Basel 3.5 – Positive News on Pillar 2 Requirements

Andrea Enria, Chair of the Supervisory Board of the European Central Bank (ECB), recently made some encouraging comments on the ECB’s opinion concerning the Pillar 2 requirements following the implementation of the new “Basel 3.5” rules (called the “finalized” Basel III rules among regulators, or Basel IV by banking community members).

First, Mr. Enria acknowledged concerns from the banking community regarding the introduction of the output floor as part of the new “Basel 3.5” rules. The output floor is a backstop that prevents banks from reducing their risk weighted assets below 72.5% of the total value calculated using the standardized approach. The output floor is expected to lead to an overall increase in average capital requirements of banks, especially in the case of banks that operate in a low risk environment (e.g. real estate financing in Germany).

Importantly, Article 104a of the amended Capital Requirements Directive (CRD V) now clarifies that banks are allowed to meet their Pillar 2 requirements using the same capital structure as for their Pillar 1 requirements (i.e. 56.25 % CET1, 18.75% AT1 and up to 25% Tier 2). This amended directive follows the approach advocated by the European Banking Authority (EBA) and represents a change to previous ECB policy focusing on CET1. According to the ECB, this new approach should generate a 90 basis points reduction in CET1 requirements on average as banks may now rely on lower quality AT1 and Tier 2 capital, which is currently available at favorable market conditions.

This relaxation of regulatory requirements should be good news for banks as the ECB had previously argued against a split of the Pillar 2 requirement to maintain a high quality of capital. Furthermore, Mr. Enria stressed that the ECB is now actively working to prevent any unwanted consequences of Basel 3.5 for bank-specific Pillar 2 requirements. For example, in the future, model risks would be addressed under Pillar 1. In addition, the ECB is considering sterilizing purely arithmetic effects of any increase in risk-weighted assets in the computation of Pillar 2 charges generated by the newly introduced output floor. According to Mr. Enria an increase in capital requirements would not be justified, if the underlying risks now covered under Pillar 2 have not changed.

Mr. Enria’s full statement can be found here: https://www.bankingsupervision.europa.eu/press/speeches/date/2019/html/ssm.sp191212~10d96807c3.en.html

For further information on this topic please do not hesitate to contact us at any time.

Dr. Uwe Rautner, LL.M. (LSE)
Managing Partner
T +43 1 361 1361-11
E uwe.rautner@rautner.com

Mag. René Semmelweis, LL.M. (WU)
Managing Associate
T +43 1 361 1361-13
E rene.semmelweis@rautner.com