ESBG submitted its response to the EBA consultation on DGS contribution calculation

Prudential, Supervision and Resolution

November 7, 2022

The European Savings and Retail Banking Group (ESBG) welcomes the initiative of the European Banking Authority (EBA) to launch a consultation aiming at reviewing its guidelines, which specify the methods for calculating the contributions to the Deposit Guarantee Schemes (DGS), as requested in Art 13(3) directive 2014/49/EU. The EBA analysed whether the original guidelines’ approach to determine the riskiness of institutions is appropriate. In particular, the EBA analysed whether institutions that required DGS interventions were among the riskiest according to the guidelines’ methodology.

Enhancing the proportionality between the riskiness and the DGS contribution.
The EBA has identified elements that should be improved:
• setting minimum thresholds for the majority of core risk indicators and adjusting their minimum weights to better reflect the indicators’ performance in measuring the risk to
the DGSs,
• introducing an improved formula for determining the risk adjustment factor of each member institution that ensures a constant relationship between the riskiness of institutions and their DGS contributions,
• specifying how to account for deposits where the DGS coverage is subject to uncertainty, including in relation to client funds, thus ensuring closer alignment between the amount of covered deposits of a credit institution and its contributions.

Further clarity is needed.

While ESBG members welcomed the EBA consultation, ESBG’s response introduced two main recommendations. First, the DGS should be requested to disclose a description of
the institution’s contribution to the DGS fund with the goal of enhancing the member institution’s understanding of their risk profile. Such communication could also encourage the institutions to lower their risk profile where necessary, which could contribute to financial stability.
A more balanced risk weight between indicators.

As a second point, ESBG advocates for a more balanced risk weight for the two following indicators: Return on Assets (RoA) and the Total Risk Exposure Amount/Total of Assets
(TREA/TA). According to the EBA analysis, the former provides a better indication of a potential DGS intervention than the latter. Consequently, the EBA proposes raising the weight of the RoA and lowering the weight of the TREA/TA. ESBG points out that this initiative is counterintuitive, as it benefits high-risk banks. Low risk remains the principal reason to avoid DGS intervention.

High-level position paper – Executive summary

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ESBG responds to the EBA consultation on the supervisory handbook for IRB systems validation

On 28 October, ESBG responded to the European Banking Authority (EBA) consultation on the supervisory handbook for Internal Rating Based (IRB) systems validation. The handbook aims to clarify the role of the validation function as part of corporate governance, in particular in terms of scope of work and interaction with the credit risk control unit.

As a general comment, we stressed that organizational suspension of the validation function should be independent of the size of the bank. In addition, it should be ensured that the validation manual is free of inconsistencies with existing supervisory regulations such as the ECB Guide on Internal Models.
ESBG stressed that it would be helpful to consider the aspect of proportionality more closely. The validation approach proposed by the EBA hardly differentiates between the materiality of models/portfolios and model changes. On the contrary, the intensity and scope of validation activities must always be based on the expected data situation, the importance of the rating procedure, and the scope and complexity of the changes made.

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TOPIC: Prudential regulation

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ESBG short paper on the bank crisis management and deposit insurance framework (CMDI)

Position Paper | Prudential, Supervision and Resolution

Prudential, Supervision and Resolution

October 27, 2022

The Banking Union is one the most relevant EU policy over the last decade. The financial crisis in 2008 and its subsequent sovereign debt crisis in the euro zone have revealed weaknesses inherent in the functioning of the banking industry and demonstrated the need to coordinate the supervision and to shape a common framework in Europe.

Created in 2014, the Banking Union was a powerful response aiming to ensure that the European banks are able to withstand the upcoming crisis in the future without recourse to taxpayers’ money. The Banking Union is based on three pillars:
i) the Single Supervisory Mechanism (SSM) set up rules on capital requirements mainly from the implementation of Basel agreement and gave to the European Central Bank the responsibility to coordinate this supervision;
ii) the Single Resolution Mechanism (SRM) established a Single Resolution Board (SRB) and a Single Resolution Fund (SRF) in order to ensure the orderly resolution of failing banks, while minimising their impact on the real economy and on public finances;
iii) , the Deposit Guarantee Schemes (DGS) aim to protect depositors in the case where their banks fail, and their deposits are not available anymore.
These new uncertain times worsened due to the high inflation and the war in Ukraine legitimates the ongoing implementation of Basel IV rules in the EU regulation. Indeed, a well-capitalised banking sector contributes to reinforce the resilience of the European economy. As regards the two other pillars of the Banking Union, the European Commission has been mandated by the Eurogroup to bring forward a legislative proposal for a strengthened Crisis Management and Deposit Insurance (CMDI) framework in June.

Without a political agreement between the Member States, the Eurogroup decided to postpone the introduction of a European Deposit Insurance Scheme (EDIS) which was included in the initial workplan drafted by the Eurogroup President Pascal Donohoe. Against this background and before the publication of the legislative package postponed at the beginning 2023, the European Savings and Retail Banks Group wishes to reiterate its supports to the current CMDI review and calls in the meantime for an evolution of the framework, not a revolution. Read our paper below:

ESBG’S PAPER

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ESBG keeps a close eye on prudential treatment of crypto assets

On 30 September 2022, ESBG responded to the second public consultation of the Basel Committee on Banking Supervision (BCBS) on the prudential treatment of banks' crypto asset exposures, which is built on the proposals in the first consultation issued in June 2021.

The basic structure of the proposal in the first consultation is maintained, with crypto assets divided into two broad groups: Group 1 includes those that are eligible for treatment under the existing Basel Framework with some modifications. Group 2, on the other hand, includes unbacked crypto asset and stable coins with ineffective stabilisation mechanisms, which are subject to a new conservative prudential treatment.

In the response to the second consultation in 2022, we advocated for the removal of the technological risk add-on from the proposed prudential framework.

The first reason for this would be the principle of technological neutrality. The regulation should focus on regulating the services but not the applicable technology in order not to prevent the adoption of a specific technology and to neither prefer nor prejudice a specific business model or service provider. Secondly, technological risk already exists in all asset classes. If persistent technological risks are detected, the supervisor could require actions for their mitigation or apply a Pillar 2 Requirement (P2R) surcharge. Finally, a common surcharge of capital would reduce institutions’ incentives to mitigate inherent risk.

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OCTOBER 2022 | TOPICS: Prudential, Supervision and Resolution | Public Consultation | Crypto Assests | Basel Framework | Technology Neutrality

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Reducing the scope of the EBA NPLs data templates

On 5 September 2022, ESBG responded to the EBA consultation on the draft non-performing loans (NPL) transaction data templates, which seek to improve the functioning of secondary markets for NPLs.

The number of data fields in the proposed templates (especially those marked as “mandatory”) is significantly higher than what has historically been proven necessary to close voluntary NPL deals from a market standards perspective and it should therefore be reduced. Such a high number of data fields would in fact bring a significant costs increase for sellers and may jeopardise the development of NPL secondary markets.

In addition to the fact that most of the required information is too detailed and not relevant for the purposes of loan valuations, the data is also not always available within the banking system. This could lead to a counter-productive effect where sellers could renounce to sales they could execute due to constraining mandatory fields.

Another main impediment for this template to be useful is the issue of data consistency. The template would mainly be populated with management data and internal methodologies that can use different calculations and logics leading to incomparable information among portfolios.

Furthermore, it makes no sense to have common templates for single names or reduced portfolios of single names and massive portfolios of NPLs. Exposures to one single debtor or to a reduced number of corporates or SMEs have historically needed a different set of information, as their potential purchasers perform a deeper financial and legal analysis of the exposures rather than a statistical analysis, which is more adequate for massive portfolios.

Overall, the remaining fields compared to the original templates from 2017 still contain significantly more information than market standards require. For a well-functioning secondary market it is currently possible to sell NPLs by providing mainly 20 data fields.

Against this background, we request that the EBA further streamlines the templates, aiming at simpler, more balanced and effective design in order to achieve a broader application and increase transparency in the NPL market, without having a detrimental impact on EU NPL deals.

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Developing a proportionate, fair and efficient IRRBB framework in the EU

On 4 April 2022, ESBG responded to the EBA consultation specifying technical aspects of the revised framework capturing interest rate risks for banking book (IRRBB) positions.

Our response stresses that the current framework is too complex and challenging to implement for smaller institutions with non-complex operations and limited market risk exposure. Although we need a sufficiently prudent management of interest rate risk amongst all EU/EEA banks, the framework should also consider the peculiarities of national banking models and the interest risk inherent in national markets.

As regards the definition of large decline for the purpose of the net interest income (NII) supervisory outlier test, the proposed “Option B” referring to a cost related metric seems more aligned with established internal interest rate risk management methodologies. Yet, the removal of the administrative expenses term, which generates volatility and complexity, is pivotal to favouring this option.

Considering the limited ability of the standardised approach to capture adequately the exposure of each entity to IRRBB, any obligation to use it should be conditional on the competent authority having demonstrated that it would be more relevant than the internal model approach (IMA) it would replace.

In the area of credit spread risk arising from non-trading book (CSRBB), the scope of the framework is too extensive as it includes all instruments. On the contrary, credit spreads, which are based on a market perception, should not apply to illiquid and non-market instruments whose value does not change according to these market spreads. The scope should thus be restricted to instruments that have a clear market price transparency andare easily tradable on a large and deep enough market, because only these assets are subject to the market perception. Moreover, a clear definition of the terms “market credit spread” and “market price of credit risk” is needed.

To avoid different interpretations and ensure a level playing field, it should be stated explicitly in the Guidelines, that non-marketable instruments, such as loans to customers, should be generally exempted from CRSBB as they are covered by the bank’s credit risk management framework.

Finally, the new IRRBB standardised methods for the economic value of equity (EVE) and NII seem to be very calculation intensive but, at the same time, less granular than many banks’ internal models. We therefore stress that both banks and supervisors may lose interest rate risk management insights if banks are required to apply them by their national authorities. ​

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Considerations on the BCBS principles for the management & supervision of climate-related financial risks

The Basel Committee on Banking Supervision (BCBS) has published a public consultation on principles for the effective management and supervision of climate-related financial risks. The document forms part of the Committee’s holistic approach to address climate-related financial risks to the global banking system and aims to promote a principles-based approach to improving both banks’ risk management and supervisors’ practices in this area. This new position paper based on our response to the consultation.

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Considerations on the BCBS principles for the management & supervision of climate-related financial risks

The Basel Committee on Banking Supervision (BCBS) has published a public consultation on principles for the effective management and supervision of climate-related financial risks. The document forms part of the Committee’s holistic approach to address climate-related financial risks to the global banking system and aims to promote a principles-based approach to improving both banks’ risk management and supervisors’ practices in this area. This new position paper based on our response to the consultation.

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ESBG welcomes EBA's greater emphasis on proportionality

ESBG welcomes that the EBA is placing greater emphasis on proportionality in regulation, and hopes that this will pave the way for more proportionality in future regulations. However, more can be done to improve the proposed classifications, increasing granularity and have a paper which better explains how the ideas could be implemented.

We welcome the EBA’s commitment to using, primarily and as far as possible, already existing data from its database of supervisory reporting. However, if more data is required from financial institutions, we urge the EBA to deliver on the promise that these collections are proportionate to the complexity of the underlying requirements itself and to the burden of institutions and supervisors to deliver such data.

We consider the step-by-step approach to be suitable in principle. However, the procedure in step 2 is not clear. In our view, the proposals for the metrics are not yet fully developed. It is not sufficiently clear how on this basis – without concrete benchmarks – the decisions of a political expert can be better supported.

ESBG very much appreciates the inclusion of a classification for co-operative and savings banks. These banks are by nature local, rather small banks with a low-risk profile and a focus on core banking business. We urge the EBA should ensure that the proportionality considerations are also applied to small and non-complex institutions that are part of a consolidated group, particularly credit institutions that are only locally/regionally active and therefore do not have a systemic impact.

We would like to point out that Classification III has clear disadvantages compared to Classifications I and II. Institutions that are to be subject to the strictest regulation are to be delimited by means of a size criterion (€ 30 billion balance sheet total; point 31 lit. d of the EBA discussion paper). A delimitation on the basis of the balance sheet total would contradict the basic idea of a sufficiently differentiated regulation on the basis of the pro-portionality principle.

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The EU Commission’s proposed ‘single-stack’ approach for Basel III finalisation would harm European banks

ESBG also calls for a proportionate implementation of the Basel III framework in the EU banking system to ensure that Europe’s diversified banking sector continues to foster economic growth.

BRUSSELS, 27 October 2021 – The European Savings and Retail Banking Group (ESBG) calls on the European Parliament and the Council of the EU to reconsider the output floor implementation on a ‘single-stack’ approach included in the European Commission’s proposal for the finalisation of the Basel III standards in the EU, announced today.

The ‘single-stack’ approach would mean applying the output floor to EU-specific capital requirements, on top of internationally agreed ones. ESBG calls for the use of the ‘backstop approach’, meaning applying the floor only to internationally agreed capital requirements. The ‘backstop approach’ would help preserve and strengthen the EU’s diverse banking system. Otherwise, the ability of Europe’s diversified banking sector to provide finance to the real economy and foster economic growth could be hampered.

“ESBG and its members believe that the Co-legislators should implement the Basel III framework adapting it to the specificities of the European banking market, where needed. This includes an application of the output floor that does not exceed what is explicitly laid down in the agreement on the finalisation of Basel III”, said Johanna Orth, Chair of ESBG’s Task Force on Basel.

The package of reforms to finalise the Basel III framework is designed for internationally active banks. Therefore, when implemented within the EU regulatory framework the EU special features should be considered, including those which are already enshrined in the banking regulation. In particular, the so-called SME supporting factor should be retained, as it provides the right incentive to stimulate real economic growth.

“The implementation of the Basel standards within the EU regulatory framework should reflect the proportionality principle, taking into consideration the risk nature, scale and complexity of the activities of European credit institutions”, said ESBG Managing Director, Peter Simon.

This would allow financial institutions to carry out their activities under a non-detrimental regulatory framework which strengthens the European banking sector – the backbone of the EU’s ‘real economy’. A disproportionate regulatory weight also would negatively impact banks, which would be overburdened with regulatory requirements that could even push resources away from customer service.

The EU banking sector’s diversity ensures that a full range of services is offered to customers at competitive prices, in particular by banks that focus on SMEs, households and local communities.

In this context, ESBG is looking forward to bringing the voice of its members to the upcoming legislative process. We believe that close cooperation among all stakeholders will be indispensable for the successful implementation of the finalised Basel III standards. We encourage the EU decision-makers to make full use of the discretions envisaged in the Basel III text, including those on operational risk, which will be crucial for continuous and solid credit provisions to the real economy after the implementation phase.

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