Commission announces a package of banking reforms

Publication November 2016


The European Commission has published a number of proposed measures that form part of its work to reduce risk in the EU banking sector, as set out in the Communication Towards the Completion of the Banking Union. The proposals also implement some outstanding elements that have recently been finalised by global standard setters – the Basel Committee on Banking Supervision (BCBS) and the Financial Stability Board (FSB).

The Commission’s proposals consist of draft legislative proposals that amend the Capital Requirements Regulation (CRR), the Capital Requirements Directive IV (CRD IV), the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism Regulation (SRMR). The draft legislative proposals are:

  • proposal for a Directive of the European Parliament and of the Council amending the CRD IV as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures;
  • proposal for a Regulation of the European Parliament and of the Council amending the CRR as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements and amending the European Market Infrastructure Regulation (EMIR) and Annex;
  • proposal for a Regulation of the European Parliament and of the Council amending the SRMR as regards loss-absorbing and recapitalisation capacity for credit institutions and investment firms;
  • proposal for a Directive of the European Parliament and of the Council amending the BRRD on loss - absorbing and recapitalisation capacity of credit institutions and investment firms and amending the Settlement Finality Directive, the Financial Collateral Directive, the Second Company Law Directive, the Directive concerning the mergers of public limited liability companies, the Directive on cross border mergers of limited liability companies, the Directive on takeover bids and the Directive on Shareholders Rights; and
  • proposal for a Directive of the European Parliament and of the Council on amending the BRRD as regards the ranking of unsecured debt instruments in insolvency hierarchy.

Key elements

The key elements of the Commission’s proposals include:

  • a binding 3 per cent leverage ratio (LR);
  • a binding detailed net stable funding ratio (NSFR);
  • a requirement to have more risk-sensitive own funds for institutions that trade in securities and derivatives, following the BCBS’ work on the fundamental review of the trading book; and
  • the adoption of new standards on the total loss absorbing capacity of global systemically important institutions (G-SIIs).

Leverage ratio

The LR is an additional prudential measure that is designed to enhance financial stability by determining capital requirements on the basis of non-risk weighted assets so as to prevent the building up of excessive leverage during economic upswings and to act as a backstop to internal model based capital requirements.

The Commission proposes several amendments to the CRR in order to introduce the LR for all institutions subject to the CRD IV. The LR is set at 3 per cent of Common Equity Tier 1 (CET1) regulatory capital and is added to the own funds requirements in the CRR which institutions must meet in addition to/in parallel with their risk-based requirements. However, the Commission states that since a 3 per cent LR would constrain certain business models and lines of business, further adjustments are warranted. Institutions may reduce the LR exposure for public lending by public development banks, pass-through promotional loans and officially guaranteed export credits. In order not to dis-incentivise client clearing by institutions, institutions are allowed to reduce the LR exposure by the initial margin received from clients for derivatives cleared through qualifying central counterparties.

The Commission’s proposal does not contain a LR buffer for global systemically important banks (G-SIBs) given that international discussions are still on-going.

Net Stable Funding Ratio

The NSFR is the ratio of an institution’s available stable funding relative to the required stable funding it needs over a one-year horizon. The amount of available stable funding is calculated by multiplying an institution’s liabilities and regulatory capital by appropriate factors that reflect their degree of reliability over one year. The NSFR is expressed as a percentage and set at a minimum level of 100 per cent, which indicates that an institution holds sufficient stable funding to meet its funding needs during a one-year period under both normal and stressed conditions.

The BCBS published the NSFR in October 2014. In December 2015, the European Banking Authority (EBA) published a report to the Commission recommending closely aligning the rules of calculation of the EU NSFR with the BCBS’ standards but adopting some adjustments to take into account certain European specificities.

The Commission is now proposing an EU NSFR and in line with the earlier EBA report is making certain adjustments. These adjustments relate mainly to specific treatments for:

  • pass-through models in general and covered bonds in particular, whose funding risk can be considered as low when assets and liabilities are matched funded;
  • trade finance activities, whose short-term transactions are less likely to be rolled-over than other types of loans to non-financial counterparties;
  • centralised regulated savings, whose scheme of transfer renders the client deposits (liabilities) and claims on the state-controlled fund (assets) interdependent;
  • residential guaranteed loans, whose specific characteristics make them similar to mortgage loans;
  • credit unions, whose statutory constraints on investment of their excess of liquidity entail a funding risk similar to that of non-financial corporates for the institution receiving the deposits; and
  • central counterparties not undertaking maturity transformation, whose business model does not imply the type of maturity transformation that the NSFR is meant to address.

The Commission states that the above specific treatments broadly reflect the preferential treatment granted to these activities in the EU liquidity coverage ratio (LCR) compared to the BCBS LCR.

The EU NSFR will apply at a level of 100 per cent to credit institutions and systemic investment firms two years after the date entry into force of the proposed Regulation. The EBA will develop draft implementing standards to harmonise the NSFR reporting requirements and institutions will need to prepare for the new reporting requirements.

Market risk – trading book

In 2009 the BCBS began work on the Fundamental Review of the Trading Book. This work was intended to tackle the remaining problems in the design of the prudential framework for the trading book. The Commission’s proposals are designed to transpose the BCBS’ work into EU law and address the weaknesses of the current market risk capital requirements by:

  • establishing clearer and more easily enforceable rules on the scope of application to prevent regulatory arbitrage;
  • improving risk-capture, making requirements proportionate to reflect more accurately the actual risks to which banks are exposed; and
  • strengthening the conditions to use internal models to enhance consistency and risk-weight comparability across banks.

However, the Commission’s proposals include some adjustments to the BCBS’ work in order to reflect some EU specificities, such as simple, transparent and standardised securitisations, covered bonds and the treatment of sovereign exposures to ensure the consistency of the EU regulatory framework and support the objectives of the Capital Markets Union. The Commission also proposes a phasing-in of the overall level of requirement, to prevent a disproportionate immediate impact on banks’ capital requirements.

In addition, whilst the BCBS standards for market risk capital requirements do not entail proportionality in its application the Commission is proposing that:

  • banks with small trading books (under EUR 50 million and less than 5 per cent of the institution’s total assets) can still benefit from a derogation, which allows them to apply the treatment of banking book positions to their trading book; and
  • banks with medium-sized activities subject to the market risk capital requirements (under EUR 300 million and less than 10 per cent of the institution’s total assets) may use the simplified standardised approach, which corresponds to the existing standardised approach.

Banks will have to apply the new rules two years after the entry into force of the proposal. Until then, banks will calculate the market risk capital requirements according to the existing rules under the CRR. Once the proposal is in force, the requirements will be phased-in over three years during which banks will be allowed to multiply their own fund requirements for market risks by 65 per cent. This multiplier will not apply to the own funds requirements for market risks when banks use the simplified standardised approach to calculate them.

Large exposures

In line with the BCBS standards published in 2014, the Commission proposes to amend the EU large exposures framework to improve the quality of capital that can be taken into account to calculate the large exposures limit, to introduce the lower limit of 15 per cent for G-SIBs exposures to other G-SIBs and to impose the use of the methods under the standardised approach for measuring counterparty credit risk (SA-CCR) for determining exposures to over-the-counter derivative transactions, even for banks that have been authorised to use internal models.

Pillar 2

To enhance legal certainty the Commission proposes to better clarify the conditions for the application of the Pillar 2 capital add-ons stemming from the CRD IV. In doing so, it distinguishes between Pillar 2 capital requirements and guidance:

  • the former being mandatory requirements that are imposed by supervisors to address risks not covered or not sufficiently covered by Pillar 1 and buffer capital requirements; and
  • capital guidance refers instead to the possibility for member state competent authorities to communicate to an institution their expectations for such institution to hold capital in excess of the Pillar 1 capital requirement, Pillar 2 capital requirements and combined buffers’ requirements in order to cope with forward looking and remote situations.

Financial holding companies

The Commission proposes a new requirement in the CRD IV for establishing an intermediate EU parent undertaking where two or more institutions established in the EU have the same ultimate parent undertaking in a third country. The intermediate EU parent undertaking can be either a holding company subject to the requirements of the CRR and the CRD IV, or an EU institution. The requirement will apply only to third-country groups that are identified as non-EU G-SIIs or that have entities on EU territory with total assets of at least EUR 30 billion (the assets of both subsidiaries and branches of those third country groups will be taken into account in the calculation).

Waivers from capital and liquidity

With the establishment of the Single Supervisory Mechanism (SSM) the Commission feels that group supervision has been substantially reinforced especially where group entities are situated in member states participating in the SSM.

The Commission proposes that where the same member state competent authority supervises parents and subsidiaries established in different member states participating in EU Banking Union, it should be able to waive the application of own funds and liquidity requirements. The Commission states that this waiver could be applied only where the parent guarantees to support the cross border subsidiaries for the full amount of the waived requirement and where that guarantee is collateralised for at least half of the guaranteed amount, with collateral governed by the law of the host member state. The same waivers are made available, as an option, for competent authorities of member states outside EU Banking Union.

Exempted entities

The CRD IV currently contains a list of entities that have historically been exempted from its scope. Whilst the Commission will maintain this list of exclusions, it is proposing to replace the current implementing power with a delegated power allowing it to exempt further entities where specific criteria are fulfilled. The Commission will assess on a case-by-case basis whether the criteria are fulfilled. Should any institution no longer fulfil the criteria, the Commission will have the power to decide if it should be brought back into scope of the CRD IV / CRR.


The Commission proposes to incorporate the total loss absorbing capacity standard (TLAC) into the minimum requirement for own funds and eligible liabilities standard (MREL). It also proposes to make certain targeted adjustments to banks that are not G-SIIs.

The Commission proposes to introduce a minimum harmonised MREL requirement applicable to G-SIIs only. Currently, 13 banking groups in the EU have been identified as G-SIIs. However, the requirement to comply with TLAC will not be extended to non G-SIIs on the basis that in the EU banks already have to comply with the bank-specific MREL provisions stemming from the BRRD.

It is also proposed that in line with the FSB TLAC standard, resolution authorities should be able, on the basis of bank specific assessments, to require that G-SIIs comply with a supplementary MREL requirement (a Pillar 2 add-on requirement). Such a Pillar 2 MREL requirement would be strictly linked to the resolvability analysis of a given G-SII and, in particular, its loss absorption and recapitalisation needs and, be justified, necessary and proportionate. Banks will also be allowed to use certain additional types of highly loss absorbent liabilities to comply with their Pillar 2 MREL requirement as long as bail in of such liabilities in resolution would not result in a treatment of creditors that is worse in comparison to their treatment under insolvency.

In line with the approach underlying the TLAC standard, the Commission’s proposal deals with entities belonging to a banking group in two different ways, depending on the resolution strategy:

  • an external MREL requirement is applicable to resolution entities (the entity to which according to the resolution strategy, resolution tools, including bail in instruments held by external creditors, will be applied); and
  • an internal MREL requirement is applicable to subsidiaries which are not resolution entities and allows to ‘upstream’ their losses to resolution entities without the need to place such subsidiaries in resolution.

Bail in

The Commission’s proposals also seek to revise the bail in rule contained in Article 55 of the BRRD so that it can be applied by member state resolution authorities in a proportionate manner. Member state resolution authorities would be allowed, for liabilities not counting towards MREL, to grant a waiver from compliance with the rule for certain types of liabilities where it is determined that it is legally, contractually or economically impracticable for banks to include the bail-in recognition clause and that such waiver would not impede the resolvability of the bank. However, it remains at the full discretion of the member state resolution authority whether it actually grants such a waiver.

Creditors’ hierarchy

The Commission’s proposals include an EU harmonised approach on subordination that would enable banks to issue debt in a new statutory category of unsecured debt available in all member states which would rank just below the most senior debt and other senior liabilities for the purposes of resolution, while still being part of the senior unsecured debt category. The new approach will not affect the existing stock of bank debt nor its ranking in a member states’ national insolvency regime and will apply to any new issuance of bank debt in the concerned category following the date of application of the proposal.

The Commission’s proposals also include a regulated moratorium tool that allows for the suspension of certain contractual obligations for a short period of time in resolution as well as in the early intervention phase.


The Commission is proposing several amendments to the CRR and CRD IV to enhance proportionality and reduce costs on institutions in the overall regulatory reporting framework. In particular, it is proposed that the CRD IV be amended to set out the precise grounds on which member state competent authorities will be entitled to require additional reporting from institutions.


The Commission points to a recent review of the remuneration rules which noted, in particular, that the requirements to pay out part of variable remuneration in instruments and defer the payment over time, are not workable for the smallest and least complex institutions and for staff with lower variable remuneration. In addition, the review found that the definition of proportionality reflected in Article 92(2) of the CRD IV have been interpreted in different ways by member states. The Commission proposes amendments that will exempt small and non-complex institutions and staff receiving low variable remuneration from the rules. The Commission also proposes another amendment to the remuneration rules that would allow listed institutions to use share-linked instruments for meeting the CRD IV requirements.

SMEs and infrastructure

The current capital reduction of 23.81 per cent for an exposure to an SME, if it does not exceed EUR 1.5 million is maintained. In relation to an SME exposure exceeding EUR 1.5 million, a 23.81 per cent capital reduction for the first EUR 1.5 million portion of the exposure and a 15 per cent reduction for the remaining part of the exposure above the threshold of EUR 1.5 million is proposed.


International Financial Reporting Standard 9 (IFRS9) has been endorsed in the EU for mandatory application from January 1, 2018 onwards. The Commission notes that the most significant impact of the new standard is the change from an incurred credit loss approach to an expected credit loss approach. As the impact on the level of provisions and capital ratios can be significant, the Commission proposes a 5 year phasing-in period to prevent any unwarranted impact on capital ratios.

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