Basel III implementation might have major impact on Banking and Capital Markets Union

Analysis by Gunnar Hökmark, Senior Advisor Kreab & former Member of the European Parliament

This week, the European Banking Authority (EBA) published the first part of its final piece of advice on the Basel III implementation in the EU. This will inform the European Commission decision-making. The advice only touches upon on two out of four issues on which the EBA was requested to provide its opinion i.e. specialized lending exposures (SLEs) and Minimum Requirement for own funds and Eligible Liabilities (MREL). The EBA analysis seems to indicate that the impact of these new requirements will not be insignificant. However, these are not the only new rules that banks would need to comply with as part of the new banking package. The industry is also concerned about the impact of other new requirements such as those on unrated corporates, equity exposures or the application of the output floor, just to name a few. They are all believed to lead to an increase of banks’ capital requirements and ultimately limit their ability to lend and support the economy.

This will have important implications for two of Europe’s core projects in the financial area – namely the Banking and Capital Markets Union.

The opportunities of the Banking Union and an emerging Capital Markets Union are not only related to but dependent on well-functioning banks in Europe and a sufficient amount of capital accessible on the markets. When talking about CMU it is crucial to remember that in Europe the banks supply more than 80% of the total financing to small and medium sized enterprises (SMEs), while the situation in the US is more or less the other way around, namely the capital markets financing the bigger share of SMEs.

So, in reality banks are an instrumental part of what we want to achieve by developing the CMU.

But there is more to it than that. As banks are the dominant part of the capital markets in Europe, there is a direct link to investments in Europe from whatever channel to the amount of capital that banks are required to have. Higher capital requirements on banks will demand more capital from the market, from funds of all kinds, in order to finance banks that are financing the main part of our business life. That’s how things are.

What now will happen with new banking legislation is therefore significant not only to banks or to SMEs but to the availability of capital for the CMU project as such. If banks are to increase their capital in not only a significant but by a substantial level, much more than what is already done, it will undermine the CMU and at the same time hinder the banks from playing there role in today’s economy.

When the European Commission prepares its new banking package it is therefore important that it lives up to the point of departure for the last phase of the Basel III process, which said that it shall not lead to significant capital increases. Current calculations by EBA (from their 2019 assessment) of a potential increase amounting to 24%, sometimes referred to as 20%, cannot in my view be described as just significant – which it should not be, but very substantial – which they absolutely must not be – if we are to honour the agreement.

If the Commission doesn’t tread very carefully here there is a risk that it will undermine the capital markets and the investments we need on their way to establishing the CMU and a more investment-oriented economy.