SO WHAT WAS the Basel Committee on Banking Supervision’s final score implementation of Basel III rules in the nine European Union countries that are part of the committee? Materially non-compliant. That’s right! Probably a bit harsh as an overall score, but the countries came up short on two measures and on that basis that you can only score as well your lowest grade. Well, the score was the score.
No big surprises, mind you, as the outcome had been leaked. But the EU’s slightly frosty response (“we agree to disagree”) and its contention that Basel has misread its own standards suggests that, while the Regulatory Consistency Assessment Programme under which the school report was compiled is supposed to facilitate dialogue between committee members, this specific conversation may not have been that cordial.
RCAP functionaries are hardly the attack dogs of the Basel regulatory mafia, but you wonder if they’re looked on as those slightly grey operatives who stand in the shadows taking copious notes you just know are being pushed up the line. In fairness, the job of the RCAP is a reasonable endeavour: rating efforts by regulators on how closely they’re keeping to the letter and spirit of the Basel standards and, perhaps more importantly, highlighting deviance from the standards around domestic regulation for internationally active banks.
Given how much I’ve moaned about lack of regulatory consistency in the past, I guess I should be rooting for the RCAP. The latest report covers efforts by Belgium, France, Germany, Italy, Luxembourg, Netherlands, Spain, Sweden and the UK, which between them account for 14 of the latest list of 30 G-SIBs and a lot more internationally active banks besides.
As well as a shot across the bows of the member states – after all CRR/CRD have been in force since January and almost a year in, the EU is still facing a ton of remedial work – the EBA came in for some stick, too. “For the full implementation of CRD IV and the CRR, the EU relies upon the timely issuance of EBA standards and guidelines and consistent adoption of rules and guidance at Member State levels as prescribed under CRD IV,” the report read. “This process remains a work in progress”. Ouch.
The internal ratings-based approach for dealing with credit risk was “materially non-compliant”
THE ASSESSMENT FOUND eight of the 14 components under review met all minimum provisions and were “compliant”, while four were “largely compliant”. However, the EU’s counterparty credit risk framework, which provides an exemption from Basel’s CVA capital charge for certain derivatives exposures, was rated “non-compliant”. The internal ratings-based approach for dealing with credit risk – primarily the treatment of SME, corporate and sovereign exposures – went one worse and was “materially non-compliant”.
Basel found “several important divergences”, including the exemptions for various types of credit exposures. “In addition,” it said, “concessionary risk weights have been extended to SME exposures for customers located in both the EU and abroad. This also constitutes an important departure from the letter and the spirit of the Basel minimum requirements independent of the economic imperatives associated with this policy choice made under the CRR and CRD IV”.
Basel also doesn’t like the splitting of residential mortgage loans into lending qualifying for a 35% risk weight. “Lending not qualifying for this preferential treatment, as permitted under EU law, is not envisaged under the Standardised Approach for credit risk”, it said.
On the approaches for counterparty credit risk, the major deviation arises with respect to CVA exemptions for various obligor exposures, which worries Basel given the global nature of OTC swap market. Another notable deviation came in the treatment of investments in the capital instruments of insurance company subsidiaries in the definition of the capital component of the Basel framework, and in the credit risk components, where, it said, “some EU requirements are more liberal than those stipulated by the Basel standards”.
The EU’s detailed retort essentially concluded that the two issues singled out by the Committee require legislative change. “We are aware of the deviation from the current Basel III framework regarding CVA risk capital requirements and its materiality according to the agreed methodology. However, in our view, the issue should also be considered in the light of ongoing discussions in the Basel Committee. I sense lots of technocratic meetings in windowless smoke-filled rooms in Basel. Hmmm … lovely.
AS A POSTSCRIPT, IFR’s Bank Capital and Funding Conference on November 20 was a huge success and we had standing room only for much of the day as we discussed the finer points of the regulatory capital debate.
I posed to one of our distinguished panels whether we might see the emergence of a layer of short-dated OpCo subordinated non-regulatory capital debt aka New Tier 3 that would sit above the capital stack and protect subordination of senior unsecured debt under TLAC/MREL bail-in.
My question was met at the time with disapproving looks and a slightly stony silence. So I was delighted to see that Danske Bank is looking at exactly that: a Tier 3 note for that exact purpose. It may never see the light of day. That’ll depend on the structurers and investor receptivity. But there’s nothing like feeling vindicated, right?
