Strict implementation of final Basel III reforms in the EU may weaken economic outlook

The final Basel III capital requirements package still needs work before its implementation in the EU is realistic. An impact analysis by Copenhagen Economics concludes that the planned implementation would involve significant increases to capital requirements in contrast to original objectives. This would undermine the EU’s standing in global banking and capital markets. The analysis was requested by the European Banking Federation (EBF).

The overarching, commendable aim of the Basel accord is to make banks more stable and secure. The regulatory framework is the work of the Basel Committee, which is made up of G20 central banks and regulatory authorities. The framework is to be transposed into local law in the economies party to the accord, including the European Union and the United States.

At the heart of Basel III is the requirement that a bank must have enough capital to match the bank’s risks in the event that they materialise. Copenhagen Economics recommends ways in which the negative impact of the new regulation can be better balanced without needing to deviate from the original accord.

The analysis recommends, for example, changing the planned EU implementation of the new framework. One of the revisions introduced in the framework is the new capital floor for banks.

“The revised calculation of risk-weighted assets will lead to a substantial increase in their amount for many banks. Capital buffers are already comparatively high in European regulation, which means that capital floors will also rise higher in the EU region than elsewhere”, Olli Salmi explains. Salmi is Head of Banking Regulation at Finance Finland.

This means that capital requirements would be stricter in Europe than in the rest of the world.

The legal instruments produced in the Basel Committee are the result of compromises reached by the negotiators, among which Central Banks have a high representation. In light of the impact analysis it would appear that other trade areas, such as the United States, have succeeded in pursuing their own interest and the result guarantees them competitive advantage over European businesses in the European market.

“Overall capital requirements should not significantly increase if we follow the original aims of the final Basel III accord. The calculations cited by Copenhagen Economics show that while the revisions would barely increase or even decrease capital requirements in the United States and the rest of the world, in Europe capital requirements would increase by as much as 24 percent”, Salmi says.

Furthermore, the Basel III negotiations did not duly consider the specificities of European markets for example in housing finance. EU legislators should understand that taking these specificities into account would not endanger compliance with the original accord.

The Copenhagen Economics report also shows that many of the new elements miss the mark on Basel III’s original purpose. Many of the already existing, working practices have been tossed aside in the final framework.

“EU banking authorities already use methods that will enable us to reach the overarching aim of the Basel reform. Even now, ECB’s targeted review of internal models ‒ or TRIM ‒ is realising the aims better than what is proposed in the Basel reform”, Salmi notes.

The Copenhagen Economics report concludes that the reform may even end up weakening the economic outlook in Europe without producing any considerable benefits. So far the EU’s official position regarding the implementation of the framework may have been a political necessity and also due to there being no analytical data on the reform in question. However, such information is now available.

“Now that politicians and authorities can finally begin to work on the reform, we hope they will heed the conclusions and recommendations of the study. It is still possible to implement the proposed revisions so that they genuinely benefit banks’ stability while also minimising the damage to European economies”, Salmi concludes.


Read the full report here


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Financial and Prudential Regulation

Olli Salmi

Head of Banking Regulation