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    ECB Study Assesses Impact of Basel III Finalization Package

    July 26, 2021

    The European Central Bank (ECB) published a paper as well as an article in the July Macroprudential Bulletin, both of which offer insights on the assessment of the impact of Basel III finalization package on the euro area. The paper applies a growth-at-risk perspective and shows that the finalization of Basel III reforms will bring about a net benefit in the medium to long term. The paper shows that reforms are expected to have a strong positive effect on the leverage ratio of banks and boost financial resilience of the banking sector through higher loss-absorbing capacity and lower bank funding costs. However, the estimates cannot anticipate the changes in the banking sector that will have taken place by 2023, the current timing of the introduction of the reform.

    Additionally, the article in the Macroprudtial Bulletin also concludes that the transitory economic costs of the plain vanilla Basel III approach are outweighed by its permanent long-run benefits. The costs of the phase-in of the plain vanilla Basel III finalization are moderate and amount to a transitory reduction of Gross Domestic Product (GDP) growth by 0.1 percentage points from the second to the fourth year after its initialization, and eventually disappear in the seventh year after the introduction of the reform. Completing the Basel III reforms will benefit long-term bank solvency and profitability. Banks will be in a better position to absorb losses in adverse economic conditions and will face lower funding costs. However, implementing EU-specific modifications to the Basel III reform, such as the small and medium-size enterprise (SME) supporting factor, credit valuation adjustment (CVA) exemptions, and discretion with regard to the operational risk capital charge reduce the already moderate transitory costs of the reform, although they also reduce its long-run benefits. Approaches that, in addition, modify the implementation of the output floor fail to further reduce the short-term economic costs of the reform while again decreasing its long-term benefits. The long-run benefits from the least binding output floor implementation (the parallel stacks approach) are negligible, amounting to only a quarter of the benefits under the plain vanilla Basel III finalization.

     

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    Keywords: Europe, EU, Banking, Leverage Ratio, Macro-Prudential Policy, Growth at Risk, CVA, Regulatory Capital, Basel, ECB

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