On 3 January 2020, Finance Watch submitted its response to a public consultation held by the European Commission on the implementation of the final Basel III reforms in the EU.
As part of the implementation process of the final set of Basel III reforms in the EU, the Commission services aim to gather stakeholders’ views on specific topics in the areas of credit risk, operational risk, market risk, credit valuation adjustment risk, securities financing transactions as well as in relation to the output floor.
In its response to specific questions of the consultation document, Finance Watch makes the following points:
- Given the cost of financial crises and of banks’ collapses for society, and given the fact that the weighted average cost of capital of banks is a direct function of the quality of their assets and not of their debt-equity mix, regulators should resist all attempts to lower the required levels of capital on pseudo-rational arguments linked to a low probability of default. This is, to a large extent, what the Basel III framework does and it is essential that it be finalised as planned.
- The fact that the Basel III framework does not change the treatment of sovereign exposures creates both a distortion to the proper allocation of capital in the EU and a major financial stability risk.
- The Output floor should be applied at the highest level of consolidation in the EU. Otherwise, it creates an opportunity for the rule to be arbitraged, as banks would have an incentive to combine risky and less risky activities in the same subsidiaries in order to mitigate the effect of the output floor. Furthermore, it could introduce a bias towards certain business models and would have the consequence of contributing to fragment the EU banking market.
- Implementing an Output floor is essential for two reasons: first, it could help restoring a level playing field which has consequences both on competition between banks of different sizes and on financial stability. Second, it could help remedy the deficiencies of the IRB modelling which creates a weakness in prudential measures as modelling has many well known theoretical limits, the first of which being the fact that past behaviour of financial assets or credit exposures is a very imperfect indicator of their future behaviour.
- There does not seem to be any logical reason for implementing both the “transitional 5-year path” for institutions to grow into and adjust to the new requirement and the “transitory cap” that temporarily prevents that risk-weighted assets increase more than 25% because of the Output Floor.
- A green supporting factor would bring no benefit in the short term and would not enhance green or sustainable investments but it would increase in a significant way the risk of a future financial crisis and endanger financial stability.
