27 October 2021

Questions and Answers on the Banking Package 2021

The main outstanding elements of the reform, included in today's package, aim to constrain the ability of banks to excessively reduce capital requirements when using internal models.

Why is the Commission proposing this package?

Following the financial crisis, the EU embarked on wide-ranging reforms of its banking rules to increase the resilience of the EU banking sector. One of the main elements of the reforms consisted of implementing the international standards the EU and its G20 partners agreed in the Basel Committee for Banking Supervision (BCBS), specifically the so-called “Basel III reform”. Thanks to these post-crisis reforms, the EU banking sector entered the COVID-19 crisis on a much more resilient footing. However, while the overall level of capital in EU banks is now on average satisfactory, some of the problems that were identified in the wake of the financial crisis have not yet been addressed.

The main outstanding elements of the reform, included in today's package, aim to constrain the ability of banks to excessively reduce capital requirements when using internal models. This will increase the comparability of risk-based capital ratios across banks and will restore confidence in those ratios and the soundness of the sector overall. At the same time, the reform is intended to simplify the risk-based framework thanks to better standardisation in the calculation of capital requirements.

Beyond the need to complete the Basel III reforms agreed at international level, several other shortcomings have also been identified in the current banking prudential framework, which today's package also tackles.

What are the key elements of the package?

The package contains a number of significant improvements to existing EU rules for banks:

• First, it faithfully implements the outstanding elements of the Basel III reform in the EU, while taking into account EU specificities and avoiding significant increases in capital requirements. It also increases proportionality, notably by reducing compliance costs, in particular for smaller banks, without loosening prudential standards.
• Second, it introduces explicit rules on the management and supervision of environmental, social and governance (ESG) risks, in line with the objectives set out in the EU Sustainable Finance Strategy, and gives supervisors the necessary powers to assess ESG risks as part of regular supervisory reviews. This includes regular climate stress testing by both supervisors and banks.
• Third, it increases harmonisation of certain supervisory powers and tools. Supervisors will be given more powers to check if transactions are sound and bank managers are fit and proper. They will have enhanced sanctioning powers to enforce rules, while also having better oversight of complex banking groups, including fintechs. Today's proposals also introduce minimum standards for the regulation and supervision of branches of third-country banks in the EU.

Do the new rules cater to the specificities of the EU economy?

Today's package takes into account the specificities of the EU's banking sector and economy.

For example, structural features of the EU's economy, such as the significant economic contribution of SMEs – most of which are currently not rated –will be taken into account. Another example is that EU banks' long-term and strategic equity holdings will not be treated as speculative investments. In addition, the ability of EU banks to finance strategic industries, such as aircraft manufacturing and infrastructure, and to provide hedging services to European clients will be preserved. Lastly, the proposal introduces transitional arrangements for low-risk residential mortgages amongst other things.

What will be the impact on EU banks' capital requirements and the wider EU economy?

The impact of the package on the EU banking sector's overall capital requirements is not significant and will be phased in over a long period. The proposed measures implementing the outstanding elements of the Basel III reform are expected to lead to an increase in EU banks' capital requirements of less than 9% on average at the end of the envisaged transitional period in 2030 (compared to 18.5% if European specificities were not taken into account). Importantly, the capital increase would be below 3% at the beginning of the transitional period in 2025.

The macroeconomic analysis carried out by the European Central Bank shows that the Basel reforms will have a positive effect on the EU economy over the long-term. They will further restore market confidence in the EU banking sector, which will contribute to its profitability and competitiveness.

Implementing the final elements of the Basel III reforms

Which principles underpin the Commission's proposal on Basel III?

The Commission carried out extensive preparatory work leading up to today's proposal. During that process, several objectives and guiding principles were identified:

• The implementation of the rules in the EU should be faithful to the Basel III international standards to provide legal certainty and signal the EU's commitment to its international partners in the G20.
• Implementation should avoid a significant increase in the overall capital requirements of EU banks.
• Where the international standards would result in unintended or disproportionate effects on the EU banking sector and the wider economy due to its specificities, adjustments should be proposed. Where possible, these adjustments should apply on a transitional basis.
• Implementation should avoid competitive disadvantages for EU banks, in particular in the area of trading activities, where EU banks directly compete with their international peers.
• The proposed approach should be coherent with the logic of the Banking Union and not cause fragmentation in the Single Market for banking.
• It should ensure proportionality and aim to further reduce compliance costs, in particular for smaller banks, without loosening prudential standards....

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