CEPS study: Finnish banks’ capital requirements could rise substantially

According to a study published by the Centre for European Policy Studies (CEPS) on 1 July, the implementation of final Basel III framework could significantly increase banks’ capital requirements in the EU, including Finland. To avoid weakening their key solvency  figures, banks would have to increase their capital by almost 400 billion euros. Alternatively, banks could reduce their lending or otherwise adjust their operations. Increased capital requirements conflict with the objectives set for the final Basel III reform, and the implementation of the standards should be considered carefully.

The Centre for European Policy Studies (CEPS) has published a study on the finalisation of the Basel III framework in the EU. The Commission is currently preparing legislative proposals, which are expected to be submitted next autumn. As seen in the study, the way regulations are implemented plays a major role in how they affect banks and thus the surrounding economy. The study was commissioned by Finance Finland (FFI), Swedish Bankers’ Association and Finance Denmark.

The Basel Committee has developed the Basel III framework in stages. In the first phase, about 10 years ago, emphasis was on the amount and quality of banks’ solvency capital. These regulations have already been implemented in the EU.

The last phase of Basel III implementation concerns the measurement of the risks of banks’ receivables, i.e., the calculation of risk-weighted assets. The most important aspect of the new rules is the introduction of output floor, which sets a limit on the extent to which the banks’ internal risk models affect risk calculation and therefore the capital required from banks. The output floor also reduces sensitivity to different risks in the calculation.

According to the CEPS study, the new rules would increase the capital requirements of European banks by an average of 18%. The increase is greatest in countries where internal risk models are widely used, and Finland is one of them. To avoid weakening their key figures, banks would have to increase their capital by as much as EUR 400 billion.

“An increase of this magnitude does not align with the Basel Committee’s mandate at all. The precondition for the reform was that capital requirements will not increase significantly”, notes Veli-Matti Mattila, director and chief economist at FFI.

According to CEPS, the output floor would mainly affect banks in countries with low levels of non-performing assets and good recovery capacity. This is unlikely the intention, and therefore CEPS proposes that the application of the output floor should be based only on the capital requirements included in the Basel framework. This would significantly reduce the increase in capital requirements and the need for banks to reduce lending or otherwise adjust operations. Additionally, according to CEPS, supervisors should assess the extent to which the current buffer requirements need to be revised in light of the new regulation. CEPS recommends that authorities closely monitor the effects of the new regulation and mitigate it if it  becomes a burden to the real economy.

“The implementation of final Basel III standards is an important event for Finnish banks. Depending on way it is done in the EU, it could have a major negative impact on the banks and their ability to finance their customers, and the CEPS study confirms this. Moreover, implementation should acknowledge the supervisory measures that have already been taken, which have achieved some of the objectives set for the new regulation. I urge the authorities and policy-makers to take this into account when they decide on the method of implementation”, Mattila concludes.

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Financial and Prudential Regulation

Veli-Matti Mattila

Director, Chief Economist