Basel III & CRD IV

Basel III

Towards a new balance in your capital management

The future implementation of the new Basel III legislation and regulations implies that banks must review their balance sheet and carry out extra work. Just as with the previous version, the banks must estimate the risks for Basel III themselves, based on the internationally-applicable guidelines. Basel III further introduces:

  • stricter requirements for capital and leverage;
  • stricter capital calculations (RWA) for counterparty credit risk;
  • a new framework for the control of liquidity risks (Liquidity Coverage Ratio, Net Stable Funding Ratio and ILAAP, comparable with the existing ICAAP).
Towards a new balance in your capital management

Major consequences

Although the regulations have not yet been fully clarified, the first effects of Basel III are a fact as of 2014. The consequences for banks are very significant, and include the following:

  • new minimum capital levels, return targets, pricing, and selection of credit and long-term strategy of the bank;
  • funding and balance structure: interbank relationships and product range;
  • methods of capital requirement: systems, control, data and IT;
  • capital and the use of liquidity by business lines: business unit management and performance management.

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Capital management policy

As a result of these changes, the banks should ask themselves if the capital management function is still responsive to the needs of the organisation itself, customers, investors and supervisors. Is the capital management policy still in line with your strategy and risk acceptance? To review your capital management policy and the capital management function of the economic capital model and to reshape the services provision may help to:

  • save capital costs and to use capital as efficiently as possible;
  • create a better connection between capital and company objectives;
  • increase the effectiveness of the capital management function and to make it more responsive to the demands of the organisation.

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How PwC can help you

  • Support with the setup and implementation of a framework for (economic) capital that complies with the new Basel III requirements, including its governance, policy and processes.
  • Support with determining the position, responsibilities and service provision of the capital management department within the organisation and the desired internal and external perception of the capital policy.
  • Support with calculating your economic capital, in particular in the context of Pillar 2 and stress testing.
  • Advice on the integration of Basel III with scenario analyses.
  • Monitoring/evaluating whether the reorganisation produced the intended result.

CRD IV/CRR: Still no level playing field

The amended Capital Requirements Directive (CRD IV) and the Capital Requirements Regulation (CRR) have legally establish the Basel III principles for EU banks since 1 January 2014. Despite the fact that identical EU regulations will apply to all member states, there will still be differences in how national supervisors interpret and apply these new regulations. The banks who deal with this best will try to get a good understanding of how the flexibility in the system can be used as much as possible.

  • Want to know what CRDIV means for you now as a bank?

As it is European legislation, the CRR has an immediate legal effect in the Netherlands. CRD IV will still have to be laid down in Dutch law by means of legislation to be drafted by the Minister of Finance. This is because CRD IV is 'only' a European directive and therefore has no immediate effect in EU member states.

Despite the fact that identical EU regulations will apply to all member states, there will be differences in how the national supervisors interpret and apply new regulations. On the one hand, this is due to the fact that CRD IV is a guideline and that, as a result, a discretionary duty rests with the national legislators and supervisors to interpret the CRD IV at a local level. On the other hand, the CRR confers certain powers to local supervisors in certain aspects in respect of the implementation of the new capital and liquidity regulations, i.e. in the establishment of transition regulations for new 'Common Equity Tier 1' deductible items.

Remuneration policy

Remuneration policy (part of CRD IV) is a clear example of a difference in approach between EU supervisors. The new guidelines set out that bonuses for obvious risk-takers must not exceed the basic salary. At the same time, the European Banking Authority (EBA) is extending the definition of risk-taker, which means that these guidelines will soon apply to a larger portion of the personnel.

A great deal of attention is being given to the impact that this guideline may have and it is causing great concern, especially among banks in the United Kingdom. It is causing less concern in other EU countries, because bonuses are a smaller part of the full salary. It is expected that the bonus cap in the Netherlands will be set at 20 percent of the fixed salary, rather than 100 percent.

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Concern about extra capital and liquidity requirements

Among the larger banks, the concern about the impact of the additional capital buffers may be even greater than the concern about the remuneration policy. For a global systemically-relevant banking group, the various systemic, bank-specific and capital conservation buffers may cause the total capital requirements to increase to up to 18 percent. Of the Dutch banks, ING has been designated as a global systemically-relevant banks group.

Smaller institutions may also be confronted with requirements that are several percentage points higher than the international minimum under Basel III - in some cases this is driven by the Leverage Ratio. The Leverage Ratio does not in fact consider risk weightings of bank assets, as a result of which a relatively risk-mitigating bank with a strong capital ratio may not meet the Leverage Ratio of three per cent.

Having to deal with higher costs is further complicated by the areas of overlap between the different elements of the regulations. An institution that decides to maintain more high-quality liquid assets to increase its Liquidity Coverage Ratio (LCR) will find that additional capital is required to absorb the capital lock-up for these liquid assets. At the same time, the institution must consider that it should still be possible to report the Leverage Ratio at an appropriate level.

It will be a challenge for many banks and supervisors to decide which order of priority should be given to the different ratios.

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Bank ratings

The ratings are also a concern for the banks. Many large banks use internal models to determine the capital lock-up for credit risk. In some cases, internal models are also used to determine the capital lock-up for market and operational risk. Each country estimates the impact of the new regulations differently. While the CRR is a single rulebook that applies to every EU country, CRD IV can be applied differently in different countries. Under the new regulations, the supervisors can focus on the use of internal models (IRB), which can lead to significantly higher costs.

Finally, concern exists about the imposition of much higher sanctions than currently apply in most countries. Fines of up to 10 percent of income for each infringement are certainly high, and can furthermore lead to even greater reputational damage. The undesired publicity resulting from these fines and sanctions will have far-reaching consequences - not only for the bank but possibly also for the sector as a whole.

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Is this a final blow?

In a broader perspective, the banks fear that the comprehensive regulatory burden (including EMIR, MiFID II, Recovery & Resolution and extraterritorial implications of US regulations, etc.) may be a final blow for their organisations. The additional capital and compliance costs have an effect on the pricing policy, profitability and the viability of certain products and business models.

There will also be structural changes that will cause disagreement. Germany has taken the lead by accepting a law that distinguishes between commercial activities and other activities, and it looks like France will soon follow in this. This is in contrast to the UK, where proposals for ring-fencing are still far from a possible implementation.

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Strategic discussion cannot be avoided

This is one of the reasons why it is surprising that there is little discussion about possible alterations to business models. It appears that most banks were too busy taking immediate action to comply with regulations and have therefore paid less attention to the economic and demographic impact on specific products and to evaluating the business model. They may also have been dissuaded by the continuing uncertainty regarding the details of the new regulations, the impact thereof and future challenges, including a possible 'Basel IV'. Despite this uncertainty, strategic discussions cannot be avoided.

Despite the fact that the CRD IV and CRR have been approved, there are still a significant number of technical standards that must be finalised by the EBA. Despite the fact that the EBA envisions an EU-wide standardisation, the thoughts within the EU about these regulations still seem to be heading in different directions. A good example of this is the Leverage Ratio. There are calls in the UK and in the Netherlands to increase the minimum Leverage Ratio, whereas Germany has opted to make the Leverage Ratio part of Pillar 2 to give supervisors more flexibility for institution-specific requirements.

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Differences reinforce each other

The German ring-fencing initiative demonstrates the differences in the pace of change. Another difference is the caution exercised by a number of supervisors in respect of internal models. This despite the shift from relying on external ratings to other factors for risk assessment, and the imposition of the use of internal models on certain banks. These differences are reinforced by the tendency among many supervisors in the EU to exercise flexibility in imposing the applicability of regulations at their own discretion.

Dealing with the cumbersome and confusing mismatch caused by the differences in approach will obviously cause considerable headaches for international banking groups. If the home supervisor interprets the rules in one way, the host supervisors may see things in another. A specific bank's importance in a local market may lead to the local supervisor imposing so many regulatory requirements that local operations are not able to manage these requirements. 

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How can your bank stay on top of all the above uncertainties, complexities and inconsistencies?

It should first of all be acknowledged that they will not disappear. It is also unlikely that there will be a completely level playing field and that most of the supervisors deliberately maintain grey areas in some respect to be able to apply flexibility. The general impact on pricing policy, structures and business models is slowly starting to develop.

Your bank will be able to position itself strongly by acting in a forward-looking way, and by determining which business is likely to be most profitable and most relevant from a strategic point of view. This enables you to deploy your capital and staff in a way that is most effective for you.

It will be crucial for banks, national banking associations and national supervisors to provide sufficient support and input to the EBA. The EBA is, after all, still working to finalise the technical standards to ensure that the definitive regulations are practical and will not have any unintentional negative consequences.

It will also be crucial in the next few months to see which tactical decisions will be made in response to the amended reporting requirements. These requirements have taken effect since 1 January 2014. This despite the fact that the details will not be finalised on time, as a result of which they cannot be incorporated in the reporting systems on time.

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Keep up with other banks

Despite the fact that a certain uncertainty will continue to exist, a consensus between banks and their national supervisors is developing about how certain aspects of the regulations should be applied. It is essential to keep up with the actions of other banks and how supervisors respond to this. This is crucial to determine the correct course.

It is a fact that it is difficult to act fully independently. It is of vital importance that you understand and take note of the many mutual dependencies. All your evaluations will have to be assessed from the point of view of the institution itself, as well as from a consolidated viewpoint. A reorientation of the place of business or from where the actual service provision takes place may be part of this evaluation. If your bank has its head office outside the EU, it will be very important for the board to understand the nuances and implications. This also includes institution-specific and consolidated considerations.

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Game changer

CRD IV and CRR will change banking for EU banks. The banks that are best able to deal with regulatory pressure will incorporate it into their strategy, make the correct tactical decisions and strengthen their reputation.



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Eugénie Krijnsen

Eugénie Krijnsen

Industrie Leader Financial Sector

Tel: +31 (0)88 792 36 98

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