04 November 2013

Risk.net: Filter furore - EU countries set to shield banks from bond volatility

It was the toughest part of Basel III for the US to swallow – a requirement that unrealised gains and losses on some bonds would hit bank capital calculations. In Europe, legislators provided an opt-out – and some countries have already chosen to use it, in breach of the Basel text.

During 2012, Allied Irish Banks (AIB) saw €553 million wiped from the value of government bonds it was holding – a loss equivalent to just more than 5 per cent of its Tier I capital. Happily for the bank, it did not have to take the hit because the bonds were held in its available-for-sale (AFS) portfolio, and Basel II filters AFS volatility out of regulatory capital numbers. Even more happily, while this filter is removed in Basel III, the Central Bank of Ireland (CBI) plans to ignore that for the next few years – a discretion granted to national supervisors in June by European Union (EU) legislators – which would insulate the country’s banks from losses that could be unleashed as interest rates rise.

Germany’s Bundesanstalt für Finanzdienstleistungsaufsicht (Bafin) and supervisors in some peripheral eurozone countries are expected to follow the CBI – a big win for their banks, but a further blow to relations between European authorities and those in the US, which chose to stick to the letter of Basel III and remove the filter for the biggest US banks when they published their own rules in July.

Tears are unlikely to be shed in the Bundestag, where the German parliament’s influential finance committee is championing the exemption. In a report published in May, the committee urged Bafin to use the discretion contained in the Capital Requirements Regulation (CRR), which is one half of Europe’s Basel III rules. Under the terms of the CRR, the filter could remain in place until an overhaul of International Accounting Standard (IAS) 39 has been completed, which could see AFS replaced as an accounting category.

But there is no unity on the subject even within Europe. Sweden, for example, has already decided to remove the filter. “It has been agreed in Basel III that the prudential filter has to be taken away, and we think there is no need to subject government exposures to any particular treatment. So we wanted to keep the regulatory framework as conservative as Basel requires", says Uldis Cerps, executive director for banks at Finansinspektionen, Sweden’s prudential regulator.

The story of what eventually entered into the official journal text of CRR as article 467(2) began in Italy in March 2012, when four Italian members of the European Parliament (MEPs) put forward amendments to the parliament’s version of CRR.

A source close to the ECON committee says the EC’s primary objection was to the open-ended nature of the amendment, so a compromise was hammered out in which the adoption of IFRS 9 in Europe – scheduled for 2015 – would force Member States to remove the filter, if they had not already done so.

As a result, the amendment moved out of what would become article 35 and was added to article 467, which details how unrealised gains and losses on non-government securities will be phased in between 2014 and 2017 – starting with recognition of at least 20 per cent of losses in 2014 and increasing annually thereafter. At the same time, the decision about whether to retain the filter was placed in the hands of national regulators, and the text was clarified to state that the exemption applied to “exposures to central governments classified in the available for sale category” of IAS 39.

The former US regulator says widespread use of the European opt-out could create a backlash in the US – and in other countries that have followed the text faithfully – potentially forcing the Basel Committee’s hand. If the committee doesn’t budge, he says it’s possible the US agencies could provide an exemption of their own for selected securities. So, the question is: which European regulators will allow their banks to put the filter back in for government exposures?

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