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EBA Banking Stakeholder Group Summary on Basel Committee Consultations (CP306 and CP307)

Core Content

The EBA Banking Stakeholder Group (BSG) has provided detailed feedback on the Basel Committee's consultations regarding the standardised approach for credit risk (CP307) and the capital floors framework (CP306). These consultations aim to improve risk sensitivity, reduce reliance on external ratings, and enhance comparability across banks. However, the BSG raises several concerns about the practicality, fairness, and effectiveness of the proposed changes.

Main Views and Concerns

1. Joint Analysis of CP306 and CP307

• The BSG stresses that the two consultations should be analyzed together, as they both impact capital requirements and risk measurement.
• They highlight the need for a careful consideration of the impact on smaller banks, which may struggle with the implementation of new rules due to limited resources.
• Jurisdictional differences across countries and sectors must be taken into account to ensure that the new standards are not overly simplistic or misleading.

2. Risk Drivers and Their Calibration

• The BSG is concerned that the proposed two-risk driver approach for residential real estate is not sufficiently risk-sensitive or simple.
• They argue that uniform risk drivers across jurisdictions and industries may not be appropriate, as they fail to reflect local market conditions.
• Calibration by national regulators is essential to ensure that the standardised approach remains relevant and accurate.

3. Impact of Capital Floors on IRB Banks

• The BSG believes that capital floors may jeopardise the development of sophisticated internal rating models, which are critical for accurate risk assessment.
• These floors could discourage risk-sensitive credit risk management, as they may force banks to take on riskier exposures to meet capital requirements.
• Binding floors are seen as a last resort and should be used only for transitional purposes or in specific cases where risks are underestimated.

4. External Ratings and Their Role

• The BSG supports reducing reliance on external ratings, but does not advocate for their complete abolition.
• External ratings consider a broader set of risk factors and are customised to issuer-specific conditions, making them a valuable complement to the standardised approach.
• They suggest that external ratings should be retained selectively, especially for bank and corporate exposures, where they have shown good performance and consistency.

5. Pro-Cyclicality and Regulatory Arbitrage

• The BSG warns that simplified risk indicators could lead to pro-cyclical behavior, where capital requirements increase during downturns and decrease during upturns.
• This may encourage regulatory arbitrage, where banks find ways to circumvent or tweak the rules for their benefit.
• They also highlight the risk of inadequate assessment of individual credit exposures, which may lead to systemic issues in credit allocation.

6. Specific Concerns on Risk Drivers

• The net NPA ratio is viewed as not effective in distinguishing credit risk and may be pro-cyclical.
• The CET1 ratio is considered more suitable than the leverage ratio, but the proposed risk weight framework based on CET1 is criticised for being too rigid.
• The 30% floor risk weight for short-term interbank claims is not justified by empirical evidence and may increase capital charges unnecessarily.

7. Treatment of Exposures to Banks and Corporates

• The BSG supports using external ratings for bank and corporate exposures, as they provide more accurate and comprehensive risk assessments.
• They are concerned about the treatment of non-Basel III banks, suggesting that local solvency requirements may be more appropriate.
• Covered bonds should receive preferential treatment, given their low risk profile and strong performance in stressed conditions.

8. Leverage and Off-Balance Sheet Exposures

• The leverage ratio is seen as a useful but limited measure for credit risk.
• Off-balance sheet exposures should be incorporated into the capital ratio to ensure a more accurate reflection of risk.
• The BSG suggests that leverage could be adapted to industry type to avoid over- or under-penalising certain sectors.

Key Recommendations

• Conduct a deep quantitative impact study (QIS) to ensure proper calibration of the new standards.
• Allow for more granularity in the risk weight table, especially for higher CET1 ratios.
• Ensure that risk drivers are calibrated locally, while maintaining global consistency.
• Use external ratings selectively, especially for bank and corporate exposures, to maintain risk sensitivity.
• Avoid binding floors unless they are economically justified and transitional in nature.
• Consider alternative asset quality measures and disclosure-based approaches for better risk assessment.

Conclusion

The BSG supports the overall objective of enhancing risk sensitivity and comparability, but is cautious about the implementation of the proposed standards. They stress the importance of careful calibration, flexibility, and consideration of local conditions to avoid unintended consequences and ensure that the new framework remains effective and fair for all types of banks.