ECB Issues Opinion on Proposed Amendments to CRR

ECB welcomes the European Commission (EC) proposal to implement Basel III reforms in European Union, reinforce the Single Rulebook, and enhance the prudential framework for credit institutions in various areas. As part of its assessment, ECB observed that during periods of economic and financial distress, credit institutions might not be willing to use their capital buffers. Looking forward, ECB is of the view that further consideration should be given to removing disincentives to using capital buffers. In its opinion, ECB sets out certain observations on the following topics:

• Introduction of output floor. ECB notes that the proposal includes significant transitional arrangements leading to lower risk-weights than those envisaged in the Basel standards in certain areas—namely, residential real estate exposures with low historical losses, exposures to unrated corporates, and the calibration of counterparty credit risk related to derivative exposures. ECB considers that these deviations from the Basel III standards are not justified from a prudential and financial stability perspective and may leave pockets of risks unaddressed.
• Standardized approach under credit risk framework. ECB notes that the proposal contains several new deviations from Basel III standards, especially regarding specialized lending exposures, equity exposures, retail exposures, and the methodology for collateral valuation for exposures secured by immovable property. ECB considers that these deviations may reduce the consistency and safety of the new standardized approach and leave certain risks uncovered.
• Operational risk. While ECB acknowledges that the Basel III framework offers the possibility to disregard historical losses for the calculation of capital requirements for operational risks, it regrets that EC did not opt for a recognition of these losses. ECB considers that taking into account the loss history of an institution would entail more risk-sensitivity and loss coverage of capital requirements, addressing the divergence of risk profiles of institutions; it would also provide greater incentives for institutions to improve their operational risk management. ECB would, therefore, favor an implementation where the internal loss multiplier is determined by historical losses incurred by the institution and is gradually introduced.
• Market risk. ECB notes that the proposal enables EC to change the calibration of capital requirements under the new market risk framework as well as to postpone, by two additional years, the implementation of this framework. This could allow the reduction of capital requirements, thus diverging from the Basel III standards. ECB favors limiting these powers under the current proposal. ECB considers it important that these standards are applied consistently at international level and calls for a faithful implementation of these internationally agreed standards by 2025.
• CVA risk. ECB notes that the proposal does not reconsider existing exemptions adopted by the European Union and recalls that these exemptions were assessed as a material non-compliance in the previous regulatory consistency assessment program of the Basel Committee in 2014. ECB considers that these deviations are not justified from a prudential perspective and leave institutions exposed to uncovered risks from their derivatives transactions with exempted counterparties
• Internal ratings based approach. ECB highlighted inconsistencies in the proposal that may hinder the overall correct implementation of the requirements. To reduce the risk of misinterpretation, ECB recommends to further align, across different articles of the amended CRR, the terms used to identify the size of corporate obligors, such as turnover, revenue, and sales. Furthermore, consistency needs to be ensured between default definition and the estimation and implementation of risk parameters. For the new requirements on probability of default (PD) estimates, ECB considers that further specification of the time horizon for rating assignments would ensure adequate risk differentiation, despite adverse economic conditions, and increase the risk-weighted asset comparability across institutions.
• Pillar 3 disclosures and reporting. ECB notes that the proposal applies different approaches in relation to the quantitative public disclosure of small and non-complex institutions (SNCIs) and larger institutions. ECB considers that SNCIs approach for quantitative disclosures could be applied to all institutions, regardless of their size and complexity, with a view to reducing the reporting burden of all institutions. ECB notes that to ensure consistency, the policy on resubmissions to the European Banking Authority (EBA) envisaged in the amended Article 434a of CRR should not be limited to public disclosures but should also cover supervisory reporting. 
• Environmental, social, and governance (ESG) risks. A better integration of ESG risks into the prudential framework is crucial to increase the resilience of the banking sector. ECB welcomes the proposal to introduce harmonized definitions of ESG risks and values the stated intention to align the definitions with those proposed by EBA in its report on management and supervision of ESG risks for credit institutions and investment firms. However, ECB observes divergence in the wording of the proposed definitions vis-à-vis the wording used by EBA. ECB proposes refinements to the wording of the definitions to ensure closer alignment with the definitions proposed by EBA.

Related Link: Opinion (PDF)

Keywords: Europe, EU, Banking, CRR, Basel, Regulatory Capital, Credit Risk, Market Risk, Operational Risk, CVA Risk, IRB Approach, ESG, Disclosures, Reporting, Pillar 3, Opinion, ECB, Subheadline