16 November 2021

EU Commission's Berrigan: “Our ultimate goal is to complete the banking union”

John Berrigan, Director-General FISMA, talks about the European Commission’s proposals to revise capital rules and introduce the Basel III output floor, climate risks, and whether the banking union glass is half full or half empty.

Interview with John Berrigan, Director-General for Financial Stability, Financial Services and Capital Markets Union, European Commission, Supervision Newsletter

 

You recently published the proposal for a revised Capital Requirements Regulation and Capital Requirements Directive. What are the main improvements?

The proposal introduces a number of important improvements to the existing prudential framework.

First, it implements the outstanding elements of the Basel III reform in the EU regulatory framework. The Commission wants to implement the standards faithfully to meet our international commitments and to strengthen the prudential framework. At the same time, the proposal seeks to avoid a significant increase in capital requirements and takes into account the specificities of the EU banking sector and the EU economy.

Second, it further increases proportionality, notably by reducing compliance costs for smaller banks in particular, while avoiding a loosening of prudential standards.

Third, it further harmonises certain supervisory powers and tools.

Last, but certainly not least, 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’s sustainable finance strategy.

What are you trying to achieve with the output floor and its level of application?

The output floor is one of the key measures of the final Basel III reforms.

Its introduction aims to reduce the excessive variability of capital requirements when these are calculated using internal models and thereby increase the comparability of banks’ solvency ratios.

The Commission proposes to implement the output floor in a single stack applied at the EU consolidated level. We also propose a redistribution mechanism to ensure adequate capitalisation of subsidiaries in the EU. Under this mechanism, any additional capital resulting from the application of the output floor at consolidated level would be distributed across the various subsidiaries of a group according to their risk profile. Moreover, we propose a mechanism that avoids double-counting of risks.

We believe that this is the approach that best ensures consistency with the Single Market, the rationale of the banking union and international standards, while avoiding significant increases in capital requirements.

How are ESG risks being taken into account in the revised Capital Requirements Regulation and Capital Requirements Directive?

The EU had already started working on improving the integration of climate and environmental risks into the prudential framework with the previous banking package, known as CRR II/CRD V.

Since 2019 banks and supervisors have made significant efforts to capture climate and environmental factors in risk management systems and prudential capital requirements. Nevertheless, we know that we need to do more.

The proposal implements the measures announced in the Strategy for financing the transition to a sustainable economy, which was published by the European Commission on 6 July 2021.

Notably, in the area of risk management and supervisory powers, the proposed measures introduce binding requirements and give a mandate to the European Banking Authority (EBA) for the integration of ESG risks in the rules for banks’ risk management and governance. Banks would be required to draw up plans to address any risks arising from a lack of alignment with the EU’s objectives under the Paris Agreement to achieve the transition to a sustainable economy. They would also have to carry out internal stress tests to assess their resilience to ESG risks. This would support the supervisory review of banks’ management of ESG risks, especially those related to the transition.

In the area of disclosures, the proposal further enlarges the scope of banks that have to disclose information on their ESG exposures to the market.

Finally, the proposal shortens the horizon for the EBA to make recommendations on a dedicated prudential treatment for exposures related to assets or activities that pursue environmental and/or social objectives.

Climate change can have a material impact on banks, but banks can also have a substantial impact on the climate and sustainability. Should public authorities pay more attention to both aspects of this “double materiality”?

This summer’s flood disasters, heat waves and forest fires in Europe have illustrated how climate change is becoming ever more tragic and costly. Banks will not escape its consequences. Effectively tackling the risks of climate change thus requires credible policies and a comprehensive approach that also acknowledges that banks play an active role in influencing these risks.

The concept of double materiality is the backbone of the Commission’s Strategy for financing the transition.

On the one hand, it is important to understand how the banking sector can amplify or mitigate these risks through its investments. Banks have a key role to play in the transition. For example, green loans and green mortgages can help households and small and medium-sized enterprises alike to improve the energy performance of their buildings or switch to zero-emission vehicles, both of which are instrumental in achieving the Fit for 55 emission reduction targets in the EU. For banks to play their role, corporate sustainability disclosures and ratings need to be reliable, comparable and transparent. Therefore, the EU Taxonomy, the Sustainable Finance Disclosure Regulation and the new proposal on corporate sustainability reporting are essential contributions. Overall, EU sustainability reporting standards will effectively integrate both materiality perspectives, that is, the risks arising for companies owing to climate change on the one hand, and an objective account of their impact on people and the environment on the other.

On the other hand, climate change and environmental risks must be taken into account in banks’ risk management. I talked about this earlier, but I would stress here that we also need to be able to adopt a macroprudential perspective on these risks in order to understand how the banking sector as a whole may amplify risks once they materialise. The upcoming review of our macroprudential framework for banks will therefore examine how the macroprudential toolkit can be used – and possibly developed – to mitigate the financial stability risks stemming from climate change.

Finally, let me recall that the effectiveness of sustainable finance policies depends on an adequate level of enforcement and supervision across the EU. Supervisors should make full use of their mandates and powers to make sure that there are no unsubstantiated sustainability claims and that climate change-related risks are adequately managed.

Fighting financial crime in the European Union is one of your core responsibilities. What is your action plan to counter money laundering and terrorism financing?

With its package of anti-money laundering legislative proposals of July 2021, the Commission is implementing three of the six pillars of the May 2020 Action plan on anti-money laundering and countering the financing of terrorism (AML/CFT): establishing a single EU rulebook for AML/CFT, creating EU-level AML supervision and providing EU support and coordination to financial intelligence units. The package consists of four distinct legislative acts: a new AML Regulation, essentially containing rules applicable to private sector entities; a new, sixth, AML Directive; a Regulation founding an EU AML authority; and a revision of the 2015 Regulation on transfers of funds, which will bring transfers of crypto-assets within its scope. The single rulebook will increase the degree of harmonisation while still giving Member States some leeway under a risk-based approach. The new AML authority, which will act as both an EU supervisor and a support mechanism for financial intelligence units, will start operating in 2024. As of 2026 it will directly supervise a limited number of the riskiest cross-border financial institutions in the EU. Altogether, the package significantly strengthens the EU framework for AML/CFT and is a huge step forward. I count on the European Parliament and Council to prioritise work towards reaching an agreement on the proposals.

The Commission is also actively pursuing the other three pillars of the Action plan. The first is to ensure good enforcement of the current AML/CFT rules. This goes far beyond monitoring the transposition of the current AML Directive and involves a deep dive into the implementation and application of the rules on the ground in the Member States. The second pillar is better detection of money laundering via exchange of information, including through public-private partnerships. On this, we will adopt a Commission report with dedicated guidance at around the turn of the year. Finally, the Commission is committed to reinforcing the role of the EU at international level – in the Financial Action Task Force and its regional bodies such as MONEYVAL...

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