New Basel banking rules’ impact on European economy

Posted on November 28, 2016

The coming days will be crucial for the future of the European economy. The Basel Committee on Banking Supervision will officially present its final set of proposals on capital requirements for the banking sector, known as the Basel IV framework.

The Basel Committee is targeting the degree of variability in how banks define the risks that ultimately determine their capital requirements. The highly technical nature of this topic should not divert attention from the fundamental question that lies behind the review: how, in the future, will European banks be able finance the economy and hence foster growth and raise employment?

Three points that the Basel Committee does not seem to have taken into account in its assessment need to be stressed.

First, it is important to emphasise that the opposition of European banks to this set of proposals is not down to their supposed readiness to ignore or disguise structural weaknesses. No doubt certain shortcomings still remain, but the vast majority of European banks have significantly reinforced their balance sheet and capital levels since the beginning of the crisis. Moreover, since the adoption of the Basel III rules, all large internationally active banks have met minimum and core equity capital requirements. At the same time, we have seen the establishment of a truly Europe-wide system for bank regulation and supervision, managed collectively by the European Banking Authority, and for the eurozone by the European Central Bank.

Second, there are important differences between the US and European banking sectors. The European economy, unlike that of the US, is largely bank-financed. In fact, more than three quarters of Europe’s businesses and households are today financed by banks.

There are also differences in portfolios and in markets. US banks have tended to keep the riskiest part of their commitments — often also the most profitable — on their balance sheets. Securitisation and deeper financial markets help them to take the remainder off their balance sheets. And they can rely on two government agencies, Freddie Mac and Fannie Mae, to reduce their exposure to residential mortgages. On the other hand, favourable weights for well-rated and well-secured credits have encouraged EU banks to keep these loans on their balance sheets.

Third, it is time to put to rest the idea that the risk-weighted models used by European banks are excessively sophisticated and therefore less reliable. The relatively low risk profile of European banks in comparison to US banks is explained by the high risk discrimination of their portfolios. Moreover, every model in use by European banks has been approved and authorised by both national and European regulators. The desire of the regulators to harmonise existing risk-weighted systems and reduce disparities between different banking systems is understandable. But this should not come at the expense of the European system or disrupt the financing of the real economy.

Beyond a greater impact on the EU banking system and the financing of the European economy due to increases in the cost of lending, the revision of risk evaluation by the Basel Committee could potentially discourage good risk management and well-diversified portfolios. The committee should therefore commit itself to making sure that the final set of proposals will not have a significant impact on the capital requirements for banks in any region.

The European project relies on the capacity of its institutions to bring prosperity and security to the peoples of Europe. While the Basel IV rules and the future of the European economy might seem like two different and separate issues, the reality is that the revision of the present framework for banks’ capital requirements could have very important consequences for Europe as a whole.

The writer is president of the European Banking Federation

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