EU banks may still get output floor capital exemption, despite global rules, docs show

EU banking officials are still pursuing measures which would undermine international rules designed to ensure lenders hold enough capital, MLex has learned.

Banks would be able to use aggressive internal models to reduce their capital requirements under the “parallel stack” approach, according to a document issued by the European Commission’s financial services arm DG Fisma, and seen by MLex.

Nevertheless, the document says, Fisma officials are still considering this model as one of the options to put forward in a legislative proposal, which is due in the coming months.

In 2017, standard-setters at the Basel Committee on Banking Supervision agreed on an "output floor" to limit the use of internal models, meaning banks must stick closely to centrally agreed formulas for assessing risk. US authorities, in particular, were concerned that European lenders would use tricksy calculations to undercut post-crisis capital standards and lend beyond their means.

Last December, the European Banking Authority agreed to model alternative approaches, including one known as a “parallel stack,” in which banks would calculate risk-weighted assets in the approved way only when applying internationally set capital requirements.

They could still use a separate, more favorable method when applying the EU’s own discretionary add-ons, such as the buffers applied to second-tier, locally systemic lenders like Commerzbank and Crédit Mutuel, and those based on supervisor’s assessments of sloppy governance in individual banks.

In practice that approach would likely mean the much-vaunted output floor actually has no impact at all. The EBA also says they would break the Basel rules, which require supervisors to stick to a single means of calculating balance sheet size.

That view is apparently shared by DG Fisma, whose legal proposals are expected sometime around June. The parallel stack “undermines [the] purpose of the output floor,” as well as other capital requirements, “as it would likely have no impact on banks with aggressive internal models,” says a document sent by Fisma officials to banking experts, seen by MLex.

Determining when undercapitalized banks need to stop paying dividends and bonuses would also become more complex, and it would be harder to compare the positions of different lenders, according to the document — which nonetheless presents the alternative as one of several ways Brussels could choose to implement the Basel deal.

Apparently under pressure from national governments and lobbyists seeking to minimize the impact of the change on the EU’s beleaguered and unprofitable banking sector, the paper also examines a few intermediate solutions, in which risks linked to the use of faulty models or fluctuating interest rates in the banking book would still be included within the output floor.

Broader

Debate continues to rage over other major features of the new regime.

The Spanish government appears to have taken up the cause of major lenders like Santander, saying banks should calculate operational risks without regard to historic losses. Others have argued the new rules are too harsh on loans made to the many European companies that don’t have a credit rating because they don’t seek capital-market funding.

The EBA has proposed applying the new rules to each of a bank’s subsidiaries rather than the group as a whole, though the European Central Bank has said that would damage individual units that zero in on specific areas like mortgage finance.

Ongoing reforms to the EU’s crisis-management framework, on which proposals are due later this year, may also prompt questions over the capital treatment of sovereign bonds, in a bid to limit the death spiral in which ailing banks can make their governments financially unstable, and vice versa.

The final decision could have a major impact on European banks, which might have to raise as much as 52 billion euros ($63 billion) in extra capital to meet global norms, EBA analysis in December said. That falls to 33 billion euros if the bloc keeps carveouts in areas like small-business lending, and just 15 billion if they can calculate using the "parallel stack" approach.

A commission spokesperson told MLex it is “looking at various implementation options for the output floor, as part of its impact assessment.”

Asked if the proposal would comply with Basel norms, the spokesperson said the commission “intends to have an implementation which will be faithful and which will take into account EU specificities.”

* Updated on Feb. 16, 2021, at 09:08 GMT: Adds European Commission's spokesperson statement.