Reform of the CRR and CRD IV

On 23 November 2016, the European Commission initiated a comprehensive revision of the Capital Requirements Regulation (CRR) and the Capital Requirements Directive IV (CRD IV), as well as the Bank Recovery and Resolution Directive (BRRD), by putting forward a package of reform proposals.¹ The work on the BRRD was subsequently defined independently and is being advanced in a separate process.²

The reform package for the CRR and CRD IV, which implement Basel III among other things, contains a large number of proposals intended to form the basis for discussions in the European Parliament and Council.³ The Commission launched its initiative with two principal objectives:

• Firstly, some of the provisions of the Basel regulatory framework have yet to be implemented. These consist of individual requirements in the Basel III package, such as the long-term stable funding ratio and mandatory minimum values for the leverage ratio, but also provisions relating to market and counterparty default risks.
• Secondly, the intention is to benefit from the experience gained in applying the CRR and CRD in practice to consider how their effectiveness can be improved, including, and in particular, with respect to proportionality.

Greater proportionality

A central concern of the reform project is to give greater prominence to the proportionality principle in the existing European regulatory framework, while not undermining Europe-wide harmonisation. For example, discussions are focussing on how to prevent regulatory requirements imposing an unjustified burden on small and medium-sized banks. These institutions have to rely on a much smaller administrative function to comply with their regulatory obligations than the large, complex financial undertakings.

German approach

The Commission's original draft already contained a number of different proposals on this subject. But in the view of some participants, they do not go far enough to actually reduce the burden for small and medium-sized institutions in practice. Together with the Federal Ministry of Finance (Bundesfinanzministerium) and the Deutsche Bundesbank, BaFin has therefore developed a German approach to proportionality which was presented as a position paper in various forums at European level in June and July 2017.

The paper is based on the assumption that all European banks are classified under one of three categories according to their size, systemic importance and risk profile. Graduated regulatory requirements with different levels of strictness and detail would then apply to those categories. Institutions in the top category, which would include institutions posing a potential systemic risk in addition to the systemically important institutions, would continue to be subject to the full regulatory requirements. Institutions in the middle category could expect selective simplified requirements in some regulatory areas, especially in relation to reporting, disclosure and remuneration. For the small, less complex institutions in the lowest category, more extensive simplifications and exemptions could be introduced or they could perhaps be subject to a separate, simplified supervisory regime.

Difficult negotiations

Achieving a consensus at European level on the classification criteria and threshold values for allocating the institutions to categories represents a major challenge. Support from European partners has so far been somewhat hesitant. This is likely to be the result of the multifaceted nature of the banking sector within the EU. The individual member states have completely different priorities in response to the specific features of their respective national banking industries. Some do not even see a need to act with respect to the issue of proportionality. Some are worried that the Single Rulebook will be diluted while yet others stress that even small banks can be responsible for substantial risks. Reaching agreement on a specific approach supported by all participants is therefore unlikely to be a straightforward process.

Selective simplifications for smaller institutions in some regulatory areas could be introduced independently of that process in the ongoing CRR/CRD review. The trilogue is unlikely to begin before the second quarter of 2018, while the conclusion of the negotiations and the subsequent publication of the revised regulations are not expected before the summer of 2019.

Threshold values

In the European legislative process, the proportional application of specific regulations is mainly achieved through the use of threshold values. The planned revision of Article 94 of the CRR in particular is expected to result in significant simplifications for small institutions. Article 94 defines the volume of trading book business above which an institution is classified as a trading book institution and becomes subject to the market risk rules. The proposed threshold is now €50 million instead of the existing €15 million. In addition, a further threshold value is being introduced for medium-sized institutions whose trading book positions are both below the threshold of 10 percent of total assets and have a nominal value of less than €500 million. This threshold value will allow them to use the simplified standardised approach to determine their market risk. This option should enable the majority of German institutions to avoid the high cost of implementing the relatively complex Basel standardised approach.

Proposal on the net stable funding ratio

Turning to the subject of liquidity regulation, a proposal for a simplified indicator for long-term stable funding (net stable funding ratio – NSFR) has been introduced into the European negotiations. It can be found in the European Parliament's draft report. The proposal is a response to the aim of restricting excessive maturity transformation by requiring an adequate amount of stable funding of the banking business, but without causing disproportionate expense for the implementation of the reporting system or the preparation and quality control of the data.

The concept of a simplified NSFR attempts to solve this dilemma for small and medium-sized institutions by keeping the prescribed ratio of available to required stable funding, but at the same time significantly reducing the degree of differentiation used in defining the factors for available and required stable funding. While the Basel framework takes a highly granular approach here in order to reduce cliff effects in major international banks' liquidity risk management functions, the German simplified NSFR approach envisages abolishing separate factors for the maturity band between six months and one year, excluding encumbered assets and combining financial instruments into categories if identical factors have already been allocated to them in the past.

While this would reduce the volume of data by more than 90 percent, the loss of information resulting from these simplifications for institutions with a traditional business model and few innovative financial products would be acceptable. Moreover, to prevent the indicator being watered down as a result of the greatly simplified calculation, a factor would always be applied to aggregated positions which would result in a higher value for the indicator. This is the only way to ensure that the proposed option for credit institutions to calculate a simplified NSFR is not used for the purposes of regulatory arbitrage.

Corporate governance guidelines

BaFin was an active participant in the revision of the guidelines of the European Banking Authority (EBA) on the internal governance of credit institutions.⁴ The purpose of the revision process is to harmonise and improve governance systems, processes and mechanisms in institutions across Europe – in conformity with the requirements of CRD IV.

The main focus is on the obligations and responsibilities of the supervisory body and the role of the various committees of that body. Furthermore, the revised guidelines are intended to improve the status of the entity's risk management function and the flow of information between it and the management body, and to ensure more effective monitoring of the risk management system by the supervisory authorities.

Management bodies and key functions

Together with the European Securities and Markets Authority (ESMA), the EBA has also published guidelines for the purpose of assessing the suitability of members of management bodies and key function holders in credit institutions. BaFin was also involved in the development of these guidelines. The suitability assessment considers whether the candidates have the knowledge, qualifications and skills necessary to guarantee proper and prudent management of the institution. The guidelines place particular emphasis on the role of the institutions in these assessments. Their objective is to harmonise and improve suitability assessments in the individual financial sectors. They are also intended to ensure that the credit institutions put in place sound governance arrangements in line with the requirements of CRD IV and the Markets in Financial Instruments Directive II (MiFID II).

Both sets of guidelines are planned to come into effect for the national competent authorities and for the consolidated institutions concerned on 30 June 2018.

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