/projections/html/index.en.html; these projections are consistent with
the Commission’s economic forecast.
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assumptions changes banks’ costs of funding depending on the macroeconomic
conditions and, as regards wholesale funding, on banks’ capitalisation and asset quality.
Regarding banks’ profits and losses, the model recalculates banks’ net interest income,
loan loss provisions and net fee and commission income in details over the simulation.
Certain components of P&L, such as dividend income or changes to the trading book
assets, follow a simpler evolution generated by dynamic assumptions.
The model also incorporates a number of support measures adopted in light of the
COVID-19 crisis, including country-specific public moratoria and guarantee schemes
adopted by Member States as well as capital release measures adopted by the ECB and
supervisory authorities306
.
The effects of the final elements of the Basel III reform are assessed using the same data
impacts and broad methodology than the EBA analysis, although the sample of banks
included in the ECB analysis is slightly different. The ECB analysis includes two
implementation options for the implementation of the reform. The first implementation
option is based on the full alignment with the final Basel III standards and BCBS
timelines, similar to option 1 in Section 5.2.1. The second implementation option is
based on the implementation of the final Basel III standards with the introduction of EU
specific adjustments (these adjustments are limited to those that EBA was able to
quantify; see Section 1 of this Annex). The second implementation option is also based
on the same ‘alternative approach’ for the implementation of the output floor as in the
EBA updated impact analysis. Therefore, the second implementation option could be
considered as a good proxy for the impact of the preferred option in Section 5.2.1
Every year starting from one year after the envisaged date of application of the final
elements of the Basel III reform, the ECB analysis produces two main macroeconomic
metrics to assess the macroeconomic costs and benefits of implementing the reform:
 the expected impact of the reform on EU GDP growth as defined by the difference
between the expected future EU GDP307
growth as simulated under two different set
of rules for the capital requirements calculations, the first one based on one of the
options considered for implementing the final elements of the Basel III reform and
the second one based on the current prudential framework. A negative difference
between two expected future EU GDPs growths would imply an expected
macroeconomic cost resulting from the introduction of the reform, and vice versa. It
is important to note that in the ECB model an increase in banks’ capital requirements
can lead to a reduction in bank lending, and occasionally a reduction in GDP growth;
306
For more detailed description see Budnik et al. (2021), Policies in support of lending following the
coronavirus (COVID-19) pandemic, ECB Occasional Paper, mimeo
307
In this context, the expected future EU GDP growth for a given year is the mathematical mean of the
distribution of the EU GDPs growth generated by the model, for a given set of model specifications (ie
given prudential framework and given set of ECB projected macroeconomic indicators for the first three
years).
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 the impact of the reform to support EU GDP growth under economic downturns as
defined by the difference between a low percentile308
of the future EU GDP
distribution as simulated under two different sets of rules for the capital requirements
calculations, the first one based on one of the options considered for implementing
the final elements of the Basel III reform and the second one based on the current
prudential framework. A positive difference between the same percentiles of the two
future EU GDP growth distributions would imply a macroeconomic benefit from the
introduction of reforms under an economic downturn, and vice versa. This approach
is based on the so-called Growth-at-Risk (GaR) macroeconomic concept which
focuses on the lower tail of the simulated EU GDP growth distribution in order to
assess the ability of the banking sector to keep lending to the real economy during an
economic downturn, thereby supporting growth.
Figure 17: Illustration of the macroeconomic metrics produced by the ECB model.
Source: ECB
Limitations/Caveats
The ECB macroeconomic impact analysis is subject to the following limitations/caveats,
which have to be carefully taken into account when interpreting the results:
 limited sample: as for the EBA updated impact analysis, the sample size used in
the ECB analysis is limited to the largest banks of EU Member States and
Norway. However, these banks hold the majority of banking assets in those
countries;
 assumptions of the macroeconomic model: the assumptions of the ECB model
tend to translate an increase in banks’ capital requirements into a reduction in
banks’ lending and a reduction in EU GDP growth. This assumption is rather
conservative and, may not be met in reality (for instance, the large increase in EU
banks’ capital requirements resulting from the reforms adopted post-GFC did not
lead to a large reduction in bank lending);
308
The ECB chose the 10th percentile of this distribution in their analysis.
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 overestimation of the impact of the EU specific implementation option: similarly
to the EBA updated impact analysis, the ECB analysis only reflected a limited
number of EU specific adjustments that are proposed under options 2 and 3 of
Section 5.2.1. This may lead to an overestimation (underestimation) of the
macroeconomic costs (benefits) of the reform, although likely not to a significant
degree.