Pauline Pelissier Director - Financial Services Consulting - London
On 29 May 2019 the European Banking Authority (EBA) published its latest Annual report detailing its achievements over the past year and outlining its priorities for the months ahead. Our synopsis below, gives an overview of the 140-page report, some of the key regulatory issues tackled in 2018, and what is on the horizon for the upcoming year.
Basel III framework
Following the European Commission’s Call for Advice in 2018, the EBA started working on the impact of the revised Basel III framework. The conclusion of this work will be submitted to the European Commission (EC) in September 2019. A report published in October 2018 on the Basel III monitoring exercise performed by the EBA, showed that the banks in the sample continue to meet the Basel III risk-based capital minimum Common Equity Tier 1 (CET1) requirement, and the Basel III's Liquidity Coverage Ratio (LCR) is steadily increasing and will reach 100% in 2019.
Benchmarking of internal models
The Agency also reported on its continued work on the repair and benchmarking of internal models. After its annual supervisory benchmarking of internal models’ exercise, whose goal is to identify outliers in the calculation of risk-weighted assets (RWA), the EBA issued horizontal reports summarising the findings for credit risk and market risk (those were published in the updated Implemented Technical Standards - ITS). For the first time, the Credit Risk Report contained results for both high default portfolios (HDP) and low default portfolios (LDP). The goal of the study was to assess the overall level of variability in RWA, and the findings indicated that a high share of variability can be explained by measurable features of institutions’ exposures. The Market Risk Report pointed to a noticeable improvement in the data quality following the simplification of the benchmark portfolios. The findings indicated that different levels of risk were quantified for different types of products, interest rate instruments exhibit the lowest level of dispersion, and variability increases with the complexity of the risk methods.
Development of new legislation and frameworks
The EBA plays a central role in ensuring effective and consistent prudential regulation and supervision across the European banking sector, while monitoring the implementation of a harmonised regulatory framework in Europe. As part of these responsibilities, the EBA participates in the ongoing development of the Capital Markets Union Action Plan, promotes an efficient and coordinated crisis management of resolution in EU, and supports the implementation of Pillar II in Europe (Table 1).
New international accounting standards – IFRS 9 – Financial Instruments
The EBA has been closely following the implementation and impact of the new international accounting standards - IFRS 9 - Financial Instruments, which came into effect on 1 January 2018. Among other things, the new standards introduce the lifetime Expected Losses. The EBA issued a report in December 2018, which is based on actual data, and provides preliminary observations with a focus on the impact on CET1 and Level of provisions. The report highlighted the fact that banks using an internal ratings-based (IRB) approach experienced a significantly smaller average negative impact on CET1 than banks predominantly using the standardised approach. This was mainly attributed to regulatory differences – for IRB banks, recurrently expected losses were already reflected in CET1.
Non-performing and forborne exposures
Last year non-performing and forborne exposures continued to be a portion of the EBA’s policy work – as part of the agency’s role to secure stability, integrity, and transparency in the EU Banking sector. Hence Guidelines on the management of NPLs and NPEs were issued in October 2018 and will enter into force on June 30, 2019. Guidelines on disclosure of non-performing and forborne exposures came out in December 2018 – as a response to the 2017 EC Action Plan to tackle NPLs in EU.
Asset quality continues to improve, driven by a reduction in NPL stocks in high-NPL countries, while profitability remained the critical concern for the banking sector – with increasing competition, low margins, and the emergence of FinTech firms challenging the banks' income streams.
In 2018, the EBA published a FinTech roadmap – a Fintech Knowledge Hub enhancing knowledge sharing and fostering technological neutrality in regulatory and supervisory approaches. Its priorities are regulatory perimeter, emerging trends, consumer issues arising from FinTech, supervisory practices on cybersecurity, and money laundering/terrorist financing risks. The Money Laundering/Terrorist Financing (ML/TF) framework was developed between EBA, ESMA (European Securities and Marker Authorities), and EIOPA (European Insurance and Occupational Pensions Authority). It aims at improving the supervision effectiveness across the EU and strengthening cooperation and information exchange between National Competent Authorities (NCAs) – domestically and internationally. AML-specific issues are due to be reflected in the FinTech roadmap in the future.
The EBA’s opinion issued in June 2018, not only outlined the risks that could appear due to the lack of preparedness by financial institutions, but also advised the establishments to consider and prepare for possible mitigations, and contingency plans. The agency also requested the competent authorities to engage with the financial institutions to provide clear information to customers who might be affected. While the EBA is not involved in the political negotiations, it is working on the preparations for the post-Brexit cooperation between supervisors, resolution authorities, and the UK authorities. Following its own recommendation, the EBA moved its seat from London to La Defense, Paris on 3 June 2019
The areas outlined above are all still on the table in 2019. Preparing the EU financial sector for Basel III implementation, following through the IFRS9 application, tackling NPLs, will all require continuous efforts from the agency and the other supervisory institutions in the EU. The Capital Markets Union Action Plan is still being developed, as well as the Pillar 2 Roadmap.
In the months to come, the financial industry should be on the lookout for the new EBA’s guidelines on loan origination and monitoring, which will present improved underwriting standards for new loans in EU. Also, in September 2019 the EBA is expected to submit with the EC the conclusion of its analysis on the impact and implementation of the revised Basel III framework in the EU. The goal for the agency is to formulate empirically-grounded recommendations on the role of historical losses in the calculation of regulatory capital for operational risk, the role of external credit ratings in the calculation of regulatory capital for credit risk, the treatment of exposures to small and mid-sized enterprises and the implementation of aggregate output floor.
As the developments evolve, the EBA – just like the rest of the European financial authorities, will follow it carefully and urge the financial world for preparedness.
Financial innovation and technology
New and borderless technologies, which are steadily and bluntly modifying the financial industry as we know it, highlight the need for supervisory and regulatory consistency. As part of its goal to better understand financial innovation, in 2019, the EBA aims to establish an “innovation radar” to identify and track a broad range of financial innovations. Through the feedback received from three key stakeholders, the EBA will offer a rounded report informing the industry and the competent authorities of trends, as well as the risks and opportunities they might represent. A thematic report on Big Data will be published later in 2019, outlining the efforts and work done by the EBA to better understand the use of big data by EU financial institutions and to identify areas of necessary supervisory attention, potential shortcomings and best practices. The agency will continue the monitoring of crypto-asset activities of banks and supporting the NCAs in their efforts to do the same, through the development of a common template in 2019.
The EBA had a busy agenda in 2018 and does not intend to slow down for 2019. While some challenges are being overcome with the convergence of supervisory practices (Basel III), others are new and require deeper analysis and new action plans to be built. FinTech and sustainable finance are the new factors stirring the world of financial regulation. The changes in these fields are often quick, with consequences that could be difficult to predict. Ultimately, banks should be keeping a close eye on developments in these areas and the resulting new regulations in order to stay buoyant in the fast-changing financial industry.
For reference: Table 1 EBA contribution to EU financial legislations 2018
Capital Markets Union Action Plan
Crisis Management of Resolution
Pillar 2 roadmap in EU
By Meglena Grueva, Mazars Frankfurt
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