Just when many of us were about to head into summer vacation this year, an updated capital requirements framework, commonly referred to as CRR II and CRD V, was published.
Based on drafts by the EU Commission from 2016, EU authorities have now agreed on and published final versions of the framework for capital requirements implementing the Basel framework introduced as a response to the latest global financial crisis in 2008 and aimed at making financial systems stronger and more stable. In addition to changes to the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD), the Banking Package includes among others updates of the Bank Recovery and Resolution Directive (BRRD) as well as Single Resolution Mechanism Regulation (SRMR) for euro participants.
Those items of the Banking Package included in the CRR are applicable without further national legislation and most changes enter into force in 2021 while some entered into force upon publication in June 2019. Items covered by directives, including the CRD, are subject to national implementation by end of 2020 and legislative processes are ongoing in the respective member states. In Sweden, the government has appointed a committee expected to present findings and a proposal of how to incorporate the requirements in Swedish legislation by December 2019. Overall the regulations also aim at calibrating several regulatory requirements for systemically important institutions as well as establishing simplified obligations under the proportionality principle for smaller and less complex banks.
Some of the finalised regulation has been anticipated and is already established in banks’ capital requirement frameworks: While the minimum requirements of a Leverage Ratio of 3% and a Net Stable Funding Ratio (NSFR) of 100% will become binding in 2021, their fundamentals are already incorporated in the EBA COREP reporting taxonomy. However, the new regulations introduce changes to the current concepts that will need to be implemented. Also, with the concept of “eligible capital” that previously included Tier I and Tier II capital discontinued, Large Exposure requirements will in future be measured against Tier I only, changing requirements for Large Exposure limits.
Significant changes stem from several changes to pillar I methodology introduced among others to the market and counterparty credit risk frameworks, the pillar II framework for Supervisory Review and Evaluation Process (SREP) as well as pillar III disclosure requirements. Also, changes in requirements for governance structures for large EU financial holding structures and remuneration schemes are introduced. Notably, the Banking Package also mandates the EBA to assess the inclusion of sustainable finance (environmental, social and governance risk) in the SREP process going forward.
While a limited number of requirements came entered into force upon publication 27 June 2019 (mostly related to significant institutions and the BRRD framework), the majority of CRR requirements enter into force in June 2021. National legislation to reflect CRD must be in place by December 2020. And as a famous German soccer player’s quote goes – after the game is before the game: In the midst of CRR II and CRD V, the finalisation of Basel III is ongoing, and CRR II is not the final word, or at least not all of it. What is often referred to as Basel IV is expected to be implemented in the EU after 2021 under a new CRR package with a third wave of changed and increased capital requirements.
Even if parts of the Banking Package, including national legislation and related changes to the EBA regulatory reporting framework, are still pending, it is time for banks to prepare for the new requirements. In a holistic approach encompassing end-to-end processes across the bank, this includes analysing the requirements, performing a gap analysis against the current framework and assumptions applied, identifying relevant scale and scope for needed changes as well as potential impact areas.
Reviewing the proportionality provisions, banks need to establish if and which simplified obligations apply, and which changes to governance, infrastructure, composition of the underlying capital requirements and resulting reporting requirements are necessary. Ideally, banks should include internal KRI/KPI frameworks based on the requirements effective in 2021 already today, and at the same time prepare for the changes and increased capital requirements expected beyond 2021.
Written by Andreas Liese