The EU’s Capital Requirements Regulation (CRR) copied out almost all the Basel 3 standards for capital, leverage and liquidity. Basel 3 focused primarily on the numerator of the capital ratio (the quantity and quality of capital that a bank is required to raise), leaving the denominator (the risk weighted assets equivalent of a bank’s credit, market and operational risks) largely unchanged from Basel 2.
The Basel Committee is currently developing significant revisions to the calculation of credit, market and operational risk; and is proposing a new ‘capital floor’ to limit the extent to which a bank’s internal models-based approaches can drive its calculations below those under the standardised approaches. The revisions to the market risk framework have already been finalised, with an implementation date of 2019. All these revisions are part of ‘Basel 4’.
The wide-ranging nature of these revisions means that they will have to be applied in the EU through substantial revisions to the CRR – in effect a CRR2 – and through a new round of EBA technical standards and guidance. Just copying out the revisions will be a massive task.
But the more interesting aspect of the development of CRR2 is how the EU will implement the Basel Committee revisions. Key considerations include:
Early signs of the Commission’s new approach emerged in its recent consultation paper on the revised market risk framework. This consults on options to take a more proportionate approach by (i) allowing smaller and simpler credit institutions to use simplified standardised approaches to market risk; and (ii) extending the existing CRR derogations under which some small institutions can take a credit risk (rather than market risk) approach to position risk.
The paper also consults on changing one way in which small firms can benefit from a proportional approach, by replacing the current ‘original exposure method’ (OEM) for the calculation of derivatives exposures with an alternative simple standardised approach for counterparty credit risk (the SA-CCR).
The Commission is also consulting on the net stable funding ratio (NSFR). The main focus here is on the treatment of derivatives and repo transactions, to limit an adverse impact on banks’ access to these sources of funding. The Commission also asks an open question on whether the NSFR standard should be applied proportionately, but without any proposals on how this might operate in practice.