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Basel IV implementation in the EU – publication of the final CRR3 / CRD6 texts
Executive Education / 12 February 2024
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Annette Blank's main focus is on the practical design of banking topics for different target groups and their implementation in appropriate forms of learning and training units, such as certificate courses, seminars or blended learning concepts.

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In October 2021, the European Commission presented its proposal to implement the Basel IV regulations in the European Union by amending the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD).

After lengthy negotiations between the European Parliament and the European Council, an informal agreement on a final text was reached in December 2023. The final adoption of the text in Parliament is expected in the first quarter of 2024, meaning that publication in the Official Journal of the European Union can be expected at the end of the first quarter or the beginning of the second quarter of 2024.

The main amendments to the legislation include:

  • Introduction of an output floor that limits the ability to reduce capital requirements through the use of internal models
  • Adjustments to the structure of risk position classes and the calculation of risk-weighted assets under the Credit Risk Standardised Approach (CRSA) and the Internal Ratings Based Approach (IRB)
  • Strict and prescriptive rules for the allocation of risk positions in the banking or trading book
  • Introduction of the Fundamental Review of the Trading Book (FRTB) rules for calculating market risk capital requirements
  • Introduction of three new approaches for calculating capital requirements for CVA risk
  • New standardised approach for operational risk, replacing all existing approaches
  • New standards for managing and publishing sustainability risks
  • Stricter requirements for third-country institutions providing banking services in the European Union

Most of the provisions will enter into force on 1 January 2025. The following points should be emphasised:

Output Floor

Contrary to the proposal made by the European Commission in October 2021, the output floor will apply to all institutions in the European Union. However, Member States will have the option to only apply the output floor at the highest level of consolidation in the respective Member State.

The proposal by the Commission was for full application of the output floor at the highest level of consolidation of an institution within the European Union (EU) or for stand-alone institutions in the EU. The additional consolidated capital requirements resulting from the application of the output floor were then allocated to subsidiary institutions at an individual level using a complicated key.

Credit risk framework and large exposure regime

The main amendments to the standardised approach to credit risk relate to the application of due diligence when using external credit assessments, the risk-weighting for positions with institutions without external credit assessments, equity investments, positions secured by real estate and off-balance sheet positions.

In addition, the final legislative text contains several minor amendments to the structure of the risk position classes – such as the deletion and addition of individual risk position classes or increased differentiation within a risk position class – and to the risk weights.

The internal ratings-based approach also includes changes to the structure of the risk position classes. In addition, the scope of application of the “Advanced IRB” is restricted. Ultimately, an institution’s freedom to use its own parameter estimates is constrained by the regulatory specification of minimum values (floors).

Handling of crypto assets

While the Commission’s CRR3 proposal does not contain specific provisions on capital requirements for crypto assets, the final text contains transitional provisions with specific provisions on risk-weighting. For example, crypto assets created through the tokenisation of traditional assets will be treated in the same way as the underlying asset, and asset reference tokens relating to traditional assets will receive a risk weight of 250%. All other crypto assets that are not based on a traditional asset will receive a risk weight of 1250%. In addition, the latter group of crypto assets will be subject to a “large exposure limit” of 1% of Tier 1 capital.

Differentiation between trading and banking book

Under the current CRR, the distinction between the banking book and the trading book is essentially based on the existence of an intention to trade. In contrast, the CRR3 contains much stricter requirements for the allocation of positions. While certain explicitly named positions must be allocated to either the trading or the banking book, others are presumed to be in the trading book for regulatory purposes. However, an institution may choose to allocate the latter positions to the banking book with supervisory approval.

As part of the differentiation criteria, the CRR3 also defines the criteria that must be met for investments in fund units to be allocated to the trading book.

Market risk

While certain institutions are already required to report capital requirements under the FRTB under the current CRR, the CRR3 introduces the FRTB framework as a mandatory standard for calculating capital requirements for market risk. It distinguishes between an internal model approach, which requires supervisory approval, a standardised approach and a simplified standardised approach. The latter calculates the capital requirement for market risk using the current standardised approach to market risk, which is subject to regulatory multipliers.

Capital requirements for CVA risk

The CRR3 replaces the existing approaches for the calculation of CVA risks with three new approaches: the standardised approach (SA-CVA), which is based on an internal model and can only be used with supervisory approval, the basic approach and the simplified approach.

The current exemptions from capital requirements for CVA risks are maintained, but CRR3 introduces a reporting obligation for exempted transactions. In addition, an institution may also decide to include exempted transactions in the capital requirement for CVA risks in order to achieve offsetting against corresponding hedging transactions.

Operational risk

The new standardised approach to operational risk replaces all existing methods. The capital requirement is based on a business indicator. The internal loss multiplier (ILM) based on historical losses proposed in the Basel IV text is not implemented in CRR3. However, institutions will still be required to collect extensive data on operational risk losses.

Conclusion

Given the strong momentum in the development of the regulations and the short time until implementation in 2025, a thorough understanding and regular updates on the latest developments are essential for banks to ensure compliance with the new regulations by 2025.

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