CMU factor is the key to any risk capital debate





December 1, 2016

Disagreements between Brussels and Basel look likely over upgrades to rules on standardising regulation on measuring risk capital requirements. But European Commission president Jean-Claude Juncker’s priority to boost growth by protecting bank interests could well prevail. By Jeremy Woolfe.

Fear of Basel refinements to regulation that could increase bank risk capital requirements are provoking strong protests from both the European Parliament and the European Commission in what could turn out to be a showdown against non-EU bank interests.

In response to the Basel Committee on Banking Supervision (BCBS), the EU is seeking to avoid conflict by going forward with other upgrades to its existing rule packages, including capital requirements regulation (CRR) and the capital requirement directive (CRD IV) (see news story: EU drifts from BCBS rules).

The disagreement centres around the commission’s view that the Basel review of how banks assess the value of their own reserves could lead to “a significant increase in the overall capital requirements shouldered by Europe’s banking sector”. It follows similar vehement opposition to Basel from the European Banking Federation (EBF) in June 2016.

A text from a commission spokesperson states: “A solution we could not support is one which would weigh unduly on the financing of the broader economy in Europe at a time when we are focused on supporting investment.”

It goes on to say: “The commission will, as with any legislation, take an approach that is proportionate to the way it is applied. That is also the approach we will take to implementing measures flowing out of Basel. We will closely consider any new Basel standards and adapt them if this is deemed necessary to reflect European specificities.” The commission could hardly have expressed itself more strongly.

However, it has come up with counter-measures. These comprise a series of proposals “to increase resilience of the EU institutions and enhance financial stability”.

Known colloquially as ‘CRD V’, these apply variously to the CRR/CRD rules, the Bank Recovery and Resolution Directive (BRRD), and to the Single Resolution Mechanism Regulation. The last two were adopted in 2014, and define what is needed to achieve the recovery of failing institutions.

All upgrades are said to incorporate the remaining elements of the regulatory framework agreed recently within the Basel Committee and the Financial Stability Board. They follow the international body’s recent note that over time “weak profitability could erode banks’ buffers”.

Risk vs stability

Hence, the commission’s new proposals aim to “reflect more accurately the actual risks to which banks are exposed” and protect financial stability and “minimise risks for taxpayers”.

Generally, the commission describes its overall position as what is needed implement the international TLAC (Total Loss Absorbing Capacity) standard. It holds that this mirrors actions taken by the US in 2014, denying a recent Financial Times headline suggesting it is motivated purely by tit-for-tat moves against the US.

The US introduced its rules based on the assumption that loss-absorption capacity in cross-border groups was held locally, in each jurisdiction, the commission writes. Its own proposal uses the same assumption.

Outside reactions to the new measures, which are no doubt intended to improve Brussels’ image with Basel, were diverse. For its part, the Association for Financial Markets in Europe (AFME), representing Europe’s wholesale financial markets, observed that CRR/CRD IV had already “greatly reduced the likelihood that banks will fail”.

Unsurprisingly, MEP Robert Gualtieri, the centre-left chair of the parliament’s crucial Committee on Economic and Monetary Affairs (Econ), likewise welcomed the measures. In contrast, German centre-rightist Markus Ferber, vice-chair of the same committee, thought that commission was not doing “a whit more” than the minimum.

The calamitous news concerning the Veneto banks, which came only a day later than announcement of the proposals, obliged the commission to dodge a detailed response: “We don’t comment on individual banks unless we are directly involved. This is not the case.”

At the top level, the relevant commissioner, Valdis Dombrovskis, told the European Banking Federation (EBF): “Significant increases in capital requirements were not appropriate in current circumstances in the EU.” He warned against European banks being put “at a disadvantage”. He elaborated that “EU banks hold more exposure [than elsewhere] to counterparties which would be negatively impacted by the recent proposals” and advocated “an intelligent solution”.

Support for the same strategy came from the Europe Parliament committee. MEPs in Econ recently voted on a resolution taking the line that the EU banking model must not be made to suffer.

However, the parliamentary position is not unanimous. Following the vote, one Econ member, German Green Party MEP Sven Giegold, commented: “This resolution marks a bad turning point after the financial crisis.” Mr Giegold noted that the motion was carried by a large majority of conservatives, social democrats, liberals and eurosceptics, but Greens and the left voted against.

Weak complex banks

Mr Giegold, who is his party’s economic spokesperson, described the EU banking sector as “still weakly capitalised and overly complex”. Many banks’ balance sheets lack strength. Even thinly capitalised banks continued to pay out dividends, bonuses and high wages. It is a severe mistake to side with the banking lobby that capital requirements were sufficient, he said.

Mr Giegold might be considered a radical by some. But many international banks would agree with him. A major global bank told GRR that Basel’s ultimate ruling has to support the international consistency of rules.

The danger of different standards across the world would be fragmentation, a disruption of the level-playing-field. If significant divergence in rules applied on bank services were to occur across the EU, arbitrage could render the international bank uncompetitive because the sector would anyway have to comply with its home country’s rules.

In the background is the recent Global Financial Stability Report from the International Monetary Fund. It found that short-term risks to global financial stability have abated since April 2016, but medium-term risks continue to build.

The EBF set out its views with a fiery retort to a targeted consultation that was sent out by the commission in May 2016. The EBF’s document, comprising 16 pages of closely-set text, pulled no punches in remonstrating against the Basel committee as a whole.

While it did support, in principle, a Net Stable Funding Ratio (NSFR), it described it as “a structural liquidity risk metric based on sustainable business-as-usual assumptions in the long term, to complement the short-term stressed Liquidity Coverage Ratio (LCR)”.

The document focused heavily on safeguarding the EU’s Capital Markets Union programme. “The Basel NSFR would be highly detrimental to CMU as the Basel assumptions that apply on capital markets activities are overly penalising,” the EBF wrote. Its views could well be decisive in promoting any anti-Basel sentiment in the EU institutions.

The EBF also warned against reducing market liquidity, and that the Basel rules will also “disincentive banks which are long on liquidity from lending into the market”.

Regarding derivatives, it continued that the application of NSFR rules as envisaged by Basel supervisions standards would be “extremely detrimental for the functioning of the European derivatives markets, and, ultimately for the European end-users such as SMEs, larger corporates, pension funds and other client service entities who require the ability to hedge away risk”.

Europe penalised

EBF president Frédéric Oudéa commented: “The reality is that the revision of the current framework for banks’ capital requirements could have very important consequences for Europe.” He went on to advocate a preference for no agreement at all rather than one that “deeply penalises the European economy”.

Clearly, views in Brussels have changed radically since a few years ago. Back in July 2013, the background to CRR/CRD IV legislation was described by the European Commission in a memo on lessons learned from the crisis. Then, it described as “an absolute necessity” the enforcement of the co-operation of monetary, fiscal and supervisory authorities across the globe. Crucial issues included banks’ quality and the level of their capital base.

One reason for the current disharmony is the wide range of national memberships of the Basel Committee. More than 40 countries are represented, ranging from Switzerland itself, to Indonesia, Japan and the US. Also included are various national central banks, such as the Bank of England. The European Central Bank (ECB), as part of its role to safeguard the value of the euro, represents the EU. The UK, Germany and France might all seek to favour the international bank sector’s arguments.

Support for a tighter grip on bank reserves also has a moral dimension: the basic Brussels opposition to bypassing international obligations and its support of the EU’s liberal image of reform and fair play.

Nevertheless, getting the EU economy moving must be a priority for Brussels. The CMU programme is a flagship element. The objective here is to diversify and amplify sources of finance and ensure that capital can move freely across EU borders. For as long as the institutional asset management sector holds back or finds it hard to participate, bank finance plays an important role.

Furthermore, commission president Jean-Claude Juncker will be conscious of next May’s elections in France, when National Front leader Marine Le Pen could provoke another European political upset. He will be aware of president-elect Donald Trump’s threat to dismantle Dodd-Frank, and of background murmurs in Brussels that EU policy is taking on an unrestrained Keynesian tone.

Favouring success for the present Brussels viewpoint of ‘keep your hands off our European banks’, against any adversary, is the fact that BCBS decisions do not themselves have legal force in the EU. They have to be transposed through the ordinary EU legislative procedure. This involves not only the commission, but, significantly, both the parliament and national governments. On the other hand, battling with the BCBS would set a sour precedent, risking fragmentation of global banking markets.

The Basel committee meeting on November 27 and 28 will be followed by a heads-of-supervision meeting on January 11. But, according to one EU commentator, this date could well be pushed back. In the circumstances, this would be no surprise. One EU official summed up the present differences as “a nightmare”. So, fireworks ahead?