When the aftermath of the financial crisis hit economies in Europe and abroad, the world's top banking supervisors were called upon to craft new reforms.
During the ensuing years, savings and retail banks across Europe have taken great interest in their initiatives and threw what weight we had behind ideas we think help. A stronger European banking sector was at stake, one that serves the real economy – especially households and small and medium-sized firms.
Banking reform has worked for the most part. For example, the Single Supervisory Mechanism successfully re-organised and boosted the quality of banking supervision in the eurozone. The so-called Single Rulebook has brought added value, in particular, for cross-border activities.
But despite these successes, there remain troubled waters ahead. Bold new proposals discussed this week at Basel level may go a step too far. That agenda includes a proposed ratcheting up of capital requirements, which could sound the death knell to some business models. Europe is a largely bank-funded marketplace, so any measure to stifle lending is unwelcome to banks, businesses and society as a whole. It has proven hard for policymakers, especially in Europe, to acknowledge this.
Upping the capital requirements hits especially hard the locally rooted and less complex model, which make up a third of retail banking in Europe and provide €500 billion in loans to SMEs there. When the required amount of money set aside by savings and retail banks climbs, lending activity suffers. That prospect threatens a diverse banking system and global level playing field. The Group of Central Bank Governors and Heads of Supervision, the oversight body of the Basel Committee, said that they don't intend to significantly raise capital requirements. We hope Europe isn't stuck carrying most of the increase.
What the Basel Committee can do
To get a fair deal for all banks in Europe, which includes a level playing field, the devil will be in the details. The Basel Committee re-considers some of its regulatory steps and re-calibrates certain proposals elements. Risk weights for various exposure classes would be a good place to start. We agree that unjustified differences in risk weights should be removed and comparability should be improved. But we question whether the correct approaches have been chosen at all times. A one-size-fits-all solution won't work. One example is the real estate sector, where risk levels vary in one region from another. Risk models should be allowed to reflect this.
Real-economy banks that make up ESBG membership back initiatives by the European Banking Authority that aim at enhancing the trust in internal ratings-based (IRB) models as a valid tool to measure capital requirements. Establishing common methodologies for these models work. Supervisory authorities should make every effort to improve internal models instead of imposing standardised floors for all credit institutions, regardless of their business model, or abandoning the use of certain models. Even if calibrated at the lowest proposed level, so-called output floors based on the standardised approach would wipe out entirely the risk sensitivity of the capital requirements for several ESBG members – stable banks focusing on traditional low risk lending – while not affecting banks with a considerably higher proportion of high risk assets on the balance sheet. We question whether this is really the Basel Committee's intention with its review. Reconciling different banking systems through one global policy approach is a tough task. Certain proposed calibrations, such as the corporate and retail exposure classes, give us pause, as do approaches to due diligence requirements around revisions to the standardised approach for credit risk.
Impact assessments have been given short shrift in this drama. In January, the Basel Committee announced that it would conduct a quantitative impact assessment during 2016. Impact assessments are welcome for not only testing the impact of new regulations on the industry but also possible calibrations. So far, the impact assessments have mostly fallen flat, lacking deep analysis. Conducted only on a consolidated basis or have been aiming at globally important banks solely, their scope leaves out smaller and less complex banks that include many of our members. Approaches are misfit for them, which means high compliance costs that don't need to be there. The Basel Committee should pursue thorough impact assessments that better take into account the impact on all banks.
Impact assessments should also take into account the interactions between the different parts of the Basel reforms as well as the existing regulatory framework and other recent developments such as TLAC. Looking at the overall picture, one can have the clear grasp of the probable outcome. It is especially notable that floors based on the standardised approach depend on the final calibration of the revised standardised approach. Limits to IRB models also rely on the other two legislative pieces.
Calibration of the revised capital requirements is so far foggy at best and inconsistencies have surfaced. With so much uncertainty, it would be best to postpone final decision about calibration until further analysis can provide sufficient evidence that the global level playing field is maintained and unwanted consequences can be excluded. Special attention should be given to savings and retail banks that finance the real economy.
Staying true to G20 calls or real economy will suffer
A safe and sound banking system requires a global level playing field, an element G20 leaders have called for. The Basel reforms on the table endanger this. If the Basel Committee sticks to G20 guidance before making any final decisions on its regulatory reforms, then no significant increase in capital requirements can occur. If they forego G20 calls, then expect the diversity in business models that has proven a great asset in times of crisis to be put in peril. Banks' ability to lend to the real economy is ultimately at stake.
>> See the related piece that appeared in the latest edition of global risk regulator
Chris De Noose