To overfulfil Basel III in Europe would deal a severe blow to banks and the real economy

A massive burden will be imposed on European banks and financial institutions if maximum implementation of the Basel III reform, the approach preferred by the European Banking Authority (EBA), goes ahead, the Association of German Pfandbrief Banks (vdp) has warned. This concern was announced on the back of the EBA’s “Basel III Reforms: Updated Impact Study”. In its latest impact study the EBA recommends that the Basel III reform be implemented far beyond the extent justified given the circumstances, despite the imponderabilities of the Covid-19 pandemic.

Under the implementation approach recommended by the EBA, the minimum capital requirement for banks across Europe would rise by 18.5 percent on average, while real estate finance providers would have to shoulder an increase of 23 percent. For German banks as a whole, this gold-plating of the Basel requirements would result in an even sharper increase in the minimum capital they must hold, namely by 35 percent – which is almost twice the burden to be imposed on European banks on average.

“It is obvious, therefore, that the supervisory authorities have missed by far the objective they set themselves, namely not to ‘significantly’ increase the capital burden for the banking industry through the Basel III reform,” vdp Chief Executive Jens Tolckmitt emphatically stated.

In order to meet the new capital requirements without raising new equity, the total lending volume of German banks would have to be reduced by roughly one quarter, Tolckmitt said.

“Gold-plating the Basel requirements in Europe would lead to undesirable side-effects and damage financial stability.”

The increase in capital requirements would primarily be driven by the planned implementation of the output floor. In the case both of German banks and of European real estate finance providers, around half of the envisaged additional capital requirements would result from the output floor, which sets a lower limit for the minimum capital these institutions must hold. In future, the output floor for the capital requirement calculated using internal models would amount to 72.5 percent of the capital requirements under the standardized approach. In consequence, the capital requirements for banks that use internal risk models would experience a massive increase, with especially serious implications for low-risk business areas such as real estate finance.

One solution that would mitigate the effect of the output floor while at the same time complying with the wording of the Basel Accord is the parallel stacks approach, which has already garnered the support both of large sections of the banking industry and of several EU Member States as an appropriate way to implement the output floor. This approach places less of a burden on banks than the EBA‘s proposal. A further advantage is that banks would continue to back their assets with capital in a risk-sensitive manner.

“Under the parallel stacks approach the output floor remains what the supervisory authorities themselves originally defined it as being: a backstop that rightly sets a lower limit for the variability of model-based capital requirements, but without becoming the control variable that prevails above all others.”

“The Pfandbrief banks are in favour of a supervisory approach that is globally consistent. For this reason, they support implementation of the Basel III reform in Europe. What is more, they are not opposed to the output floor according to the wording of the Basel resolutions or to the level of the output floor of 72.5 percent under the standardized approach, as agreed in Basel. However, they emphatically take issue with an implementation in Europe that far exceeds – without any need whatsoever – the level that Basel stipulates,” Tolckmitt remarked.