How the ECB is further developing the German Basel revolution for small banks

What is left for small banks from the anticipation of the liberating blow?

When the German supervisors launched their non-papers on the reform of the capital adequacy regime in August, there was a great deal of excitement. The proposals seemed like a break with the basic principles of the Basel world: for small banks, the risk-weighted capital backing was to be largely abolished and replaced by a single, significantly higher leverage ratio. At the same time, a strict separation of capital requirements for ongoing business operations (going concern) and for resolution (gone concern) was planned. The idea: less complexity and more clarity.

Four months later, the response from the European level is available. The High-Level Task Force on Simplification (HLTF), set up by the ECB Governing Council, has presented 17 recommendations.¹ Its mission: to simplify banking regulation without jeopardising the stability of the system. The result is a reform package that addresses many issues, but remains vague on many ideas, including some of the German ones, and only talks about “possibilities” and “options”.

Simplifying the capital architecture

The HLTF generally recommends a significant streamlining of the capital structure. In future, there should only be two buffers: one that cannot be released and one that can be released. This will eliminate complex overlaps without weakening the supervisory authority’s rights to intervene. The leverage ratio framework will be reduced from four to two elements: a minimum requirement of three per cent and an additional buffer that can be set to zero for smaller institutions. This strengthens proportionality, but does not replace the risk-based requirements.

The role of AT1 and Tier 2 instruments is particularly relevant. The HLTF provides for two options: Either their loss-absorbing capacity is strengthened in the going concern, or they are gradually removed from this pillar – in each case Basel-compliant and capital-neutral.

Greater proportionality for “small, non-complex institutions”

The German non-papers had proposed a radical change to a pure leverage ratio for small banks. The HLTF recommends extending the existing SNCI regime for smaller institutions and introducing harmonised simplifications across the EU. International models such as the small bank regimes in Switzerland, the UK and the US are explicitly cited as examples, where “only one prudential capital stack (LR or RW) is applied, Basel MDA triggers are not applicable and risk modules are simplified or removed. The new simpler regime would be harmonised and calibrated in a more conservative manner, to maintain resilience and ensure sufficient risk coverage”.

Without any concrete formulation, it is also proposed to provide for harmonised, simplified governance requirements and a lower frequency and granularity of the SREP for SNCIs.

Gone Concern: MREL will be simplified, but not abolished

The HLTF is also focussing on simplification when it comes to processing requirements. The European MREL requirements are to be harmonised with the global TLAC standard. In future, MREL will essentially stand alongside TLAC as an institution-specific supplement. The aim is to reduce the complexity of the special European approach without lowering the level of protection. The German demand for a strict separation of the capital stacks is therefore not being met. Instead, interactions are to be limited and scrutinised.

The goal remains: less overlap, more clarity.

Harmonisation and relief in the regulatory reporting

In addition to capital issues, the HLTF also addresses supervisory practice and reporting. More EU-wide regulations are intended to reduce national room for manoeuvre. Stress tests are to be methodically simplified and more closely linked to regular reporting.

The task force wants to significantly simplify the reporting system by harmonising the large number of reporting requirements and avoiding duplicate reporting. It proposes an integrated European reporting system that brings together statistical, regulatory and settlement data. In addition, small errors should no longer lead to resubmissions and Pillar 3 disclosures should be more closely interlinked with the reporting system in order to reduce parallel processes.

Classification: Will the German proposals be taken into account?

The radical abolition of risk weighting and the switch to the leverage ratio for calculating capital requirements for small banks is not an explicit part of the HLTF proposal, but is still an option in the context of the recommendations. Proportionality with structural simplifications and many possible but as yet undefined measures, which are to be implemented more uniformly across the EU, is explicitly emphasised. This does not mean that the relevant German proposals to introduce an LR approach for small banks alongside IRBA and CRSA have been taken off the table, but they have not been specifically finalised either.

The strict separation of capital pools (regulatory and supplementary capital) has not been able to prevail in the proposals, but the complexity of both worlds is to be significantly reduced.

Conclusion

The HLTF brings movement to European regulation – not as a revolution, but as an evolution. The aim for banks should be: less complexity, more clarity, but no compromises in terms of stability. The discussion about the details will characterise the coming months. It is regrettable that the recommendations for proportionality in particular remain so vague. Whether an LR approach will be introduced for small banks will be one of the most exciting questions.