Changes in the EU Banking Package: Basel IV on its way

It has been known since the beginning of the year that important changes are coming for banks with the revision of the Basel III standards. Recently, the details and a timeline for the implementation of Basel IV have started to take shape.

Specifically, on June 27, 2023, the Council of the European Union achieved a milestone by announcing the successful conclusion of the trilogue negotiations* on the EU banking package. This means that the introduction of Basel IV regulations in the EU will proceed as planned in 2025. Although the final legislative texts are still being worked on, there are already exciting insights into the negotiation results.

Overview of the banking package

The EU banking package not only includes the implementation of Basel III standards but also comprises a range of measures to strengthen the EU supervisory framework regarding sustainability risks and the supervision of branches from third countries. In addition, improved tools will be made available to the supervisory authorities overseeing banks in the EU.

Why are these reforms so important? 

Significant changes are being made in how banks calculate their risk weights, leading to a change in the calculation of capital requirements. This can have substantial implications for their capital positions, business models, and risk management strategies. Banks must ensure they have sufficient capital reserves to meet the new requirements.

3-stage Model

One of the most interesting changes in the package concerns the revision of Article 121 of the CRR (Capital Requirements Regulation) - "Exposures to unrated entities." 

Currently, risk exposures to institutions that are not rated by a nominated rating agency (ECAI) are assigned a risk weight that corresponds to the credit quality step assigned to exposures to the central government in whose jurisdiction the institution is domiciled. Under the new revised approach, institutions must then categorise their exposures to these institutions into one of three grades based on a number of quantitative and qualitative criteria. The new approach attempts to break the link between institutions and their sovereigns.

This results in three new classifications for risk weights:

Class A

  • Institutions with sufficient capacity to fulfil their financial obligations over the entire credit period
  • Institutions that exceed the capital requirements, P2R and the combined capital buffer requirement

Class B

  • Institutions with significant credit risk where repayment depends on a stable and positive economic situation
  • Institutions in this class fulfil all regulatory minimum requirements, while at least one applicable buffer (e.g., buffer for systemically important banks, capital conservation buffer and countercyclical capital buffer) is not fulfilled

Class C

  • Class C serves as a catch-all category for institutions that cannot be classified as Class A or Class B
  • This class includes institutions that do not fulfil at least one of the minimum regulatory requirements or for which the auditor has issued a qualified audit opinion or has significant doubts about their ability to continue as a going concern.

The risk weights for these categories were determined accordingly, with class A having the lowest risk weight, followed by class B and class C:

Assessment of Credit RiskClass AClass B Class C
Risk Weights40%75%150%
Risk Weights for Short-Term Positions20%50%75%
T1 ≥ 14%, LR ≥ 5%, and Risk Category A (short term)30%--

What happens next?

Following the provisional agreement in the trilogue process, the technical drafting of the legal texts for the compromise solutions found and a review of the final CRR III draft will now take place. Following the adoption of the final version of the EU banking package by the European Commission, the European Parliament and the EU Council, the package will be published in the EU Official Journal. The new regulations are expected to be officially announced at the beginning of 2024 and will enter into force 20 days after publication. Full implementation of the changes to the Capital Requirements Regulation (CRR) is scheduled for 1 January 2025, with certain elements being introduced gradually over the coming years.

Clear advantages for FinAPU customers

These developments of the EU banking package have far-reaching effects on the European banking landscape and on how risks are assessed and regulated. FinAPU has been working with its partners since the spring to implement these requirements. Our clients benefit from our access to financial data from banks, which is essential for assessing banks and carrying out regulatory calculations.

We are also exploring the possibility of assisting internationally active banks in reducing their capital charges for their unrated bank exposures. FinAPU can access a database containing minimum capital requirements, along with additional buffer information, to assign risk weights. This would offer a clear and up-to-date overview of the new capital requirements and risk weights for the portfolio of banks you monitor. If you are interested in obtaining this dataset, please contact us.

* A procedure in the European Union (EU) that is used for legislation. It occurs when the EU institutions - the European Parliament, the Council of the European Union and the European Commission - have different positions on a legislative proposal.

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