Regulation (EU) 2024/1623 aims to amend the prudential framework for banking institutions in the European Union in response to challenges revealed by the 2008-2009 financial crisis. It seeks to implement the finalized Basel III standards while avoiding a significant increase in capital requirements. This regulation also includes a comprehensive assessment of the banking system to ensure depositor protection and…
The document is Regulation (EU) 2024/1623 adopted by the European Parliament and the Council of the European Union on May 31, 2024. It amends Regulation (EU) No 575/2013 (CRR) concerning prudential requirements applicable to credit institutions and investment firms. The scope covers requirements related to credit risk, credit valuation adjustment risk (CVA), operational risk, market risk, and the capital floor, within the implementation of the finalized Basel III framework. The document applies to the banking and financial sector of the European Union, focusing on the post-global financial crisis period of 2008-2009 and the COVID-19 crisis, and aims to strengthen the resilience of the European banking system while taking into account the economic specificities of the Union (p. 1-16).
Regulation (EU) 2024/1623 aims to amend the European prudential framework (CRR) to incorporate the latest international standards from the finalized Basel III framework, notably regarding credit risk, CVA risk, operational risk, market risk, and the capital floor. This topic is crucial as it addresses gaps revealed by the global financial crisis of 2008-2009 and the COVID-19 pandemic, strengthening the stability and resilience of the European Union banking sector. The main findings are that, although overall capitalization is satisfactory, some issues persist, notably the underestimation of risks by internal models, excessive variability of capital requirements, and insufficiently risk-sensitive treatments in the standard approach for credit risk. The regulation introduces a capital floor set at 72.5% of the requirements calculated according to the standard approach to limit the underestimation of risks by internal models. It also provides for a revision of risk weights for exposures to institutions, corporates, subordinated claims, equities, and specialized financing, as well as transitional provisions to facilitate institutions’ adaptation, notably regarding external ratings and low-risk residential mortgages. Operational risk is simplified by adopting a new standard approach not based on internal models, excluding the consideration of historical losses to ensure fairness. Market risk is adjusted to integrate the final FRTB standards with targeted mitigation measures to preserve the competitiveness of European institutions. Furthermore, the regulation enhances transparency and data publication, notably on non-performing exposures and ESG risks, to support the transition to a sustainable economy. Finally, it provides for a comprehensive assessment of the European banking system and a future review of the prudential framework. Key recommendations include rigorous application of the capital floor, phased implementation of new risk weights, maintenance of adapted transitional periods, and enhanced monitoring of emerging risks such as crypto-assets. The regulation also provides for implementing and regulatory technical standards to be adopted by the Commission, in cooperation with the EBA (p. 1-16).
The document was developed to implement in Union law the latest elements of the finalized Basel III framework, aiming to correct deficiencies revealed by the global financial crisis of 2008-2009 and the COVID-19 pandemic. The objective is to increase the resilience of the European banking sector without significantly raising the overall level of capital requirements, while taking into account the economic specificities of the Union and avoiding competitive disadvantages, notably in trading activities. The regulation is part of a decade-long reform process aiming to harmonize prudential requirements, improve comparability of capital ratios, and strengthen risk supervision. It also provides for a comprehensive assessment of the European banking system, including the capital floor, and a future review of the prudential framework. The scope covers credit institutions and investment firms subject to the CRR, with particular attention to internal models, standard approaches, exposures to corporates, real estate, specialized financing, operational risks, market risks, CVA risks, and ESG risks. The document does not cover the following 128 pages of the regulation, limiting the summary to the first 61 pages provided (p. 1-16).
1. Implementation of the finalized Basel III framework:
- Objective to correct deficiencies of internal models and improve comparability of capital requirements.
- Introduction of a capital floor set at 72.5% of the requirements calculated according to the standard approach to limit the underestimation of risks by internal models (p. 1-3).
2. Credit risk:
- Revision of the standard approach (SA-CR) to increase risk sensitivity, notably by recalibrating weights for exposures to institutions, corporates, subordinated claims, and equities (p. 3-6).
- Grandfathering clause for existing strategic participations to avoid disruptions.
- Transitional preferential treatment for unrated corporates in the NI approach, with incentive to increase external rating coverage (p. 3-5).
- Specific adjustments for exposures secured by residential and commercial real estate, maintaining and adjusting the loan splitting approach, and transitional provision for low-risk residential mortgages (p. 5-7).
- Introduction of specific treatment for specialized financing exposures, distinguishing project, object, and commodity financing, with transitional provision for reduced weighting (p. 6-7).
- Alignment of classifications between standard and NI approaches for retail clients, and introduction of a 10% credit conversion factor for unconditional cancellable commitments with transitional period (p. 7).
- Introduction of calibrated floors for risk parameters (probability of default, LGD, conversion factors) to avoid excessively low estimates, differentiated by exposure types and transitional period for specialized financing (p. 6-7).
- Clarification of definitions and treatments of guarantees in the NI approach (p. 7).
- Possibility to revert to less sophisticated approaches under competent authority control to avoid regulatory arbitrage (p. 7).
3. Operational risk:
- Replacement of all existing approaches by a new standard approach not based on internal models, combining size-based indicator and indicator considering loss history (p. 8-9).
- Harmonization of exclusion of historical losses for all institutions to ensure fairness and simplicity (p. 8).
- Mandate to the EBA to study recognition of insurance policies as risk mitigation techniques (p. 8).
4. Market risk:
- Implementation of final FRTB standards with targeted adjustments to mitigate impact on trading activities important for the Union’s economy (p. 7-9).
- Authorization for institutions with medium-sized trading portfolios to apply a simplified standard approach (p. 8).
- Introduction of a specific weighting for exposures related to the EU Emissions Trading System (EU ETS) (p. 8).
- Temporary implementation of strict exclusions for residual risk add-on to allow hedging of certain instruments (p. 8).
5. Credit valuation adjustment risk (CVA):
- Implementation of revised Basel III standards to improve calculation of capital requirements for CVA risk (p. 9-10).
- Maintenance of exemptions for certain derivative transactions to avoid excessive cost increases, with obligation to report capital requirements in absence of exemption (p. 9-10).
- Mandate to the EBA to develop guidance on CVA risk supervision (p. 9-10).
6. Transparency and publication:
- Obligation for institutions, including small non-complex entities, to publish information on asset quality, non-performing exposures, and renegotiations (p. 9-10).
- Creation of a centralized online platform by the EBA for data publication, reducing administrative burden and improving comparability (p. 10).
7. Environmental, social and governance (ESG) risks:
- Integration of ESG factors into the prudential framework, with uniform definitions and obligation for institutions to determine their exposures to activities causing significant harm (p. 10-11).
- Extension of ESG risk disclosure obligations, with granularity proportional to institution size and complexity (p. 10-11).
- Mandate to the EBA to establish annual reports on specific prudential treatment of exposures related to environmental and social objectives (p. 11).
- Need for greater transparency on exposures to fossil fuel sectors and renewable energies (p. 11).
8. Definitions and consolidation:
- Clarification and modification of definitions of “parent undertaking,” “subsidiary,” “ancillary services undertaking,” “financial holding company,” “financial institution,” and others to improve consistency and consolidated supervision (p. 13-16).
9. Crypto-assets:
- Preparation for implementation of a prudential standard specific to crypto-asset exposures from January 1, 2025, with transitional treatment for certain tokenized assets and high risk weighting (1,250%) for other crypto-assets (p. 11-12).
10. Other points:
- Reassessment of the minimum haircut framework for securities financing transactions, with report to the Commission by the EBA (p. 12).
- Increased supervision of exposures on securities financing transactions, notably to adjust the standard approach (p. 12).
- Adoption of implementing and regulatory technical standards by the Commission in cooperation with the EBA to specify modalities of application (p. 12-13).
Findings:
- Implementation of the finalized Basel III framework is necessary to correct deficiencies of current prudential requirements, notably underestimation of risks by internal models and lack of risk sensitivity in the standard approach (p. 1-3).
- The capital floor set at 72.5% of the standard requirements limits unjustified variability of capital requirements and improves comparability between institutions (p. 2-3).
- Risk weights for exposures to institutions, corporates, equities, specialized financing, and real estate are recalibrated to better reflect actual risks (p. 3-7).
- The new standard approach for operational risk replaces existing approaches, simplifying the framework and excluding consideration of historical losses (p. 8-9).
- Implementation of final FRTB standards for market risk is adjusted to mitigate impact on significant trading activities (p. 7-9).
- Transparency requirements are strengthened, notably via a centralized publication platform (p. 9-10).
Assumptions:
- Transitional adjustments will allow progressive adaptation of institutions without disrupting markets (p. 3-7).
- Increasing external rating coverage for unrated corporates is achievable within the given timeframe (p. 4-5).
Interpretations:
- The capital floor is a key tool to restore credibility of internal models and ensure fair competitive conditions (p. 2-3).
- Simplification of operational risk aims to reduce excessive diversity of practices and improve comparability (p. 8).
- Integration of ESG risks into the prudential framework is essential to support the transition to a sustainable economy and manage associated financial risks (p. 10-11).
Uncertainties:
- The exact impact of new requirements on the competitiveness of European institutions, notably in trading activities, remains to be monitored (p. 7-9).
- Availability and quality of ESG data, as well as institutions’ capacity to integrate them effectively, are still evolving (p. 10-11).
- Evolution of crypto-asset markets and implementation of associated standards present risks and technical challenges (p. 11-12).
Regulation (EU) 2024/1623 concludes that rigorous implementation of the finalized Basel III framework is essential to strengthen the resilience of the European banking sector and ensure fair competitive conditions. It recommends applying the capital floor at 72.5% of the standard requirements to limit underestimation of risks by internal models. It advocates targeted adjustments of risk weights to better reflect actual risks, with adapted transitional periods to avoid disruptions, notably for low-risk residential mortgages and unrated corporates. Simplification of the operational risk framework by a new standard approach is recommended to improve comparability and simplicity. Implementation of the final FRTB standards for market risk must be accompanied by adjustments to preserve competitiveness. Strengthening transparency obligations, notably via a centralized platform, is essential to improve supervision and market discipline. Integration of ESG risks into the prudential framework is a priority to support the ecological transition. The regulation also provides for the establishment of implementing and regulatory technical standards by the Commission in cooperation with the EBA. Finally, it calls for a comprehensive assessment of the European banking system and a future review of the prudential framework, notably concerning the capital floor and emerging risks such as crypto-assets. Transitional measures are limited to a maximum of four years, with justifications required for any extension (p. 1-16).
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