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Opinion 14 June 2019

New package of banking reforms to prevent crises

In this article, Javier Pablo García Tolonen and Pilar Soler Vaquer, Financial Regulation BBVA, explains his vision about the “banking reform package”.

On June 7, after more than two and a half years of intense negotiations, the reform of the prudential and bank resolution frameworks, the so-called “banking reform package”, was published in the official journal of the EU finally. This new set of rules is part of the risk reduction measures for the banking sector that some see as a necessary step to continue moving towards deeper integration in Europe.

The objective of this reform is to introduce the latest Basel standards that had not yet been transposed into European legislation (although it does not include the package known as Basel IV), to implement the international standard for loss absorption “TLAC” (Total Loss Absorption Capacity) and to introduce a series of technical improvements to the regulatory framework that had previously been identified in an impact assessment by the European Commission.

The new “CRR 2” and “CRD 5” introduce important changes to the prudential framework. On the one hand, the legal requirements for the leverage ratio and the net stable financing ratio, which until now have only been included as a reporting obligation, become binding. In addition, the package also reviews the way some risks are measured, such as counterparty credit risk or interest rate risk within the banking book. Initially, market risk requirements were also going to be included, but the Basel Committee published the final standard in the middle of the negotiations, so EU legislators decided to postpone it. New rules are also introduced for exposures to central counterparties and for large exposures.

On the other hand, another set of reforms respond to technical improvements in the regulatory framework. Among them, an attempt is made to provide greater proportionality to regulatory requirements, mainly in terms of reporting, information disclosure or remuneration. Finally, the Pillar 2 framework is reviewed, in order to make it more homogeneous and comparable between entities, and changes are introduced in the macroprudential capital cushions, making the framework more flexible for large entities.

The “BRRD2” introduces significant changes to the recovery and resolution framework. Systemic banks (those supervised by the ECB) will have to comply with a minimum MREL (minimum requirement of own funds and eligible liabilities) equal to TLAC. But both systemic and non systemic banks will have to comply with an additional requirement that will be set case by case based on a relatively rigid formula but which is tougher than the current requirement.

However, the most significant change to the financial management of banks will be the new subordination requirement, which obliges entities to comply with MREL with a high percentage of subordinated liabilities (those that absorb losses before other ordinary liabilities). At the end of the negotiations, the toughest version was adopted, according to which large EU banks will have to comply with MREL with a minimum subordination requirement equivalent to 8% of their total liabilities and own funds.

Additionally, EU authorities have approved a new “moratorium” tool applicable to certain liabilities including covered deposits. The idea is to contain bank runs for a few days by limiting the withdrawal of deposits; in other words, a corralito. The authorities will have additional time to manage banking crises but it would be more reasonable to do it with liquidity support, an aspect still missing in the resolution framework.

Next steps

Certain parts of the new regulations will come into effect on June 27, such as MREL for G-SIIs, conditions for the amortization of capital instruments and eligible liabilities and disclosure of some prudential requirements. But most of the new regulations will not take effect until December 2020 – June 2021. Finally, some requirements benefit from a period of grandfathering before which they will not be mandatory as the eligibility of capital instruments (6 years) or that of eligible liabilities (until maturity).

To conclude, the publication in the OJEU does not mean the end of the legislative cycle. Now begins the work of the EBA, which will have to develop standards and technical guidelines, the so called ” Level 2″ legislation. The work of the EBA is crucial since banks need clarity when it comes to complying with more and more complex regulations. In parallel, each state must transpose a large part of the regulatory package to its national framework. In short, one step forward, but not the last.

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