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Economic and monetary challenges - Review of EU regulations to support the financing of the EU economy and financial stability

Regulatory stability and proportionality to support financing of the economy

By Vaillant Isabelle - Director, Regulation Department, European Banking Authority (EBA)

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After the crisis and the thorough reform of the prudential framework, the regulatory cycle is being closed. Being mindful of the need of a regulatory pause the EBA is diligently finalizing the Single Rulebook against CRR/CRDIV and BRRD.

When looking at the finalisation of the pieces and their interaction the leverage ratio is certainly the major innovative and last piece to be brought into the range of regulatory tools. It has been conceived as a backstop to make sure that excessive leverage is not building up in the system. On its own it brings a valuable perspective to the supervisory analysis and sheds light on the banks’ business models. The EBA will produce its advice on the leverage ratio and its application to the various business models identifiable across the EU by the summer. Our work will benefit of input from the ESRB regarding the potential effects of the leverage ratio on market liquidity. In parallel, our efforts will focus on the use of banks’ internal models in the definition of regulatory requirements. The EBA has already published an Opinion on the regulatory review of the internal ratings-based (IRB) approach, defining the roadmap for ensuring greater consistency and reliability in credit risk models. The EBA aims at harmonising definitions and supervisory practices in the definition of default, the estimation of risk parameters and treatment of defaulted assets, credit risk mitigation techniques and disclosure in four phases. These changes should be supplemented by amendments to the underlying framework – beyond what is currently allowed in European legislation. In this perspective the EBA is making key contributions to bring the European perspective into the final discussions led by the Basel Committee.

Proportionality has already been extensively applied in the Single Rulebook, which does not apply a “one-size-fits-all” approach to regulation but aims at reflecting the specific features of various business organisations and models. For instance, cooperative and mutual organisations are specifically treated under the own funds framework. But we are aware that the new regulatory framework is highly complex and implies significant compliance costs, especially for smaller firms. The EBA started considering options for simplifying the Single Rulebook. There are a number of criteria that can be considered (size, interconnectedness, scope and complexity of activities, risk profile, etc.), but the key is to strike a balance between easier compliance for less complex/smaller institutions and maintaining a robust set of rules for all institutions facing similar risks across the EU, so as to safeguard the institutions themselves, their consumers and the economy they serve. The EBA is committed to prioritise its review of compliance costs and assess reasonable options for simplified reporting. It has recently published its standardised templates for the issuance of Alternative Tier 1 instruments (AT1) which provide a simple option to use standard term sheets compatible with prudential regulation and may help smaller banks in particular when they need to have recourse to such market segment. The EBA is also reviewing the effects of the existing capital discount for SME exposures (the so-called supporting factor), introduced by the legislator to stimulate lending to SMEs. Our results cast some doubts on the effectiveness and appropriateness of lower capital requirements in stimulating lending. Still, we acknowledge that the limitations of the data available to us and the relatively recent introduction of the supporting factor suggest caution in drawing any firm policy conclusions. Hence, our suggestion is to continue monitoring the effects of the supporting factor and reconsider the issue at a later stage.

With the closure of a regulatory cycle, the Single Rulebook has now provided good ground for a robust and harmonised definition of capital and the banking sector is well-capitalised, which is a pre-condition for a sustainable recovery of lending to the economy. The new stress test will tell us more about that. If there is room for improvement both in terms of proportionality and risk sensitivity, we stand ready to assess sensible ways of applying the new rules.