In a joint letter to the European Commission (EC), the Central Bank of Malta (CBM) and 24 other national central banks and financial supervisory authorities from 20 member states are calling for EC to ensure that the proposal on updated capital adequacy rules for banks in the European Union follows the global agreement known as Basel III. During the autumn, EC is expected to publish a proposal for updated capital adequacy rules for banks in the European Union. The authorities emphasize that the output floor for risk-weighted assets and the standard method for credit risk should comply with the international agreement and that the European Union should not introduce any deviations from the rules. Deviating from the Basel agreement could have a negative impact on confidence in both the European banking sector and the regulatory framework in European Union. It is therefore important that the global agreements are met in full, on time, and in a consistent manner.
According to the letter, the European Union implementation should adhere to the letter and the spirit of the Basel III agreement. Diluting the framework would not be in the best interests of Europe. The pandemic shows that more resilient banks are better able to support the real economy, even during times of crisis. Ensuring that banks are resilient is, therefore, good for economic growth, something Europe clearly needs. Adhering to the Basel framework would also facilitate market monitoring, as it simplifies comparisons of different banks. This, in turn, would assist in the much-needed restructuring of the European banking industry. However, if the European Union deviates from the agreement, Basel III implementation may be derailed in other countries also, not to mention the following three important implications of this for the European Union:
- The output floor should be implemented as agreed in Basel, with all risk-based capital measures and buffers calculated on the basis of one single set of risk-weighted assets. This has several benefits: it is simple and transparent; it reduces the variability of risk-weighted assets; it builds confidence in banks’ capital structures; and it improves the level playing field between banks using internal models and banks using standardized models as well as between different banks using internal models worldwide. This also increases the usability of the capital buffers. A parallel stack approach to the output floor does not attain these benefits and, therefore, should not be pursued. Furthermore, the application of the output floor to all levels of consolidation, consistent with the prudential requirements such as the leverage ratio, should be considered.
- The new Basel standardized approach for credit risk should be implemented as agreed globally. This approach is more risk-sensitive than the old one and it entails a delicate balance between the risks in different exposure types.
- The European Union-specific deviations should be minimized and the existing deviations from Basel should be re-assessed. In addition, the European Union should refrain from making further exemptions from Basel III or from making the banking regulatory framework more complex.
Keywords: Europe, EU, Malta, Banking, Credit Risk, Basel, Regulatory Capital, CBM, Central Bank of Malta
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