The International Chamber of Commerce (ICC), the world business organisation, has publicly praised a recent accomplishment by European Union (EU) policymakers – the successful conclusion of negotiations concerning the third revision of the bank capital framework, the Capital Requirements Regulation 3 (CRR3).
Unpacking the Capital Requirements Regulation (CRR)
The journey of the CRR originates from the EU’s proactive measures to guarantee the financial health of its banks, introduced in 2013 following the 2007-2008 global financial crisis.
This regulation outlines the amount of capital banks must hold as a cushion to mitigate against potential risks associated with their assets.
However, as is the low default nature of trade finance landscape, certain problems that were identified in the aftermath of the global financial crisis remained unresolved, even under the CRR’s guidelines.
This led to further refinement in the regulation, leading to the inception of CRR3.
CRR3: A synthesis of Basel III principles and unique EU context
The CRR3 builds on the international Basel III agreement’s key principles, such as reducing the excessive variability of risk-weighted assets (RWA).
Under Basel III, an output floor was set, determining the minimum amount of capital a bank could draw from the use of internal models to 72.5% of the capital required under the standardised approach.
CRR3 mirrors this approach while accommodating the unique features of the EU’s banking sector.
What is an output floor?
In simple terms, the Basel III “output floor” is a rule that ensures banks maintain a minimum level of capital to cover potential losses, regardless of how they calculate the riskiness of their assets.
Banks use models to calculate the amount of risk they’re exposed to, and the riskier their assets are perceived to be, the more capital they need to hold. Some large banks use their own sophisticated ‘internal models’ to do this, which can sometimes result in lower risk weightings, and hence lower capital requirements.
The “output floor” of 72.5% was introduced to prevent these banks from underestimating their risks and holding too little capital. It sets a limit to how much a bank’s capital requirements can be reduced by using internal models.
Even if a bank’s internal model says it can hold less, the bank still needs to maintain capital equal to at least 72.5% of what it would have to hold under the standardized approach. The standardized approach is a simpler, one-size-fits-all method for calculating risk and capital requirements provided by regulators.
CRR3: A resilient framework
CRR3 marks a decisive step forward, introducing significant changes that include maintaining a 20% credit conversion factor (CCF) for technical guarantees and recognising effective maturity for short-term trade instruments.
Additionally, CRR3 addresses the need for sustainability in banking, making it necessary for banks to identify, disclose, and manage environmental, social and governance (ESG) risks.
This evolved regulation also introduces stronger enforcement tools—arming supervisors with more robust mechanisms to oversee EU banks—promoting financial stability and resilience.
Decoding the ICC’s perspective
John Denton, the secretary general of ICC, applauded the newly formed agreement. According to Denton, this deal represents a “great outcome for the real economy in Europe.”
Denton affirmed the importance of this balanced and proportionate framework for trade regulation, which, in his view, successfully promotes financial stability without stifling the provision of critical financing to European businesses.
Roadmap to CRR3 implementation
Following a process of legal translation, the revised regulation will now undergo a formal voting process in the European Council and Parliament.
This key milestone precedes the expected implementation of CRR3 in 2025, indicating a new phase in the EU’s banking sector.
Highlighting the larger global implications of CRR3, Tomasch Kubiak, policy manager for the ICC’s Global Banking Commission, emphasised the potential of CRR3 to influence banking regulation worldwide.
Kubiak said, “More broadly, we hope that today’s outcome will send a clear signal globally on the imperative to carefully consider the capital treatment of trade assets in a number of important respects – based on robust industry data showing the performance of the asset class.
Our hope is that the provisions secured in CRR3 will become a template for reforms in other major jurisdictions.”
The ICC reiterates its commitment to fostering a collaborative dialogue with regulatory authorities, financial institutions, and businesses.
Are there unintended consequences of CRR3?
While CRR3 brings promising developments, it’s essential to be aware of potential unintended consequences.
The increased capital requirements, for instance, could inadvertently tighten banks’ ability to lend, affecting sectors such as SMEs—particularly in emerging and developing markets—that heavily rely on bank lending.
Moreover, the blanket approach of CRR3, while aimed at promoting a level playing field, could inadvertently stifle innovation and competition.
Banks that have robust internal risk management systems might find themselves at a disadvantage with the introduction of uniform regulatory norms.
Furthermore, the implementation costs of the new regulatory changes might disproportionately burden smaller banks, potentially leading to further consolidation in the banking sector and reducing competition.
Level the CRR3 playing field
In the realm of global banking regulations, CRR3 aims to promote a more level playing field by aligning the EU’s banking norms with international standards, such as Basel III.
However, the effectiveness of this alignment will hinge heavily on the specifics of implementation within different jurisdictions.
A look ahead: CRR3 and it’s global impact
In comparison to its predecessor, CRR3 emphasises sustainability risks and introduces the Basel III ‘output floor’ into the EU regulatory framework.
This output floor aims to curb the variability of RWAs across banks, thereby increasing the comparability, and ideally, the competitiveness of EU banks in the global market.
However, the ultimate success of this goal will depend heavily on the implementation details and the market participants’ reactions.
As CRR3 navigates its course towards implementation in 2025, the banking world will undoubtedly be watching closely.
