CRR III – Transitional provisions

Banks must take foreseeable regulatory changes into account in their capital planning. The transitional provisions, which significantly mitigate some aspects, are particularly decisive for the impact of the revised Capital Requirements Regulation (CRR III)¹ in the coming years. The transitional provisions relate to the Credit Risk Standardized Approach (CRSA²), in some cases specifically the CRSA for IRBA institutions, which they must calculate as part of the output floor, and the Internal Ratings Based Approach (IRBA³).

With the presentation of the final version on December 4, 2023, it was confirmed that the new rules would come into force on the planned date of January 1, 2025. For some details, the European Banking Authority (EBA) received work orders from CRR III to develop standards that will not, however, change the basic requirements of the CRR.

Transitional rules for equity investments

The most relevant exception is for existing holdings that had a significant influence on the company for at least six years at the time CRR III came into force. Despite its definition in the transitional provisions (Article 495a (3) CRR III), it remains permanent. There is a transitional phase for the equity investments affected by the increase in risk weights, during which the risk weights will be gradually increased to the target level from 2026 to 2030 (see Table 1).

Table 1: Transitional regulation for equity exposures (Article 495a CRR III)

 
As no alternative approaches to the standardized approach will be permitted for equity exposures in future, the new regulation affects CRSA and IRBA institutions equally. For IRBA institutions, the secondary condition applies that they must apply the internally estimated risk weight during the transitional phase until 2029 if this is higher than the respective transitional value.

Transitional regulation for off-balance sheet items

Previously, commitments that could be revoked at any time without conditions were not relevant for the minimum capital regardless of the risk of the counterparty. This will change as a result of the increase in the credit conversion factor (CCF) from 0 % to 10 % under the new CRR. This means that these off-balance sheet positions will in future be included in the exposure for the calculation of risk-weighted assets (RWA) in the amount of 10 % of the committed amount. The specific risk weight is determined by the exposure class, such as retail business or corporates. However, this change will only apply gradually from 2030 (see Table 2).

Table 2: Transitional regulation for revocable commitments (Article 495d CRR III)

 
This is only relevant for IRBA institutions if they do not estimate the CCF themselves anyway, whereby their own CCF models may only be used for revolving exposures (Article 166 (8b) CRR III).

Transitional provisions for the output floor

The regulator is providing for a transitional period for the output floor, which initially allows only 50 % of the minimum capital requirement to be held in the (new) standardized approach using internal models when CRR III comes into force in 2025. Thereafter, the minimum capital ratio will increase by 5 percentage points per year compared to the standardized approach until 2029. From 2030, the final level of 72.5 % will finally come into effect, which equates to a maximum capital saving of only 27.5 % of the standardized approach minimum capital requirement (Table 3), although this may be reduced by 2032 due to further transitional regulations (only for use in the output floor).

Table 3: Transitional regulation for output floor (Article 465 (1) CRR III)

 
In parallel, it applies (only) in the transitional phase until 2029 that institutions do not have to hold more than 125 % of the capital calculated using the IRBA, i.e. the output floor may be reduced (Article 465 (2) CRR III).

Furthermore, the risk weight for the calculation of the CRSA by IRBA institutions for companies that are internally rated with a default rate of no more than 0.5 % (“investment grade”) is set at 65 % until 2032. The risk weight of 100 % will only come into effect in the comparative CRSA from full implementation in 2033 (Article 465 (3) CRR III).

For the counterparty default risk of derivatives, there is a simplification in the calculation of the exposure value of the netting set in the output floor until 2029, in that the alpha value is 1 instead of 1.4 (Article 465 (4) CRR III).

For institutions with a residential real estate portfolio in the IRBA, a transitional regulation will take effect, according to which the reduced risk weight of 20 % for the share of exposure up to 55% exposure-to-value (ETV) will be reduced to 10% by 2032. In addition, the increased risk weight that is due under the new regulation for the exposure amount between 55 % and 80 % ETV is limited to 45 % until 2029 if it is not SME exposure. From 2030, a higher risk weight is gradually applied to the portion between 55 % and 80 % ETV in accordance with Table 4.

Table 4: Transitional arrangement for residential real estate in the output floor CRSA (Article 465 (5) CRR III)

 
There are a few further conditions for this transitional arrangement that will be met in Germany and Austria. For residential real estate in the retail business without SMEs, the risk weight of 75 % will apply from 2033 for the share of exposure of 55 % to 80 % ETV. Residential properties outside the retail business (excluding SMEs), which will have a risk weighting of 100 % from 2033, will also fall under this transitional regulation.

Transitional provisions for new IRBA regulations

For specialized lending exposures, a minimum figure will be applied in future for self-estimated LGD (input floor), which will be mitigated by a factor during the transitional phase until 2029 in accordance with Table 5 (Article 495b CRR III).

Similarly, there is an adjustment factor for the newly introduced volatility adjustment for collateral values of “other physical collateral” (Table 5), which applies in particular to lease receivables (Article 495c CRR III).

Table 5: Transitional regulation for adjustment factors

 
The EBA is given the task of collecting differentiated loss data for specialized lending and leasing positions and the EU Commission is mandated to issue deviating regulations on this basis.

Impacts and conclusion

For revocable open commitments, the new rule that equity must be backed at all will only come into force in 2030 and then only gradually. This gives institutions that do not already estimate the utilization themselves time to reduce the amount of open commitments or to introduce customer-oriented management.

The capping of the output floor at 125 % of the IRBA result until 2029 could avert the greatest hardship for some IRBA institutions. The transitional regulations for IRBA institutions with a large residential property portfolio significantly mitigate the increase in capital requirements that would result without the special regulation until the full introduction of the new CRR in 2033.

The fact that capital backing for revocable commitments will not begin in stages until 2030 will provide relief for retail banks in particular. They should use this time to introduce active management for the amount of credit lines and card limits, which previously had no impact on equity.

msg for banking has already supported several banks in the impact analysis by performing a comparative calculation of capital requirements, taking into account the planned business development and the transitional provisions relevant to them. As the effects of new regulatory requirements must be taken into account in capital planning, every institution should determine the capital requirements for the coming years in a timely manner, taking into account CRR III and its transitional provisions. In view of the fact that the rules are on the table, the supervisory authority is unlikely to show much leniency on this point.